| NEW YORK, July 16
NEW YORK, July 16 With the latest proposal to
remake rules for storing metal at London Metal Exchange
warehouses, a four-year "long squeeze" is yielding, for the
moment, to a short squeeze.
Aluminum traders scrambled last week to buy prompt metal,
shrinking the gap between immediate prices and higher rates for
next year to near the narrowest in years, a move traders said
was the first sign that an overhaul of the LME's vast
warehousing network might have unintended consequences.
The buying was sparked by fears that the new rules, aimed at
easing wait times of up to a year in five key locations across
the globe, could in fact limit the amount of metal that storage
facilities would be willing to accept. The rules were announced
on July 1, but might not come into force until next April
following several months of consultation.
It was also fueled by the realization that some major
warehousing firms, owned by Wall Street banks such as JP Morgan
Chase & Co and traders such as Glencore Xstrata Plc
, have quietly suspended offering financial incentives
to store metal as they calculate the impact of sweeping reforms.
Suddenly, after years in which metal was flowing easily into
warehouses, but slowly out of them, the reverse is true. Now,
dealers fear they might not be able to get enough metal into the
LME network to deliver it against expiring short positions.
Traders raced to buy nearby contracts and simultaneously
sold later ones, effectively borrowing the metal for that period
of time to cover the risk of short-term delivery.
"Off-exchange metal that was going to be warranted between
July 1 and March 31 next year may not be able to be warranted
now, so people borrow the spreads and it's definitely happened.
The first reaction was to borrow Dec-Dec," said a London-based
Buying December 2013 and selling December 2014
cut the spread nearly in half to $58 per tonne on
Monday, the narrowest since it hit a record in February. It
stood at nearly $99 a tonne at the end of June.
Some have downplayed the issue, saying traders will always
find a home for the metal in the LME's over 700 facilities in 36
locations. But they also acknowledge that delays in getting the
metal there might cause temporary backwardation, when nearby
prices are at a premium to far forward.
The warehouse reforms are the exchange's boldest approach
yet to a problem that plagued outgoing chief executive Martin
Abbott for four years and threatened the reputation of the
136-year-old exchange - a logjam of metals attempting to leave
It is the first effort since the LME was acquired six months
ago by the Hong Kong Exchanges and Clearing Ltd(HKEx),
which has pledged to answer complaints from industrial clients
that they are paying excessive premiums for prompt metal, while
waiting as long as a year to take delivery off the LME.
The proposal's most significant element would be to link the
minimum rate at which a warehouse with big stockpiles and long
wait times - more than 100 days - is required to load out
material to the rate at which it brings in new metal.
For instance, until now, warehouses with 900,000 tonnes were
required to load out metal at a minimum rate of 3,000 tonnes per
day, regardless of how much metal was delivered into the
warehouse. Under the new rule, if a warehouse accepts an average
of 3,000 tonnes a day, then its minimum load out rate would be
that amount plus another 1,500 tonnes, a total 4,500 tonnes.
In outlining its proposal, the LME warned it might have a
warping effect on the market at times by incentivizing some
warehouse companies to limit the in-flows of new metal, since it
would then be required to load out metal more quickly.
"As a default is not an option on the LME, backwardated
markets may be artificially exacerbated or created as shorts
seek to delay delivery on-exchange," it said. "Therefore,
potentially, this policy could itself unintentionally create an
artificial supply and demand dynamic in LME markets."
Even so, the abrupt market reaction surprised traders since
the proposals are months away from being implemented. The spread
action is possibly one of the "most serious and perhaps least
recognized implications" of the change, Barclays analysts said.
In the long term, the changes will depress aluminum
premiums, the price paid on top of the LME for physical
delivery, which are at record highs, even though the market is
in chronic surplus. LME stocks are close to records above 7
million tonnes, with as much metal estimated to be stored in
financing deals off the exchange. So far, there is no indication
of that happening. Premiums are still at over 11 cents a pound , up from less than 3 cents per lb in 2008.
LME spreads are likely to gyrate even more wildly in the
coming months as traders work out how best to proceed.
"This isn't something that's going to go away. In the
meantime, the warehouses are on the sidelines wondering if or
when something will happen," said a second London-based trader.
It also means the likely end of a booming business model for
the companies that own warehouses, charging rent for storage
while also limiting the amount of metal that can be shipped out.
Traders say the move will most directly affect three
warehousing companies. They are Pacorini, owned by Glencore
Xstrata; Metro operated by Goldman Sachs Group Inc ; and
NEMS run by Trafigura in four locations with queues longer than
100 days - New Orleans and Detroit, Johor in Malaysia,
Vlissingen in the Netherlands and Antwerp in Belgium.
The sheds with lengthy queues are holding back from making
new offers for storage as the owners assess the "complete
reengineering" that might be required, a market source said.
The stand-off is likely to be only temporary and warehouses
will tout business again soon, but the outlook will be vastly
different. Their appetite for metal will be lower because they
will be restricted on the size of the queue they can create to
100 days. That will rein in the size of payments, known as
incentives, doled out to attract metal.
The market source calculated incentives might plunge to $50
to $60 per tonne for a 100-day waiting time, about a fifth of
the current $250 per tonne paid for aluminum in Detroit, where
Metro dominates capacity.
"Everyone in the industry from the truck drivers, port
operators to the producers is interested in how this works and
the consequences for them," source said.