LONDON (Reuters) - Rising price, tightening time spreads and plunging warehouse stocks. The Shanghai Futures Exchange (ShFE) lead contract is showing all the signs of a classic bull market.
There is plenty of evidence to suggest that the futures market is accurately reflecting acute stress along the length of the country’s physical supply chain.
Within a tightening global raw materials market, China’s lead production sector has come in for particular scrutiny as Beijing wages war on industrial pollution. And the stresses could become more acute as China loses an important source of raw materials from North Korea as part of its commitment to international sanctions.
It’s a starkly different picture to that on the London Metal Exchange (LME), where stocks and time spreads are still at comfortably relaxed levels and money managers are short.
(For graphic on Shanghai Futures Exchange lead price, open interest and stocks, click: tmsnrt.rs/2xNhdWJ)
ShFE lead stocks were 16,568 tonnes at the end of last week, down 80 percent from a May peak of 83,622 tonnes and the lowest since March 2016.
The historical comparison needs to be put into context, since the Shanghai contract was a low-key, low-volume market until the fourth quarter of last year.
Low and falling inventory has flipped Shanghai time spreads into backwardation, with nearby months trading at premiums to next-dated months all the way through to April next year.
Both price and market open interest are at their highest since last December, a record-breaking month for the Shanghai lead contract after its 2011 launch.
Back then it was only one of several commodity markets to experience the gale-force impact of China’s “flash” investment crowd. But what is noticeable this time is that volumes, though spiky, are nowhere near the levels during the December bubble.
That suggests lead is not on the retail investment radar right now, or at least only dimly lit.
Rather, the signals from the futures market, particularly the dramatic drawdown in inventory, point to a genuinely tight physical market.
The first sign of stress in the sector came from the country’s trade figures.
China began importing refined lead in significant quantities in February. Cumulative imports through July were 59,000 tonnes. That may not sound like much, but it’s the strongest pull on the international market since 2009.
The country’s smelters were already struggling with falling availability of mine concentrates, part of a global squeeze at the start of the lead supply chain. Imports of concentrate slumped by 26 percent last year and are down another 2 percent this year.
Then came the inspections.
Beijing has teams of inspectors fanning out across entire industrial supply chains to check environmental performance and to close “illegal” capacity.
Industrial metals are one of Beijing’s prime targets and lead, a metal associated with toxicity, seems to have come in for special treatment. Mines, smelters and lead-acid battery makers have all come under scrutiny.
“This year domestic environment inspections have reached their most severe period in history,” says Antaike, the research arm of the China Nonferrous Metals Industry Association.
It estimates that the crackdown has led to the closure of about 80 percent of “illegal” secondary smelters, meaning those using scrap as feedstock.
“Illegal” is a word with a rapidly lengthening list of definitions for Chinese environmental inspectors. But if it means a completely unauthorized black market operation, it also means that the plant’s production was never counted in the official figures.
What is being closed, in other words, is statistically unknown; an invisible but expanding hole in the country’s already stressed supply chain.
Another crack in the chain has opened in the form of a technical failure at the 100,000 tonne-per-year smelter in Liaoning province operated by Haicheng Chengxin Nonferrous Metal Co.
It is now expected to close for a month of repairs, bringing forward a planned maintenance scheduled for the end of October.
Haicheng Chengxin also happens to be the main buyer of North Korean lead concentrates. Its smelter is only 140 miles (230 km) from the border.
Official imports of North Korean material totaled 108,000 tonnes (bulk weight) last year and jumped by 45 percent over the first seven months of this year.
Indeed, North Korea has been China’s second-largest supplier of concentrates by volume this year. Its share has risen as availability from other traditional suppliers has dwindled.
Haicheng Chengxin says it will switch to domestic mine supply, but in doing so it will add further pressure to a sector in which output slid by 4.3 percent in the first seven months of the year, according to Antaike.
While the Shanghai lead market bubbles, London remains flat.
LME three-month metal has just clawed its way back above $2,400 a tonne after slipping to $2,257 early this month.
Time spreads are in relaxed contango with cash metal’s discount to the three-month price valued at $25.75 a tonne at Monday’s close.
LME lead stocks experienced an early-year raid but have since stabilized. At a current 162,700 tonnes, they are down by 32,200 tonnes, or 16.5 percent, this year. However, last week’s inflow of 17,050 tonnes, largely at Antwerp and Rotterdam, suggests a lack of physical market tightness.
Money managers are still playing this market from the short side, says LME broker Marex Spectron.
It estimates that lead is the only major LME metal to exhibit a net speculative short position, albeit to the fairly marginal tune of 1.4 percent of open interest.
Lack of bullish interest may reflect the much-loved LME play of trading lead and zinc as a relative value pair, with lead playing the role of ugly sister.
Funds have bought into the zinc bull story but have shied away from lead, at least partly because of its lack of coherent statistical narrative.
The problem is the lack of visibility on lead’s all-important scrap dynamic, an issue that in China is compounded by the broader unreliability of metals production figures.
The Shanghai market, however, is very visibly signaling growing stress in the statistical void that is the country’s lead supply chain.
(The opinions expressed here are those of the author, a columnist for Reuters.)
Editing by David Goodman