Supply the differentiator for base metals in first quarter: Andy Home

LONDON (Reuters) - After last year’s collective slump base metals showed signs of bottoming out over the first three months of 2016.

Aluminium ingots are seen outside a warehouse that stores London Metal Exchange stocks in Port Klang Free Zone, outside Kuala Lumpur, March 23, 2015. REUTERS/Olivia Harris

The London Metal Exchange (LME) index touched a six-year low of 2,049.0 in January but closed March out at 2270.9.

Even the worst performer among the LME’s major contracts, lead, ended the quarter down by just 2.3 percent.

The two best performers were tin and zinc, both up almost 16.0 percent, a double manifestation of the current overriding narrative in the industrial metals world.

With all the base metals reeling from the shock of slowing demand growth in China, the differentiator of price performance right now is supply.

(Graphic on relative price performance on the LME:


The reason tin and zinc were the out-performers in the first quarter is down to faltering supply in both markets, a clear and present danger for tin, a looming threat for zinc.

The LME tin contract, the smallest and least liquid of the core metals traded on the London market, has been plagued by low stocks and tight spreads for much of the last three months.

The benchmark cash-to-three-months period flexed out to $220 per ton backwardation in late February.

That has sucked some metal into the LME warehouse system but at a current 4,810 tonnes, registered inventory is still down 14 percent on the start of the year and cash was still commanding a modest $29 premium as of Thursday’s close.

As ever with tin, this is all about Indonesia, the world’s largest exporter of the soldering metal.

Exports slumped by 45 percent over the first two months of 2016, largely due to yet another tightening of the regulatory screw on the hub of independent producers operating on the Bangka and Belitung islands.

Exports should recover over the coming period but that low level of LME stock is indicative of a market facing structural supply issues.


Zinc bulls are pinning their hopes on similar structural supply issues resulting from the closure of some of the world’s biggest mines.

There is tangible evidence the raw materials supply chain is starting to tighten, even if there remains considerable uncertainty as to when that will feed through into metal availability.

But with tin too small a playground for the market’s bigger players, zinc is the best bullish supply story in town.

Encapsulating the high hopes for this market was a report issued this week by Leon Westgate, analyst at ICBC Standard Bank.

“Refined deficits of 550,000 tonnes in 2016 and 660,000 tonnes in 2017, representing nearly 5 percent of refined consumption, will rapidly destock the zinc market and will provide the foundations for zinc to reach record high prices in the next 24 months.” (“Zinc - the Revenant”, March 30, 2016).

The previous record high was $4,580 all the way back in 2006, which still looks a long, long way up from the current price of $1,850.

Zinc has, however, re-established a premium over sister metal lead, the laggard of the LME base metals pack.

This is partly seasonal. Lead is moving out of the period of seasonally strong winter demand for replacement automotive batteries.

But it may also partly reflect the conflicting signals emanating from LME stock movements.

These have been distorted by a long-running battle for units between warehouse operators. The resulting loss of visibility on the real state of the physical lead market has not been helped by a still-to-be clarified reporting error in LME stocks held at the Dutch port of Vlissingen.


Copper was the third-best base metals performer of the quarter with gains of around 5.0 percent.

It was doing better until a week or so ago when the Shanghai Futures Exchange (SHFE) contract started coming under renewed bear attack, a running feature of the copper market for many months.

Chinese investors may well take a negative view of copper’s prospects given the huge build in SHFE stocks this year. Even with a sharp drop over the last week, they have still more than doubled to 368,725 tonnes.

LME stocks, by contrast, are low and still falling. Open tonnage, meaning that not earmarked for physical load-out, is hovering around two-year lows and front-month spreads are tightening accordingly.

The cash-to-three-months spread ended March valued at $32 per ton backwardation, the tightest the period’s been since August last year.

Is this market in feast or famine? Rather confusingly, it appears to be showing symptoms of both depending on where you look.


No such doubts as to either the nickel or aluminum markets. Both are burdened by high stocks and excess production.

Nickel’s supply side has proved curiously inelastic to low prices with most producers hanging on in there in the hope that Chinese nickel pig iron (NPI) producers will close first.

China’s NPI sector is being squeezed by low prices and low availability of the nickel ore it uses as a raw feed and there is mounting evidence that run-rates are now steadily declining.

The problem is that supply everywhere else is running too strong and stocks are still building, particularly in Shanghai.

Even if the global market does move into deficit, it will take a long time to translate into tangible tightness.

Such considerations explain why the LME nickel price is doing no more than tread water at its current bombed-out levels. It ended the quarter flat on where it started at $8,500.

Aluminum fared better with a 3.0 percentage gain after a run-up over the last half of March.

That may have been a reaction to a strong rally in Shanghai, itself a possible sign of improving dynamics in China, the source of the global market’s problems of excess capacity and over-production.

Chinese production appeared to drop sharply over December and January which would help explain the strength of the local rally in prices.

But everyone’s wary of Chinese production figures around the end of the year, both calendar and lunar, and those for February remain conspicuous by their absence.

The LME market itself, meanwhile, has been more about spreads than outright prices. The latest spasm of tightness has passed but the aftermath is still playing out in the form of massive cancellations of LME stocks prior to physical load-out.

This metal is largely on its way to cheaper off-market storage and as it moves, at the new faster rates stipulated by LME rules, the store of available tonnage in LME warehouses is going to tumble sharply.

Another bout of spread contraction looks to be just a matter of time.

If so, it will merely extend the contradiction sitting at the heart of the aluminum market, namely its increasing tendency toward technical tightness even at a time of huge stock overhang.

Editing by Susan Thomas