LONDON (Reuters) - Zinc bulls have been waiting a long time for this, but the slow-burning supply crunch has at last travelled all the way down the supply chain to bite holders of short positions on the London Metal Exchange (LME).
LME time spreads exploded last week and they’ve grown wilder still this week.
The benchmark cash to three-month spread closed on Monday at a backwardation of $66 a ton. That’s the widest cash premium since January 2007.
Contraction of the forward curve reflects acute tightness on the cash date itself as evidenced by continuing turbulence within even the shortest-dated of LME spreads.
With exchange stocks falling and more metal being canceled before physical load-out, those who have taken short positions look set for a torrid time.
However, this sort of extreme tightness on the LME could yet prove a double-edged sword for bulls if it sucks “hidden” metal out of off-market storage.
Graphic on LME Zinc Spreads, Cash-3s and Tom-next:
The whole front part of the LME zinc curve is now showing signs of extreme stress.
“Tom-next”, that curiosity of the LME’s complex trading date system, has been trading in backwardation since the start of last week. The cost of rolling a short position from tomorrow to Thursday has this morning been as high as $15 a ton.
The cash-to-October spread flexed out to a $45 backwardation on Monday and around $40 this morning.
The mechanics are pretty straightforward.
The LME’s market positioning reports have shown one entity controlling 50-80 percent of available LME stocks over the past few days. <0#LME-WHL>
It was briefly joined by another entity with a similar-sized cash position at one stage last week, though it had dropped out of sight by Friday’s close.
However, the one that remained still controlled 50-80 percent of stocks. Factoring in cash-date positioning, its dominance was even greater, accounting for more than 90 percent of non-cancelled stocks. <0#LME-WHC>
Someone has all the LME stocks and they’re making the shorts pay, albeit within pre-set limits dictated by the exchange for such dominant positions.
LME inventory is itself a moving target.
Headline stocks have fallen by 39 percent this year to 260,325 tons, hovering around levels last seen in 2008.
The key stocks metric at times of tightness, however, is not the headline figure but how much “live” tonnage is in the system.
What the LME terms “on-warrant” tonnage is the real stocks liquidity base and those dominant position ratios are calculated against it. And on-warrant stocks have again dipped sharply lower.
This morning’s LME stocks report showed 23,050 tons of metal stored at New Orleans moving to the canceled category, leaving on-warrant stocks at 128,100 tons.
What is already a tight market, in other words, could become even tighter. Or, if you hold short positions, even more financially painful.
WHAT‘S OUT THERE?
Those with LME short positions always have a third option beyond closing out the position or rolling it forwards. They could deliver against the position if they have access to physical metal.
Which raises the question of how much more zinc is “out there” beyond the reach of the LME warehouse system.
The zinc market has been wrong-footed in the past, most recently in 2015, by the sudden appearance of previously “hidden” stocks.
Two years of a tightening physical supply chain should mean there is far less hidden material than in the past, but there are still good reasons for caution.
Zinc is still occasionally entering the LME system in reasonable size volumes.
Last week brought 7,750 tons of “arrivals” at New Orleans. This is not only where most of the LME stocks are located but is also where a lot of zinc has been sitting in non-LME sheds in recent years.
“Arrivals” here are probably nothing of the sort, just metal being rotated out of financing deals back into the LME system.
But it’s not only New Orleans. The previous week brought 28,425 tons out of the statistical shadows into LME warehouses in the Belgian port of Antwerp.
The extreme tightness on the LME market, in other words, may not be fully reflective of the physical supply chain.
Another reason for caution on physical availability is China’s relatively weak call on metal this year.
Imports of refined zinc have picked up to more than 60,000 tons a month in both July and August but cumulative net imports of 302,000 tons over the first eight months are still 6 percent off last year’s pace.
And last year was a weak year for Chinese zinc imports. At 424,000 tons inbound flows were the lowest since 2011.
This is curious, given that China is supposed to be particularly vulnerable to global raw materials tightness and is itself suffering supply chain disruption because of environmental inspections at mines and smelters.
Stocks registered with the Shanghai Futures Exchange (ShFE) are low, having fallen 86,000 tons since the start of January to 67,225 tons last Friday.
All of which suggests China should be importing more refined zinc than ever. That is what is happening to “sister” metal lead, which is struggling with similar supply issues.
But while bulls will take comfort from the past two months’ stronger import figures, the overall trend is still humdrum by historical standards.
There is simply no way of accurately measuring stocks of zinc outside of exchange warehouses, with as many estimates as there are analysts.
But if there is metal available, the current incentive to deliver it to LME sheds is as high as it has been in a decade.
The current backwardated structure of the LME curve should, in theory, suck metal out of the off-market shadows.
We’re all about to find out whether theory translates into reality.
(The opinions expressed here are those of the author, a columnist for Reuters)
Editing by David Goodman