According to Wikipedia, the notion of backwardation applies to a downward sloping forward curve. It occurs when the spot price is more than the forward price, meaning the “cost of carry doesn’t factor into the equation because the underlying metal is not available for current purchase. According to Reuters on Friday, the LME cash price of tin, moved to backwardation, the first time this has occurred in eight months. The spot price (cash price) traded $29 over the 3-month contract. (Cash closed at $9.4075/pound or $20,740/ton while the 3-month price closed at $9.3440/pound or $20,600 on Friday). So what might metal observers wish to make from this recent development?
But first, we digress. Stuart reported earlier this month, the fundamentals for tin support a rising price. That post pointed to several trends that have played out including:
- Exchange inventories have dropped as prices have increased
- World tin production peaked back in 2005 and serious supply constraints suggest no to low single digit supply increases
- According to that August 4 post, a July analyst poll conducted by Reuters concluded prices would reach $18,767 per ton this year and $18,550 per ton next year. But according to Stephen Briggs, metals strategist at BNP Paribas, “We expect the tin price to move comfortably above $20,000 a ton before the end of 2010, and see an even stronger advance next year, with the metal probably topping the May 2008 record high of $25,500 sometime in the second half of 2011.
So two trends and a price prediction for increases. Now we turn back to the significance of backwardation as it relates to tin. When the spot price exceeds the futures price, we can conclude that nobody is willing to “arbitrage.” So why would one pay more today than tomorrow? Our conclusion – this time the backwardation relates to supply shortages. A bird in the hand is better than two in the bush, so the saying goes which may explain the trend change. See current inventory levels below:
Are there any other plausible explanations? Possibly. Last time tin went into backwardation, some speculated that was due to one large “Mr. Tin Man or hedge fund buyer, according to this Telegraph article. But given what has happened to tin thus far this year, we think supply shortages (or the prospect thereof) is probably the bigger culprit.