What LME Inventories Tell Us About Where Aluminum Is Headed – Part Two

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Non-ferrous Metals

Continued from Part One.

Bank financing for the stock and carry trade is becoming tighter and alternative sources of finance may want a position that is more readily liquidated. Nothing could be quicker than holding the metal in an LME warehouse where it can be sold at the touch of a button.

The drawback has always been cost. LME warehousing is more expensive than private storage, but if the trader owns the warehouse, the cost become a moot point. So what we could be seeing is merely financing or possibly refinancing of positions with funding from new sources having conditions attached.

Meanwhile, there is a massive short position in the LME forward dates for Dec. 21; the inflowing metal could be position-taking prior to that crunch date, but again, no one but the protagonists involved can be sure.

In China, largest consumer and producer of aluminum, the SHFELME arbitrage window has opened and metal is inflowing from West to East. But part of the enthusiasm for physical metal is said to be avoidance of domestic financing costs.

Investors use letters of credit with long-dated settlement dates to import aluminum and resell the metal in the domestic market, as they are not required to pay back to local banks for the L/C before 3-6 months. They can either use the funds released to lend at higher domestic rates or to fund their own company needs.

While the arbitrage window is open and domestic interest rates are high, this will continue, but shouldn’t in itself be seen as confirmation of surging demand. The robustness of the SHFE premium is more of an indication of domestic demand meeting high domestic production costs.

In summary, it is too early to be sure why such huge volumes of aluminum have surged into LME warehouses in recent days, but it is certainly a development to be kept under close review — as will prices around the Dec. 21 crunch date.

–Stuart Burns

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