The World’s Biggest, Best-Kept Secret of the Metals Business

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Five companies operate 75% of the LME’s 778 licensed warehouses – but that’s not the secret.

All of them own shadow facilities as well, a recent WSJ article reports, while in some instances, a single firm runs licensed and unlicensed warehouses in the same building, with the metal counted by the LME separated from hidden stockpiles by a chain-link fence. For context, start with Part One of this article. 

Long load-out queues at LME warehouses have exacerbated the problem as investors have opted for off-market warehouses where they have lower rents and better control over metal access.

What Does This Means for Physical Premiums?

In an effort to reduce the physical premiums being charged in the market and reduce the excessive load-out queues, the LME is introducing increased load-out rates and other restrictions to LME warehouses that have queues of more than 50 days, but so far, physical premiums have risen rather than fallen in anticipation of the change.

Physical premiums in Asia are approaching $300 per metric ton in recent tenders for Q2 delivery, according to Metal Bulletin, while Japanese buyers have fixed first quarter premiums at $255-256 per metric ton with the prospect of higher premiums for Q2.

LME Rule Changes = Disaster

LME rule changes could have disastrous effects in a worse-case scenario.

Of the 5.5 million tons of metal on warrant in LME warehouses, those with queues of more than 50 days are estimated to be holding some 3.5 million tons, or 7% of global annual demand. If that were forced to be delivered out with no corresponding uptake back into the system, the impact on prices could be significant, the WSJ fears.

In reality, of course, under the current circumstances much of that metal will simply find its way into the shadow system. But those circumstances can change – indeed, nothing ever remains constant.

A rise in interest rates or a drain in liquidity is the most likely risk raising the cost of borrowing and undermining the model. Taper relief is already being very gradually wound down in some countries, but the US Fed holds the key; there may be another year of ultra-low interest rates, but at some point they must rise.

What This Means for Metal Buyers

In the meantime, we could have unexpected and unpredictable price movements as a result of unseen stock movements into and out of the market. Make no mistake: shadow warehouse stocks present a risk to the market, and there’s probably not much any of us can do about it.

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