MetalMiner Editor-at-Large Stuart Burns and I often have telephone chats about various topics relating to metals. After all, what else are we going to talk about? Most recently, we had a chit-chat about aluminum and thought we’d share with our readers. This is part two of that conversation, here’s part one, in case you missed it…
There are a lot of warrants being canceled right now. What does that mean? Where is the material going?
We don’t see any North American buyers using the LME for physical metal availability now any more than they used it a year or three years ago. The canceled warrants may have come as a result for several reasons. The first theory suggests this metal tied up in financing deals may have moved locations and will continue to move from high priced LME warehouses to lower priced off market locations.
Believe it or not, sometimes the metal moves to the other side of a chain link fence where rents are less. A conspiracy theorist may say Goldman Sachs and Glencore, kings of the warehousing world have decided to have one last hurrah by maxing out their load-out queues while still holding a dominant position in the warehouse. A third explanation points to the end of the stock and finance trade. We don’t put much stock into that theory however, because the spot to 18-month-forward spread maintains enough strength to support the trade, and an end of the stock and finance trade would not see a mass cancellation of LME warrants like we are seeing right now.
What else explains the cancelled warrants?
A more likely explanation is that what we are seeing is the stock and finance trade turning to the LME as a source of metal. In other words, financial players have historically used the LME as a price discovery vehicle, but not as a supplier of actual metal. Now, we could see the Glencore Xstratas and Goldman Sachs’ of this world turning to the LME to actually buy metal. Instead of having to pay a producer the LME price + a physical delivery premium, the financial players simply buy their metal at the LME price in return for a warrant, which provides them with contracted metal at any LME contracted location. The stock and financial players have to pay rent on their metal regardless of where they hold it. So if they pay rent in an exit queue, it is only slightly worse than paying it in an off-warrant warehouse.
However, if you own the warehouse, you pay yourself rent while material sits in queue. Not only that, but when an industrial buyer purchases LME warrants they can’t control the physical location of the metal. So if the industrial buyer requires a 10,000-ton parcel, they will have some metal in Detroit and some in Busan, or Rotterdam, or in a location where no exit queues exist at all. Trade buyers would pay a premium to swap Detroit warrants for warrants in Busan or Rotterdam or some other location. The financial players can make money from industrial buyers by swapping the warrants in other locations to consolidate material in the desired location.
Rather than paying a producer a physical delivery premium to secure metal, a hedge fund or trader will be better off paying the basic LME price as a starting point.
Finally, we believe a linkage exists between sky-high premiums that began early this year and the mass cancellation of warrants.