An interesting article in Thomson Reuters’ Inside Metal publication by Andy Home this week explores the question of when physical delivery premiums will come down and the London Metal Exchange price of aluminum will again represent a fair market price for the metal.
Japanese first quarter premiums have just been set at $425/ton over the cash aluminum price on the LME. As the article points out just $5/ton over the last quarter but compared to $255 this time last year and $114 the year before it represents an increasingly massive disconnect between the LME and the true market price. It also highlights another disconnect in the aluminum market: Japan is sitting on excess stocks of primary aluminum and generally there is an oversupply situation in much of Asia but premiums are rising – driven, the article explains, by the North American market where premiums are hitting $535 per metric ton.
What is Driving Premiums Higher?
So, what is continuing to drive these ever-higher premiums? And will, as analysts have been predicting, they peak this year and begin to come down? They said the same thing this time last year and the premiums kept rising.
Some argue a reduction in LME warehouse queues will signal the end of the premium, but the only two locations where the queues remain substantial are in Detroit and Vlissengen, Netherlands. The article goes into a well-argued and interesting exploration of what impact these queues are actually having on the premiums and whether the eventual decline in queue length really will have any impact. We won’t go into that here as we have discussed this before but suffice it to say, Reuters’ conclusion is the same as ours was – the queues are more a symptom than a cause of what is driving of the premiums.
Warehouse operators such as Metro International Trade Services are at best making $350/ton of extra rent out of the metal in their load out queues, yet would have to offer incentives of $535/ton to compensate anyone looking to deliver metal in. Clearly, the queue isn’t the cause and something else is driving the physical demand for metal and depriving consumers of supply. It’s not warehouse operators. That something, Reuters agrees with our earlier conclusion, is the stock and finance trade.
Before we jump on the banker-bashing bandwagon, the finance part of this doesn’t necessarily mean a bank. It’s more likely to be a hedge fund, major investment vehicle or trader than a bank nowadays, but the fact remains virtually all of the 670,000 tons that left Detroit’s LME warehouses last year simply went into off-market storage at lower rates.
Unfortunately, there is nothing illegal in the stock and finance game even though the cost to consumers is considerable. It is too simplistic to argue if the trade wasn’t there, the LME price would simply rise from $1,850 to $2,385 (1850+535) per ton and consumers would pay the same, anyway. In the current environment consumers have a portion of their costs they can hedge via the LME and a portion they cant. Nor does anyone have a clear enough understanding of the situation to say with any confidence whether the premium will be higher or lower in 6 months time, there is no fundamental analysis to be made because the stock and finance trade is dependent on a solid LME forward price curve, and the LME spreads are becoming increasingly volatile as the available tonnage on the market shrinks.
How Big of an Aluminum Deficit?
The article tells us the aluminum market is now expected to be in a 54,500-ton deficit this year compared to a 102,500-ton deficit predicted in a previous poll. That probably doesn’t reflect much more than maybe a different group of analysts were asked, but no one seems to be in any doubt the market will be in deficit, at least outside of China. We will explore the underlying supply and demand picture in a follow-up article next week as, stock and finance aside, the aluminum market is undergoing considerable change and the issues deserve deeper analysis than we have time for here.
The above raises a question: Why is off-market metal not being attracted back into the physical market when the finance period comes to a close? With delivery premiums of $535/ton over the LME price, surely that is way more than the return possible on playing the forward price curve. At best that would be a net 2-3%. $535/ton represents nearly 30% premium over the current LME price. I wish I had an answer to that. If anyone has an inside track please get in touch, I am sure we would all like to better understand what has in a few short years become one of the primary drivers of the worlds largest non-ferrous metal market.