LONDON, Nov. 12 (Reuters) – What happens when the market of last resort, the London Metal Exchange (LME), runs out of metal? And should it then restrict the right to withdraw metal from its warehouses if it results in price distortion?
The 144-year-old exchange, which sets benchmarks for global industrial metals markets, has always prided itself on its role as the ultimate buyer and ultimate seller of physical metal.
But “there is a fascinating political question” of whether this should always be the case, LME chief executive Matthew Chamberlain told the Reuters Commodities Summit.
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Chamberlain’s thoughts come after the LME was forced to restrict its copper contract, which risked a disorderly breach after mandate swap stocks fell to a decades-long low of 14,150 tonnes.
They’ve since rebuilt to 49,900 tons, but it’s not just a copper issue. LME tin inventories were at extremely low levels for most of the year. Lead stocks also appear to be depleted. The offset became anchored in the futures curve of both contracts.
In fact, the total stock recorded at the LME has fallen by nearly 600,000 tonnes since the start of the year. Inventories of all metals stand at 1.469 million tonnes, the lowest since 2008.
The visible drawdowns were complemented by an even greater reduction in LME ghost stocks, which fell 64%, or 1.21 million tonnes, in the first nine months of 2021.
CHANGE THE FUNDAMENTALS
The largest component of LME inventories historically has been aluminum, a market until recently characterized by excess global production capacity and high inventories.
Fierce competition for low cost storage has characterized the LME aluminum market for over a decade. Much of the metal rotates between mandate storage and LME shadow storage, defined as a warehousing agreement with explicit reference to the LME delivery option.
The month of March was marked by a particularly important turn of the wheel with ghost stocks in free fall of 723,000 tonnes and stocks recorded at the LME up by 557,000 tonnes.
However, shares of both categories have since fallen in tandem. Phantom aluminum inventories stood at 558,548 tonnes at the end of September, up from a high of 1.74 million tonnes in February and the lowest level since the exchange began publishing its monthly reports in February 2020 .
Combined on and off-warrant inventories fell 1.13 million tonnes between January and September and since then significantly more metal has left the stock market count.
The infiltration of so much aluminum out of the LME’s storage network reflects the turnaround in market fundamentals, in particular the emergence of China as a major base metal importer due to production shutdowns linked to energy.
LME inventory is used to fill supply gaps that have opened up elsewhere, which is how the market of last resort is supposed to work.
The strength of the post-COVID manufacturing upturn, first in China and now the rest of the world, has impacted not only aluminum, but all metals in LME to varying degrees.
Supply chains, on the other hand, are strained by the continued disruption of the global shipping industry, where container rates remain high and many ports, especially the United States, are congested.
This generated an additional call on LME stocks, with lead being the clearest example.
The LME lead stock of 53,700 tonnes is down 60% from the start of the year and close to last month’s multi-year low of 48,175 tonnes.
Inventories in Europe, where supply was impacted by the failure of the German foundry in Stolberg, have fallen particularly hard and continue to be depleted. The European sites only hold 12,325 tonnes, including a minimum of 234 tonnes in parallel storage at the end of September.
There is no advance on US sites, which underlies historically high physical premiums.
There is a lot of lead sitting in Shanghai. Under other circumstances, he would have jumped to the nearest LME warehouses in Taiwan or South Korea in response to the cash bonus.
Chinese exports increased significantly in September and a total of 9,400 tonnes were delivered to LME warehouses in those countries in mid-October. But arrivals have since slowed to a trickle, suggesting that high shipping costs are restricting expected arbitrage flow.
With supply scarce in the US and European markets, it is clear that LME lead stocks will not recover until shipping rates normalize.
OUT OF STOCK
Renewed demand, production problems and shipping constraints have already depleted LME’s tin stocks.
They have been very low throughout the year and currently total a minimum of 845 tonnes, of which 155 tonnes are reserved for physical loading. The fictitious stocks at the end of September were only 50 tonnes.
While reflecting the current dynamics of tin, such a low stock leaves the market extremely vulnerable to potential distortion.
You could buy the remaining open tonnage from the LME for $ 26 million, and then you would have cornered the market.
The exchange would almost certainly not allow that to happen although it tolerated the cancellation of 180,000 tonnes of copper over a four week window, resulting in the fiercest setbacks in living memory.
Fictitious copper stocks were only 28,828 tonnes at the end of September, signifying low availability of the metal immediately guaranteed before the October tightening.
Additionally, the ability of shorts more generally to deliver metal against the cash premium has also been constrained by multiple global logistics bottlenecks.
In hindsight. the LME contract was as vulnerable as the tin to massive inventory deletion, which is why the stock market had to step in and cap lending rates.
These “special measures” remain in place and will remain so until the inventory rebuilds to such an extent that the spread does not immediately become unleashed once the restrictions are lifted.
There has been a glaring lack of copper inventory cancellation activity since the LME’s intervention, but at some point someone will need metal from the exchange warehouses again.
Will there be enough copper at this point to avoid another time crunch? The larger cross-metals picture of LME inventory decline suggests not.
We begin to understand why Chamberlain of the LME wonders about the limits of a market of last resort.
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Editing by Barbara Lewis
Our Standards: Thomson Reuters Trust Principles.