LONDON: Here we go again.
This time last year saw a clash of the titans in the London Metal Exchange (LME) aluminum market.
And one year on it looks as if we're in for a repeat performance.
The December-January spread has been tightening steadily over the last couple of months.
There was a view a few weeks back that those holding December short positions would roll before the third-Wednesday prompt date. There was equally an expectation that the tightness would dissipate when the big index funds performed their own early-December roll, a monthly splash of liquidity for shorts.
But here we are. Third Wednesday (Dec. 19) is almost upon us, remembering that in the quirky LME date system it actually arrives on Monday.
The shorts are still there and the tightness is cranking up a gear.
That spread was valued last night at $30 per ton backwardation, representing the cost of rolling a short position to the January third-Wednesday prompt date (Jan. 16).
It has flared out to a level sufficient to pull the whole benchmark cash-to-three-months period into a $6.75-per tonne backwardation.
This morning has brought no relief. December-January has already traded in reasonable volume as wide as $34.8 backwardation.
If anything, this is an even more intense long-short battle than the 2011 showdown.
Who's dishing out the pain to whom?
As ever with the enigma-machine that is the aluminum market, it's nigh impossible to say at this time.
But at least, thanks to the LME's market positioning reports, we can get a feel for how the battle-lines are drawn.
The exchange's latest futures banding report shows a long position on the December date equivalent to 30-39 percent of open interest and three shorts, one in the 5-9 percentage band and two in the higher 10-19 percentage band.
These reports are somewhat of a rear-view mirror because they actually show the state of play two days ago, so these were the battle-lines at the close of business Wednesday.
That said, these are mega positions and unlikely to have disappeared in the intervening two days, witness the continued tightening of that December-January spread.
Just how mega?
Well, the LME's open interest report shows total open interest on the December date of 92,722 lots, equivalent to 2.32 million tons.
That means the long position is somewhere between 695,000 and 905,000 tons in size and the cumulative short position between 600,000 and 1.1 million tons.
This is, after all, aluminum, the LME's most liquid contract, and December in any year is characterized by a concentration of positions.
Still, unless one or the other side blinks, next week could get ugly.
Of course there is the distinct possibility that one, two or all three shorts have no intention of rolling at all and that the tightness is being caused by a rush of smaller players trying to get out of the firing line before the big guns go off.
This was pretty much how last year's battle played out with the short position-holder handing over 500,000 tons of metal, all of it stored at LME warehouses in Vlissingen in the Netherlands, to the long.
It marked a new front in the aluminum "warehouse wars" that had previously been confined to Detroit. The rest, as they say, is history.
Physical delivery this time around is equally possible. The recent tightening of the front part of the aluminum forward curve has destroyed the profitability of stocks financing deals, which are predicated on a sufficiently large contango to cover the costs of storage, insurance and money.
A stocks financier with a December expiry date on the deal is going to struggle to renew it in the current environment.
In which case, we're witnessing another tussle between market giants for a slice of the aluminum stocks mountain.
The only question is whether the delivery would take the form of metal already warranted in the LME system or of metal that is currently sitting off-market in cheaper storage.
Aluminum consumers should hope that if physical delivery is indeed the outcome of this battle, the metal will come from off market.
Physical premiums, which have rocketed over the last year, finally appear to have leveled out.
The first-quarter premium for Japanese buyers, set to become an ever more important benchmark as the industry switches from annual to quarterly premiums, is coming in at $240 per ton over LME cash, representing the first quarterly fall in a year.
Weak demand in Japan has finally trumped low metal availability, the latter of course resulting from the proliferation of stocks-financing deals.
If, though, another million or so tons of LME metal are going to be transferred and moved out of the LME system, the visible stocks picture will deteriorate sharply, shifting that availability-demand dynamic back in favor of stronger premiums.
A more profound and unsettling question raised by this latest showdown in the LME aluminum market is what exactly will be the eventual end-game?
With the US Fed and other central banks showing no intention of taking their foot off the quantitative easing pedal, there is no reason to expect the current through-the-looking-glass world of cheap money and negative real interest rates to change any time soon.
And that means, excepting the sort of cash-date squeeze we are currently witnessing, the stocks-financing game will be with us for a good time to come.
But not for ever.
What will happen then to the millions of tons of aluminum currently locked up in financing deals? Even an orderly unwind could send shock-waves through the market. A disorderly unwind doesn't bear thinking about.
That, though, is a question for another day.
As for now, if you have the luxury of doing so, sit back and enjoy the annual aluminum showdown show time.
— Andy Home is a Reuters columnist. The opinions expressed are his own.
