Lead availability tested by August squeeze

LONDON: August tends to be a seasonal low point in trading activity on the London Metal Exchange (LME) as many traders time their holidays to coincide with the summer lull in manufacturing activity across the Northern Hemisphere.
The result is sleepy, range-bound metal markets flittering around on currency moves. And this year is proving no different.
Unless, that is, you happen to be a lead trader, particularly one holding a short position on this week's prime LME prompt date.
Short-position holders of the heavy metal seem to have sleep-walked into a massive bear-trap.
As ever with cash-date squeezes on the LME, the pain has been concentrated on "tom-next", the shortest-dated spread in the exchange's singular prompt date system.
Yesterday "tom-next", the cost of rolling a position from Wednesday to Thursday, traded out to $9.3 per ton backwardation.
Nor was this a case of a little bit of last-minute book-tidying. One cleared trade alone on Tuesday morning was for 917 lots, equivalent to 22,925 tons. Ouch!
And the tightness was still there this morning, early "tom-next" trades going for between $3.5 and $5.0 per ton backwardation.
This was an accident waiting to happen.
The LME's market-positioning reports have been showing a massive long-position holder on the August prime date for some time.
The exchange's warrant banding report for Tuesday showed one entity holding cash positions equivalent to 80-90 percent of non-cancelled LME lead stocks at the beginning of the week. That translates into a long position somewhere between 231,000 and 260,000 tons in size.
That's the scale of the trap that short-position holders have been clawing their way out of.
Now, all the evidence suggests that this is one of those localized flare-ups that often characterize LME prompt dates, signifying no more than a mismatch of date-positioning between bulls and bears.
Cash-date tightness has not been acute enough to drag the whole cash-to-three-months period into backwardation. The benchmark near-term spread was valued last night at $10 per ton contango.
But it could be a warning sign of reduced availability of units, both within the LME warehouse system and in the world "out there".
Superficially at least, there is no shortage of lead in the LME warehouse system, 323,450 tons of the stuff ahead of the August prime prompt week.
The headline figure is still defined by the multi-year high of 388,500 tons recorded in the fourth quarter of 2011. By any historical yardstick other than last year, there is a lot of metal sitting in LME sheds.
But stocks are falling and they have been falling steadily for several months now, particularly in Europe.
Inventory in LME warehouses in Europe has slumped by 42 percent so far this year, compared with an 8-percent fall across the system as a whole.
Moreover, at the start of this week a significant amount of LME tonnage, 34,450 tons, was in the cancelled category, meaning the metal has been earmarked for physical drawdown.
Open tonnage, which is the benchmark against which the LME calibrates dominant long positions, was therefore just 288,900 tons.
And even that figure is misleading, a reminder that when it comes to LME stocks, what you see is not necessarily what you get.
Detroit, for example, currently holds 46,250 tons of LME-registered lead. It is the fourth largest concentration of units in the system after the Malaysian ports of Johor and Port Klang and Singapore.
But the metal is effectively trapped behind the 724,900 tons of aluminum waiting load-out in the city.
Over the course of July, 3,275 tons of the Detroit lead inventory was canceled. Not a ton has since left. It could be a long time before it does, particularly if it is located in sheds operated by Metro, the dominant logistics player in Motown and the one with most of the aluminum.
Probably not as long as anyone looking to take delivery from Fortress Vlissingen, the warehousing fiefdom of Glencore's logistics unit Pacorini.
The Dutch port currently holds 17,950 tons of LME-registered lead. Not a ton has been canceled and frankly, why would you with over 830,000 tons of aluminum in the load-out queue?
Factoring in queue-locked stocks at these two locations reduces accessible tonnage in the LME system to just 224,700 tons.
By the way, the lock-down of so many units at Vlissingen reduces the amount of non-canceled accessible tonnage in Europe to 26,700 tons. Physical premium players take note!
Even those figures, both for Europe and the LME warehouse system as a whole, are probably an overestimate.
There are several locations, such as Antwerp in Belgium and Singapore, which have seen minimal lead stocks movement in recent months, hinting that what is there is locked down in financing deals.
On the other side of the equation is the lack of inflow against August short positions, a mere 225 tons.
This could reflect no more than the nature of the August shorts, namely financial rather than industrial players. But it could have broader significance in terms of how much lead is "out there" in the world beyond the LME system.
The high LME stock levels at the start of this year resulted from the periodic squeezes that characterized the lead contract last year.
Each one of those sucked metal into the LME system, such that LME stocks of lead at the end of May represented 57 percent of global stocks as assessed by the International Lead and Zinc Study Group (ILZSG).
That's a significantly higher ratio than represented by LME stocks of sister metal zinc, even though the latter are much larger in outright tonnage terms.
Moreover, ILZSG figures suggest that lead is closer to balance than its "ugly sister", registering a cumulative surplus of 32,000 tons in the first five months of this year, compared with a surplus of 96,000 tons in the equivalent period of 2011.
That's within the margins of statistical error, particularly when it comes to the statistically opaque lead market. It is one of the metals with the highest ratio of supply coming from scrap, a statistical black hole in just about every industrial metal.
Another layer of statistical opacity comes in the form of China's lead supply figures.
Did the country's mined production really increase by 42 percent in the first five months of this year? There are plenty of analysts who would argue not.
China, however, exists as a discreet self-contained market when it comes to lead. There has been very little net flow of metal either in or out since 2009.
Stripping China out of the ILZSG figures shows mined production in the rest of the world grew by just 4 percent and refined production by just 1 percent in the January-May 2012 period. Refined usage, by contrast, is estimated to have grown by almost 2 percent.
Which would explain both why the assessed surplus is rapidly shrinking this year and why LME stocks have been steadily falling.
This week's cash squeeze on LME lead is already passing. But it has exposed the limits of LME stocks availability and suggested limited availability outside of the LME.
The LME's futures banding report shows a whole posse of shorts and longs on the September prompt date.
No mega long this time, but there is a mega short, equivalent to 30-40 percent of open interest, which stands at 18,163 lots, or 454,075 tons.
Looks like it's only a matter of time before this market is tested again.
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— Andy Home is a Reuters columnist.
The opinions expressed are his own.