Falling stocks pose problem for London Metal Exchange

The 144-year-old exchange, which sets benchmark prices 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” about whether that should still be the case, LME chief executive Matthew Chamberlain told the Reuters Commodities Summit.

Chamberlain’s reflections come after the LME was forced to restrict its copper contract, which risked a disorderly break after stocks on the exchange of warrants slumped to a multi-decade low of 14,150 tonnes.

They have since rebuilt to 49,900 tons but it’s not just a copper problem. LME tin inventories have been at very low levels for most of the year. Lead stocks also appear to be depleted. The discount became anchored in the forward curve of both contracts.

Indeed, the total stock recorded at the LME has fallen by nearly 600,000 tonnes since the start of the year. Stocks of all metals stand at 1.469 million tonnes, the lowest since 2008.

The visible drawdowns were complemented by an even greater reduction in virtual LME stocks, which fell by 64%, or 1.21 million tonnes, in the first nine months of 2021.

Change the fundamentals

The largest component of the LME’s inventory has historically been aluminum, a market that until recently was characterized by excess global production capacity and high inventories.

Fierce competition for low-cost storage has characterized the LME aluminum market for more than a decade. Much of the metal rotates between Mandate Storage and LME Parallel Storage, defined as a storage agreement with explicit reference to the LME delivery option.

Monthly change in LME aluminum inventories

March saw a particularly significant turn in the storage wheel with fictitious stocks falling by 723,000 tonnes and LME registered stocks increasing by 557,000 tonnes.

However, stocks in both categories have since fallen in tandem. Aluminum phantom inventory was 558,548 tonnes at the end of September, down 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 stocks fell by 1.13 million tonnes between January and September and much more metal has left the stock market tally since then.

The seepage of so much aluminum out of the LME’s warehousing network speaks to the reversal of market fundamentals, in particular the emergence of China as the main importer of base metals due to the shutdowns of energy-related production.

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.

Shipping issues

The strength of the post-covid manufacturing recovery, first in China and now in the rest of the world, has impacted not just aluminum, but all LME metals to varying degrees.

Supply chains, on the other hand, are being strained by continued disruptions to the global shipping industry, where container rates remain high and many ports, especially those in the United States, are blocked.

This generated additional call on LME stocks, with the lead being the clearest example.

The LME’s recorded lead inventory of 53,700 tonnes is down 60% at the start of the year and close to last month’s multi-year low of 48,175 tonnes.

Stocks in Europe, where supply has been hit by the shutdown of Germany’s Stolberg smelter, have fallen particularly sharply and continue to deplete. The European locations hold just 12,325 tonnes with a low of 234 tonnes in shadow storage at the end of September.

There are no leads on US venues, underpinning historically high physical bounties.

There’s a lot of lead in Shanghai. In other circumstances, he would have bounded to the nearest LME warehouses in Taiwan or South Korea in response to the cash bounty.

Chinese exports increased significantly in September and a total of 9,400 tons were delivered to LME warehouses in these countries by mid-October. But arrivals have since slowed to a trickle, suggesting high shipping costs are restricting expected arbitrage flow.

With supply tight in the US and European markets, it is clear that LME lead stocks will not recover until shipping rates normalize.

Sold out

The upsurge in demand, production issues and shipping constraints have already depleted the LME’s tin stocks.

They have been very low all year and currently total a minimum of 845 tons, of which 155 tons are reserved for physical loading. Virtual stocks at the end of September were only 50 tonnes.

While reflecting tin’s current momentum, such a weak stock leaves the market extremely vulnerable to potential distortion.

You could buy the remaining LME open tonnage for $26 million, in which case you would have cornered the market.

The exchange would almost certainly not allow that to happen, although it did tolerate the write-off of 180,000 tonnes of copper over a four-week window, resulting in the fiercest write-offs in living memory.

Fictitious copper stocks were just 28,828 tonnes at the end of September, signifying low availability of immediately guaranteed metal ahead of the October tensions.

Additionally, the ability of shorts to more generally deliver metal against the cash premium has also been limited by the multiple global logistical bottlenecks.

In hindsight, the LME contract was as vulnerable as tin to mass inventory elimination, which is why the exchange had to step in and cap lending rates.

These “special measures” remain in place and will do so until stocks recover to such an extent that spreads will not immediately go wild again as soon as restrictions are lifted.

There has been a conspicuous lack of fresh copper inventory write-off activity since the LME intervention, but at some point someone will again need metal from exchange warehouses.

Will there be enough copper at this point to avoid another spread tightening over time? The broader picture of the falling LME inventory cross metals suggests not.

You can begin to understand why LME’s Chamberlain questions the limits of being a market of last resort.

(Editing by Barbara Lewis)