Copper hit a three-year high of $6,970 per tonne on the London Metal Exchange (LME) on Tuesday morning. Aluminium is faring even better, trading above $2,100 per tonne for the first time since 2013. Zinc eclipses both. At a current $3,200 per tonne it is traversing chart levels last seen during the great bull run of 2007-2008.
The whole base metals complex seems to be on an upwards charge. The LME index of metals has jumped by 20 percent over the last three months. A previous pattern of price divergence between individual metals is dissolving. Among the major base metals traded on the LME, only tiny tin is declining to join the bull party.
Simple market mechanics, the forced covering of short positions on both futures and options, explain some of the ferocity of the recent moves. A weaker dollar is acting as an accelerant to the bull flames, although its impact should not be overstated. Looking at copper specifically, analysts at Goldman Sachs argue that the dollar effect can account for only "a fraction" of the recent rally ("Copper: fundamentals and technicals point to different directions", September 5, 2017).
Speculative money is definitely in the mix, fund positioning flexing higher across the spectrum. But this largely unexpected metals rally is also pointing to a shift in market narrative from the specific to the general in terms of demand and supply. Rallies such as these acquire their own momentum as waves of short-covering trigger ever more buy signals for the host of automated trading systems. It's a virtuous or vicious cycle depending which side you're on.
Fund net long positioning on the CME's copper contract has, quite literally, gone off the charts to unprecedented levels. In London the collective speculative long position on the LME copper contract was over 50 percent at the end of last month, according to LME broker Marex Spectron. Such bull length, it added, hadn't been seen since 2004.
And Chinese commodity exchanges are fending off one of those increasingly common "flash" money surges from a retail crowd that acts collectively like a giant momentum-chasing black box trading programme. From iron ore to steel to esoteric metals such as ferro-silicon, mainland exchanges have been raising fees and margins to brake runaway prices.
Even so, open interest on the Shanghai Futures Exchange's aluminium contract is now above 1 million contracts for the first time ever. Such collective exuberance has analysts almost united in their view that things have got a bit out of hand and that some sort of corrective reaction is fast approaching.
Even though verging on the irrational at times, this exuberance is built on a rational rewrite of the market narrative. The first half of this year saw periods of wide divergence between individual LME-traded metals as the market priced according to supply dynamics.
Zinc is challenging those historic peaks because of a tight raw materials supply chain and falling stocks of metal in exchange warehouses. Nickel was a chronic underperformer after two cogs of the ore supply chain, Indonesia and the Philippines, turned bearish.
But nickel has now caught up. At $12,180 per tonne, LME three-month metal is up almost 23 percent on the start of the year, hot on the heels of copper, up 26 percent. Nothing has changed on the nickel supply side. Visible stocks are still high and there is no evidence of raw materials constraints on China.
What has changed is a collective reassessment of the demand picture for industrial metals. Global manufacturing appears to be enjoying one of those rare coordinated growth moments, judging by the slew of positive purchasing manager indices out at the start of September.
Factory activity in China, Europe and the United States is expanding and fund money seems to be entering the industrial metals space to capitalise on that. Nickel's ever-changing raw materials supply chain is now overshadowed by the prospects for stronger-than-expected demand growth from the stainless steel sector.
It's been lifted by a rising macroeconomic tide. It's not that individual supply differentials have gone away. They are still there, but they are also being subsumed in a much bigger supply-side shock. One which is fanning out in waves from Beijing in the form of inspection teams tasked with inspecting whole industries for illegal and environmentally unsafe capacity.
This started in the steel sector with a hard-hitting campaign against small, illegal operators, "zombie" plants and even large producers operating in targeted environmental clean-up zones around Beijing. It has since spread to just about every industrial supply chain, with metals attracting particularly close scrutiny.
One week it's tin smelters in Yunnan province being closed for inspections. The next week it's wire and cable manufacturers in Hebei. The forced closure of massive amounts of aluminium capacity has transformed that market's persistent narrative of structural oversupply, even if no one's quite sure how much actual production will be affected. And that's the problem.
China, it's often overlooked, is a significant producer as well as consumer of metals, albeit one that operates in a black hole of reliable statistics. And its internal supply chains are being overhauled in an unprecedented way with implications that are still nigh impossible to predict. Take steel, for example.
China has been making good on its commitment to tackle excess capacity in its huge steel sector. It closed 42 million tonnes in the first half of this year, equal to 84 percent of its target this year. Yet actual steel production is not only rising, it hit a record in July.
There's some statistical sleight of hand in those figures, since much of the illegal capacity that is being closed was never counted in the first place. But China's steel mills are seeing profitability soar thanks to less competition and buoyant demand from the core construction and infrastructure drivers.
It seems a counterintuitive outcome of capacity closures. But Beijing is creating its own virtuous circle of eliminating "illegal" operators, which boosts prices, which in turn boost the financing standing of state favourites such as aluminium producer Chalco. This all-encompassing supply shock is still evolving. A whole new set of capacity curbs in the provinces around Beijing is due to kick in at the start of the winter heating season in November. Also still evolving is the new narrative for base metals, one in which micro fortunes are being enveloped by a combination of macro demand optimism and macro supply uncertainty.
Comments
Comments are closed.