In March, the London Metal Exchange (LME) suspended its nickel contract after the price jumped above $100,000 a tonne. The three-month nickel is now trading around $22,500, almost back to where it was before the descent into chaos.
Copper, aluminum, zinc and tin hit record prices in March. Lead was the only LME base metal to miss the super-bullish coupon.
After the meltdown in March, however, industrial metals are now in the process of melting. The LME index just suffered its steepest quarterly decline since the global financial crisis.
The shift in sentiment from super-bulls to super-bears was the February 24 launch of what Russia calls its “special operation” in Ukraine.
Fears of sanctions against the Russian metal helped push prices to record highs in March. But flows of Russian aluminum, copper and nickel have so far been largely unaffected.
Rather, traders are now focused on the recessionary impact of high energy prices as the Russian invasion continues.
The bears come out to play
Investor positioning in industrial metals has shifted from long to short over the past few weeks, with systematic funds reacting to chart breaks and downward price momentum by increasing bearish bets.
Money managers had a net long position in the CME copper contract of 42,000 contracts at the start of April. Net short now stands at 25,402 contracts, the lowest position since April 2020.
The last few remaining bulls are throwing in the towel. Funds’ final long positions shrank to a two-year low of 33,926 contracts.
This is symptomatic of the broader metals investor environment, with heavier funds reducing passive long exposure and trend-following funds systematically selling on price weakness.
LME broker Marex estimates there are now significant speculative short positions across the London market complex, with some near multi-year highs in terms of size.
China coming to the rescue?
It’s not hard to understand the rationale behind investors’ bearishness.
High energy prices are fueling inflation and central banks are responding by tightening policy.
They are also beginning to cool down manufacturing activity.
The latest series of purchasing managers’ indexes reported stalled growth in Asia, the United States and Europe.
China is the potential bright spot in the global economy, with manufacturing activity expanding in June for the first time since February as the country gradually emerges from continuous lockdowns in the first half of the year.
However, there is much caution that China’s recovery could still be held back by Beijing’s zero-covid-19 policy, with several cities tightening restrictions over the weekend as new cases emerged.
Tellingly, Chinese players themselves are playing metals like copper on the short side.
Marex estimates that the collective short position of the copper contact on the Shanghai Futures Exchange, expressed as a percentage of open interest, is as high as it has been since 2008.
That speaks to a lack of conviction about the strength of any recovery in the world’s biggest consumer of metals.
A liquidity trap
The speed of the collapse in base metal prices was partly explained by the outflow of liquidity on the London Metal Exchange as a result of the controversial halt in the nickel market and the subsequent cancellation of trades.
Since then, LME volumes have declined. Trading activity in the second quarter decreased by 13% compared to the previous period and by 21% compared to the first three months of 2022.
Nickel is the most obvious victim, prone to sharp price swings on low volumes, but this is a wider problem for both the LME and the physical supply chain.
Lower investor and industry participation in the LME leaves market action increasingly dominated by short-term systematic funds.
The resulting increased volatility reduces the funding capacity of physical players as banks reassess their exposure to the metals sector.
The Revenge of the Micro?
It is possible that such financial constraints could lead to an influx of metal into LME warehouses, reversing a defining trend of recent months.
Total recorded inventories of all metals stood at 696,000 tonnes at the end of June, down from 2.36 million tonnes a year earlier.
LME zinc inventories currently stand at just 22,050 tonnes, causing time spreads to narrow, with the cash premium for the three-month metal jumping to over $200 a tonne last month, even as the final price has been falling.
Such is the divergence between micro and macro right now. The recessionary gloom is crushing any micro positives such as the dangerously low coverage of zinc stocks.
Or the long list of layoffs at aluminum smelters in Europe and the United States as high energy prices weigh on the notoriously energy-intensive sector.
Alcoa has become the latest producer to announce a 54,000-ton capacity cut at its Warrick smelter in Indiana, citing “operational challenges.”
The entire Western aluminum supply chain is facing challenges right now. The same goes for zinc. Physical premiums for both metals remain extremely high, particularly in Europe, where regional production losses are compounded by logistics issues.
It is a sign of extreme supply pressures to the West that China is exporting both aluminum and zinc despite high tariffs on outgoing shipments of the refined metal.
With no relief in sight for power prices in Europe, regional steelmakers face margin problems until further notice.
The LME paper market priced in a recessionary hit to demand while ignoring the still-bullish fundamental story of low inventories and ongoing supply chain stress.
The disparity is becoming more apparent, and it may only be a matter of time before the ever-larger short positions collide with the ever-smaller stocks.
Coupled with uneven liquidity, there is a strong chance that the second half of 2022 will see more metal booms and busts.
(Editing by Ian Harvey)
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