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COLUMN-Metals melt as recession fears overwhelm supply issues: Andy Home


By Andy Home

LONDON, July 4 (Reuters)Industrial metals went from boom to bust in just three months.

In March, the London Metal Exchange (LME) suspended its nickel contract after the price soared to over $100,000 a ton. Three month nickel CMNI3 is now trading around $22,500, roughly where it was before the descent into chaos.

Copper, aluminum, zinc and tin all hit record prices in March. Lead was the only LME base metal to miss the super-bull party.

However, after the March breakout, industrial metals are now in disarray. The LME index has just experienced its biggest quarterly decline since the global financial crisis.

The pivot of sentiment from super bullish to super bearish was the February 24 launch of what Russia calls its “special operation” in Ukraine.

Sanctions fears against the Russian metal helped push prices to those record highs in March. But Russian aluminum, copper and nickel flows have so far been largely unaffected.

Instead, traders are now focusing on the recessionary impact of high energy prices as the Russian invasion continues.

THE BEARS GO OUT TO PLAY

Investor positioning in industrial metals has shifted from long to short in recent weeks, with systematic funds reacting to chart breakdowns and lower prices by increasing bearish bets.

Fund managers were net long the CME copper contract at 42,000 contracts in early April. The net short now stands at 25,402 contracts, the most bearish positioning since April 2020.

The last remaining bulls throw in the towel. The funds’ outright long positions fell to a two-year low of 33,926 contracts.

This is symptomatic of the broader landscape of metals investors, with heavier funds reducing passive long exposure and trend-following funds selling into price weakness.

LME broker Marex believes there are now significant speculative short positions in the London market complex, with several near multi-year highs.

CHINA TO THE RESCUE?

It is not difficult to understand the bearish reasoning of investors.

High energy prices are fueling inflation and central banks are responding by tightening policy.

They are also beginning to dampen manufacturing activity.

The latest round of PMI indices captured stalled growth in Asia, the US and Europe.

China is the potential bright spot for the global economy, with manufacturing activity expanding in June for the first time since February as the country gradually emerges from continued lockdowns in the first half of the year.

However, there is considerable caution that China’s recovery could still be held back by Beijing’s zero COVID-19 policy, with several cities tightening the brakes over the weekend as new cases emerged. . .

Tellingly, Chinese players themselves play metals such as copper on the short side.

Marex believes that the collective short position in the copper contact of the Shanghai Futures Exchange, expressed as a percentage of open interest, is as high as it has been since 2008.

This speaks to a lack of conviction about the strength of any recovery in the world’s largest user of metals.

LIQUIDITY TRAP

The rapidity of the collapse in base metal prices can be explained in part by a liquidity drain on the London Metal Exchange following its controversial suspension from the nickel market and the subsequent cancellation of trades.

LME volumes have been falling ever since. Trading activity in the second quarter was down 13% from the prior year period and 21% from the first three months of 2022.

Nickel is the most obvious victim, subject to large price swings on low volumes, but this is a broader problem for the LME and the physical supply chain.

Weak investor and industry participation in the LME leaves market action increasingly dominated by short-term systematic funds.

The resulting high 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 funding constraints will lead to metal inflows 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.

The stock of zinc available at the LME is currently only 22,050 tons, which is why time spreads have tightened, the cash premium on the metal at three months CMZN0-3 climb to over $200 a ton last month even as the absolute price fell.

Such is the mismatch between micro and macro right now. The gloom of the recession overwhelms all micro positives such as dangerously low zinc inventory coverage.

Or the growing list of aluminum smelter closures in Europe and the United States as high energy prices weigh on a notoriously energy-intensive sector.

Alcoa has become the latest producer to announce a 54,000 tonne capacity reduction at its Warrick, Indiana smelter, citing “operational challenges”.

The entire western aluminum supply chain is currently operationally tested. The same goes for zinc. Physical premiums for both metals remain extremely high, particularly in Europe, where regional production losses have been compounded by logistical issues.

It is a sign of the extraordinary supply tensions in the West that China exports both aluminum and zinc despite high tariffs on outbound shipments of the refined metal.

With no relief in sight for electricity prices in Europe, regional metal smelters are facing margin issues until further notice.

The LME paper market is pricing in a pullback to demand while simultaneously ignoring the still-bullish fundamental story of low inventories and continued supply chain strains.

The mismatch is getting more and more glaring, and it may only be a matter of time before bigger and bigger short positions come into conflict with smaller and smaller stocks.

Combined with uneven liquidity, there is a good chance that there will be more boom and bust in the metal in the second half of 2022.

The opinions expressed here are those of the author, columnist for Reuters.

LME metals go from boom to boom with echoes of 2008-2009https://tmsnrt.rs/3uoQStX

Funds raise bearish bets on CME copper contracthttps://tmsnrt.rs/3OLpbDQ

(Editing by Jan Harvey)

(([email protected]44-207-542-4412 and on Twitter https://twitter.com/AndyHomeMetals))

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.



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