March saw the London Metal Exchange suspend its nickel contract due to the spike in nickel prices above $100,000 per tonne. A three-month-old nickel trades at $22,500 now, almost exactly where it was prior to the collapse into chaos. Aluminum, zinc, and copper all saw record prices in March. LME lead was the only LME metal that did not make it to the super-bull parties.
However, after the March meltdown, industrial metals are now in meltdown. The LME Index recently experienced its sharpest quarterly plunge since the global crisis. The February 24 launch in Ukraine of Russia’s “special opera” has markedly changed sentiments from super-bullish and super-bearish.
Fears over sanctions against Russian metal led to record-breaking prices in March. However, the flows of Russian iron, copper and nickel are largely unaffected. Instead, traders are now focusing their attention on the potential recessionary impact of rising energy prices, as the Russian invasion presses on.
Bears make an appearance to play
Over the past weeks, investors’ positioning in industrial metals changed from being long to short. This is due to systematic funds responding to charts and downward price momentum with increasing bear bets. CME Copper contract money managers were net long to the tune of 42,000 contracts at April’s beginning. The net short now stands in at 25,402 Contracts, the worst position since April 2020. The last few remaining bulls are leaving the market. The two-year low in funds’ overall long positions of 33,926 has seen them drop to 33.926 contracts. This is typical of the overall investor landscape in metals. Larger-weight funds are selling into price weakness and passive long exposure is being reduced by heavier-weight ones.
China to rescue?
It is not difficult to understand why bear investors make their decisions. Inflation is driven by high energy prices. The central banks are reacting to this fact by tightening the policy. They are also beginning chill manufacturing activity.
The latest series of purchasing managers’ indexes have caught stagnant growth in Asia as well as the United States and Europe. China is emerging as a potential bright spot for the global economy. China’s manufacturing activity expanded in June after it emerged from rolling lockdowns in February.
China’s recovery will be hindered by Beijing’s zero covid-19 strategies. Many cities tightened curbs this weekend as more cases emerged. It’s interesting to see that Chinese players are also playing copper from the short end. According to Marex, the Shanghai Futures Exchange’s collective short position in copper contact is at its biggest level since 2008. That is an indication of a lack of conviction about any recovery in the most important metals user of the world. Partly due to the rapid price fall of base metals, liquidity on London Metal Exchange has been drained. This was in response to the suspension of the nickel exchange and subsequent cancellations.
LME volumes have been declining since then. Trading activity during the second quarter of 2018 was 13% lower than the year before and 21% lower than the first three months of 2022.
Due to its sensitivity to price fluctuations on small volumes, nickel is the loss that stands out the most. The LME and physical supply chains are also affected by this larger problem. Market action has become more controlled by short-term, systematic funds due to lower industry and investor participation at the LME. The increased volatility in the market is making it difficult for banks to finance players.
Revolt of the micro?
It is possible that these financing constraints could lead to inflows of metal to LME Warehouses, reversing an important trend over the past few months.
Total registered stocks of all metals were at 696,000 tons at the end of June, down from 2.36 million tonnes a calendar year earlier.
LME-Zinc inventory is currently limited to 22,050 tonnes. This is why there has been a tightening of time spreads and the cash premium above three-month metal climbing up to more than $200 per Tonne last month while the overall price was falling.
Such is the disconnect that exists between micro and macro at the moment. Recessionary gloom is destroying all micro positives such as zinc’s dangerously small inventory.
Or the long list of aluminum smelter closings in Europe or the United States due to high energy prices taking a heavy toll on this notoriously powerful sector.
Alcoa announced that it will reduce its Warrick smelter’s capacity by 54,000 tonnes. The reason? “Operational challenges”
Operationally, the entire Western aluminum supply chains are under pressure right now. Zinc is also in trouble. Both metals still have very high physical premiums. This is especially true in Europe, which has suffered from regional production losses and logistical difficulties.
It’s an indicator of the extraordinarily high supply tensions that exist in the West, that China has been shipping both zinc and aluminum despite high tariffs on outbound shipments.
European power prices are not set to rise, meaning that regional metal smelters may experience margin pain for some time. LME paper is pricing in a recessionary hit by demand, but simultaneously ignores the still bullish basic story of low inventory levels and continual supply-chain stress.
The mismatch is getting increasingly severe, and it is only a matter if ever larger short positions will clash with ever more small stocks. In combination with the lackluster liquidity, there’s a high chance of more metal boom and bust in 2022. Marex LME broker says there are currently significant speculative shorts positions across the entire London market complex. Many of them are at multi-year highs.