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Saturday, August 13, 2022

COLUMN-The hand that gently rocks the LME copper spreads: Andy Home

(The opinions expressed here are those of the author, a columnist for Reuters)

By Andy Home

LONDON, Aug 10 (Reuters) – Storms, floods, drought, strikes, protests, power problems.

Copper supply has been rocked by all of them in the last few months with analysts poring over production figures to measure the hits against their disruption allowances.

The very fact that everyone has a disruption allowance in their spreadsheets is a reminder that copper supply is particularly prone to the unexpected.

This year, though, is turning out to be particularly challenging for the world’s copper producers.

Not that you’d notice anything from copper’s recent price performance. On the London Metal Exchange (LME) three-month metal has this morning touched a fresh six-year low of $ 5,118 per tonne.

Supply woes are being trumped by demand woes, first and foremost are concerns about the health of China.

Even (Taiwan OTC: 6436.TWO – news) news that Chilean producer Codelco has suspended spot sales of refined metal in China has generated little more than a collective shrug, such is the over-supplied nature of the market.

Unsurprisingly, black box funds are feasting on the downtrend, turning net short of LME copper this month for the first time since the LME started publishing its Commitments of Traders Report (COTR) a year ago.

But are they walking into a trap?

Because if there is a potential tight spot in the entire copper supply chain, it is the LME marketplace, where over half of available stocks are still held by one player.


Graphic on LME spreads and open tonnage stocks:


Graphic on money mangers positioning and “tom-next”:




There’s been a dominant long position holder on copper for so long it’s become a semi-permanent feature of the LME landscape.

As of today’s report , denoting positioning at the close of business last Thursday, one entity controls between 50 and 80 percent of open LME tonnage, meaning somewhere between 166,000 and 265,000 tonnes.

The LME doesn’t identify holders of dominant positions, more’s the pity, but speculation as to who’s got all the copper has been a talking point on the “Street” for as long as the position has been there.

And, according to the word on the “Street”, the position has changed hands at least once, quite possibly twice.

The original copper long is thought to have bailed out during the ferocious January sell-off with the position transferred to another player, possibly via an intermediary.

The key point is not so much who’s got all the LME copper but why there is still so little copper in the LME warehousing system.

Sure, headline stocks are up on the start of the year. In fact, they’ve pretty much doubled but from a historically low base of 177,025 tonnes at the start of January.

They currently stand at 354,125 tonnes with metal still arriving piece-meal across a wide range of locations, a normal pattern for this time of year, when northern hemisphere manufacturing activity slows during the summer holiday season.

But they’re still a long way short of 2013 levels, when headline stocks peaked at over 660,000 tonnes, let alone 2002 levels, when LME stocks were close to one million tonnes.

There’s currently more metal sitting in the Shanghai bonded zone than there is in the LME warehousing system.


And that’s partly because there is no compelling incentive to deliver surplus metal to the LME market.

The benchmark cash-to-three-months spread has been trading in contango since the middle of May.

Tom-next , the shortest-dated spread in the LME system and the best indicator of cash-date pressure, has also been becalmed of late.

The last time it flared into serious backwardation was during the January maelstrom, when activity exploded amid a mass adjustment of positioning, both by longs and shorts.

And yet there is a strong sense that the current contango environment is at least partly a manufactured one.

The outright price seems to be telling us that copper’s supply-demand profile right now is as bad as it’s been since the dark days of Global Financial Crisis in 2009.

Yet the spreads are not.

The widest the cash-to-threes contango has flexed is $ 31 on June 15. Since then it’s traded in a relatively narrow $ 5-25 range and closed last week valued at $ 7.00.

Not tight, but not loose either.


Short positions, meanwhile, are accumulating.

The LME’s latest COTR, covering the week up to Friday Aug. 3, showed money managers net short to the collective tune of 5,249 lots, or 131,225 tonnes.

It’s the largest collective net copper shorts since the LME introduced the report at the end of July 2014.

It may also be an undercount due to the fact that some fund order flow may be over-the-counter in origin and netted off by LME members before execution.

Marex Spectron, for example, publishes its own assessment of “speculative positioning” on the LME. Its take as of July 30 was that the net short on copper was 28,700 lots, or a much larger 717,500 tonnes.

The calculations may differ but the key takeaway doesn’t.

Funds are net short and increasing their short bets as the price extends its downwards path.

There has been no significant counter-move since the second week of July. Even then there was no discernible spread reaction.

Nor, for that matter, are any warning flights flashing from the LME’s futures banding report . The next three big prompt dates show only clusters of relatively small short positions, the largest of which is in September and between 10 and 20 percent of open interest in size.

Yet it’s hard to see how copper can avoid some sort of short-covering reaction at some stage, given it has been trending lower in almost a straight line.

And it’s hard to see how that reaction, when it comes, isn’t going to cause spread volatility given the ever-present entity controlling so much of the exchange’s available tonnage.

But until that day, the dominant long seems happy to keep gently rocking the spreads in a way that is unthreatening to the growing number of bears.

Just as long as the bears don’t get gently rocked to sleep.

(Editing by David Evans)

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