COLUMN-Fasten seat belts as LME spreads tighten: Andy Home

(Repeats Aug. 27 item. The opinions expressed here are those of

the author, a columnist for Reuters)

By Andy Home

LONDON, Aug 27 (Reuters) - For every action there is an

equal and opposite reaction.

Or translating Sir Isaac Newton's third law of motion into

financial language, markets don't move in straight lines.

Although you'd be forgiven for thinking so after the

pummelling base metals have taken over the last couple of weeks.

There are, however, the first tentative signs of stabilisation

as the selling momentum starts to fade.

Some sort of short-covering reaction looks likely. Which is

where things might get interesting.

It (Other OTC: ITGL - news) is in the nature of the London Metal Exchange (LME) with

its singular rolling daily prompt system that buying back a

short position or simply holding on to it is not as

straightforward an exercise as on a vanilla futures exchange.

Dates need to be adjusted on a buy-back while holding a short

position means rolling it forward.

Either way, it means navigating the potentially choppy

waters that are the LME nearby spreads.

And the outlook could be for something a bit worse than

choppy, judging by the way front-month spreads are tightening

right across the base metals suite.

PHYSICAL SQUEEZE

The most extreme example is tin, where the benchmark

cash-to-three-months spread flared out to a

$540-per-tonne backwardation on Aug. 18.

That's the widest cash premium since 2009, when what is one

of the LME's least liquid contracts was subjected to a

protracted and painful squeeze.

Things have eased a little over the last week but as of

Thursday morning's ring sessions the period was still trading at

a hefty $101 backwardation.

Tightness in the LME tin market is easy to understand,

reflecting more than anything else the low level of available

stocks in exchange warehouses.

There were just 3,940 tonnes of "live" on-warrant stocks on

Aug. 17, the lowest tally since late 2012 and a low liquidity

cover for the three sizeable shorts that were sitting on the

Aug. 18 third-Wednesday prompt date.

*******************************************************

Graphic on LME tin spreads and on-warrant stocks:

http://link.reuters.com/hyf55w

*******************************************************

A premium for cash metal is entirely logical in these

circumstances and, in theory at least, should incentivise

deliveries of physical metal into the LME warehouse system to

alleviate the tightness.

The problem is that stocks have rebuilt only marginally with

open tonnage now at 4,790 tonnes. And as of the close of

business on Tuesday, up to 80 percent of them were controlled by

two entities, according to the LME's warrant report.

The LME's futures banding report , meanwhile,

shows just how crowded the tin contract is on the

third-Wednesday prompt dates over the coming three months.

In September (Sept. 16), four sizeable longs are facing off

against two shorts. In October (Oct (HKSE: 3366-OL.HK - news) . 21) it's a case of five

longs versus six shorts and in November (Nov. 18) five longs are

looking down the barrel at one short, but it's a big one,

accounting for 30-40 percent of open interest (3,460 tonnes in

the middle of that range).

Any or each of these dates could trigger renewed cash

tightness.

Which may be one reason tin prices have weathered the recent

made-in-China storm better than most other base metals, the

potential for further spread tightness deterring would-be

shorts.

*******************************************************

Graphic on aluminium, copper, lead, nickel, zinc spreads:

http://link.reuters.com/gyf55w

*******************************************************

DOMINANT LONGS

Copper spreads have also tightened significantly over the

last couple of days, with the full cash-to-three-months period

moving into backwardation last week.

It is currently indicated at $26.50 backwardation after

flexing out to $32 on Wednesday.

It's a little hard to make the same argument for cash-date

tightness in copper as in tin. On-warrant stocks of 318,100

tonnes are not exactly low. In fact, they are almost double

where they were at the start of the year.

The problem with copper is not how much stock is in the

exchange warehouse network but rather the fact that 50-80

percent of it is controlled by one entity.

Still.

Because that dominant long position has been there all year,

although the word on the "Street" is that it has switched

ownership at least once.

Quite evidently there must be a lot of shorts in the copper

market, given it has fallen by $1,400 per tonne since early May.

Anyone looking to cover back their position or looking to

roll over their position is likely going to have to pay a price

to that dominant long, although the daily cost of doing so is

capped by the LME.

There's a potentially even bigger dominant long sitting on

the October third-Wednesday date in aluminium. It accounts for

over 40 percent of open interest and is a hot talking-point in

the market.

The October-November spread (CMALV5-X5) is already tight,

trading on Thursday at $7 backwardation, which is why the full

cash-to-three-months contango has been dragged in to

around $20 from $45 in the middle of last month.

Shorts on the October date may be in for a torrid time.

The last time the spreads got ugly on aluminium was in May,

when the cost of rolling a position widened to $9.50 per tonne.

Per day!

WHO'S SHORT?

Forward curves in zinc and lead are

still in contango but only marginally so, while the nickel

contango , like that in aluminium, is steadily

shrinking.

Stocks of all of them are relatively high and only lead is

prey to a dominant long, currently holding 40-50 percent of

available inventory.

But tightening spreads are a natural reaction to the amount

of short-selling that has been taking place with positions

having to be adjusted by borrowing the nearby dates.

This is particularly the case for speculative/investment

(delete according to preference) players, who are not in a

position to settle their positions by delivering physical metal.

Which begs the question of just how many shorts are out

there and just how short they are.

To which there is no easy answer.

Analysts have started tracking the LME's Commitments of

Traders Report (COTR), specifically the managed money category,

for clues to fund positioning.

No one's quite sure as to just how accurate it is. As of the

end of last week, for example, money managers were net long of

all the main LME contracts.

Which seems curious given the scale of the sell-off. And

which sits oddly with an alternative data series on "speculative

positioning" produced by LME broker Marex Spectron.

The differences between the two are stark, as shown in this

table.

Fund/Speculative Positioning (Lots)

Aug-20 LME COTR Marex Spectron

Aluminium 52,384 -211,400

Copper 1,174 -33,000

Lead 4,790 -7,400

Nickel 10,167 -31,200

Tin 3,024 -1,400

Zinc 7,381 -47,200

Depending on which one you want to believe, for example,

"funds" are either still collectively net long of aluminium to

the tune of 52,400 lots or running what Marex Spectron calls

"the biggest spec short in aluminium since July 2012".

Quite evidently, if Marex is correct, that collective

speculative short is on a collision course with the mega long in

October.

It doesn't mean a major trend change in the outright price

but it does point to a lot of turbulence ahead.

In fact, all these metal spreads are signalling the same

thing.

The "fasten seat belt" signs have just gone on. It's going

to be a bumpy ride.

(Editing by Dale Hudson)