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COLUMN-The mysterious case of the 31,700 tonnes of LME lead stocks: Andy Home
(The opinions expressed here are those of the author, a columnist for Reuters)
By Andy Home
LONDON, March 15 (Reuters) - Phantom stocks are the bane of every analyst's life.
Everyone knows that there is always more metal out there than shows up in exchange stocks. But how much is quite literally anyone's guess.
Phantom stocks define the aluminium market. The price is weighed down not by the 2.9 million tonnes sitting in London Metal Exchange (LME) warehouses but by the many more million tonnes sitting in off-market storage.
Zinc bulls have been repeatedly caught off-guard by the sudden appearance of phantom stocks in New Orleans, where metal has been riding a long-running carousel between on- and off-LME storage.
But recent events in the LME lead market take phantom stocks to a whole new level because 31,700 tonnes of metal that were supposed to be in exchange warehouses were not apparently there at all.
Even (Taiwan OTC: 6436.TWO - news) if they were physically in the Dutch port of Vlissingen, they certainly were not in the LME's electronic warrant system.
There's been remarkably little outcry over what the LME termed an "error in reporting".
Maybe it's because traders have become inured to the mass movement of units into and out of LME warehouses as stocks financiers and warehouse operators battle for tonnage across the base metals spectrum.
Yet there is evidence that those phantom lead stocks did play a part in shaping price formation in the LME lead contract.
A sign perhaps that exchange stocks movements haven't become entirely irrelevant.
(MIS)COUNTING THEM IN, (MIS)COUNTING THEM OUT
On March 8 the LME issued a notice to members warning that the daily stocks report due to be issued at 0900 London time the following day would show 31,700 tonnes of lead stored in Vlissingen as a delivery out.
"Please be advised this is not a physical delivery out but a correction of an earlier error in reporting by the Warehouse."
Not that it would have taken the market long to work out something was amiss with a single-day delivery of that size.
Warehouse operators have long treated the exchange's minimum daily out-delivery requirements as a maximum and the highest required load-out right now is 4,000 tonnes and only for Pacorini in Vlissingen because it has so much aluminium stuck in a load-out queue.
But did anyone work out that the original "inflow" was erroneous?
Make that "inflows" plural because that lead showed up in two tranches, 18,425 tonnes in the LME's Feb. 17 report and 13,275 tonnes in the Feb. 19 report.
It (Other OTC: ITGL - news) was the first major arrival of lead at Vlissingen since June 2015, when 36,500 tonnes of metal entered warehouses operated by Worldwide Warehouse Solutions (WWS), the logistics arm of Noble Group (Dusseldorf: N2X.DU - news) .
And WWS seems to have been the "recipient" of the phantom 31,700 tonnes last month, judging by the LME's latest monthly report showing stocks by operator.
The only other arrival activity at Vlissingen in February was the warranting of 85,100 tonnes of metal at Pacorini's sheds, a figure that exactly tallies with the pace of aluminium warranting last month.
The inference is that there were two separate inflows, one of aluminium to Pacorini and the lead that "went into" WWS sheds.
Quite how the mistake happened is unknown at this stage.
Evidently, it's hard to miss the arrival of 31,700 tonnes of lead at a storage compound. But the process of actually placing such a tonnage of metal onto LME warrant, meaning it goes into the "arrivals" count, can be done with the stroke of a keyboard once the metal is in place.
Or, apparently in this case, at two strokes of a keyboard.
A (MIS)LEADING INDICATOR?
The "arrival" of 31,700 tonnes of metal would have barely been noticed in aluminium, such is the size of inventory movement in this financier-dominated market.
But in lead it represented a not insignificant 17 percent increase in total LME stock levels relative to the 182,225 tonnes that were already there.
True, the LME lead market has seen its fair share of stocks anomalies, largely reflecting a warehouse war that started in March last year, when a massive 98,350 tonnes of metal was cancelled in a single day.
Some of that tonnage ended up with WWS in Vlissingen. Another major 50,000-tonne tranche made it as far as sheds operated by Metro (Other OTC: MTRAF - news) in the South Korean port of Busan.
Not for long, though. Metro's tonnage in Busan has fallen from 75,200 tonnes at the end of July 2015 to just 10,950 tonnes at the end of February.
This tit-for-tat game has significantly reduced the price impact of daily LME stock movements. Indeed, they can as often as not be misleading rather than leading indicators of price.
But a closer look at the price action around the time of the two LME reports with the original errors shows there was a discernible market reaction, particularly on Feb. 17.
(Graphic on lead prices at the time of the original inflows:
In the 10 minutes after the release of the daily stocks report at 0900 London time, three-month lead dropped by $16.50 per tonne to $1,768.50.
A similar, albeit more muted, pattern can be seen around the Feb. 19 LME stocks release.
Causality is near impossible to prove, not least because lead was already trending down from what was then a year-to-date high of $1,865 per tonne.
But there is a lot of circumstantial evidence, not least the fact that copper, which often acts as a pack leader in the LME market, was rising sharply just as lead was falling on Feb 17.
Moreover, is it purely coincidence that lead fell by $120 on a close-to-close basis in a week that seemed to show such a large double-hit flow of metal into the LME system?
Over the course of that week LME stocks went from being net down on the start of the year to the tune of 10,250 tonnes to being net 27,525 tonnes higher.
Did that turnaround help shape sentiment in the market, which slid further to a Feb. 25 low of $1,679 before rebounding?
Do LME stocks movements even help shape the trading decisions of black box programmes? It's not entirely inconceivable given some funds are known to have plugged the figures into their algos.
MYSTERY
The LME has said nothing further beyond its brief members notice on March 8.
But it is a racing certainty the exchange is investigating further the mysterious case of the 31,700 tonnes of phantom lead.
Stocks and warehousing are something of a sensitive issue with the LME right now, given the furore over load-out queues and the subsequent regulatory remoulding of the exchange warehousing model.
And even in this age of phantom stock movements, completely wrong stock movements need, at the very least, to be explained and, if necessary, punished.
Because the tentative message from this whole fiasco is that LME stocks haven't become completely divorced from price formation.
Some people, and possibly some machines too, do seem to react to stock movements, particularly if they are both large and unexpected.
Not a message that will necessarily be good news for either the LME or the man with the fat finger in Vlissingen.
(Editing by)
