Aluminium market creaks under weight of financing deals← Homepage
* Not enough liquidity for amount of metal in financing deals* Aluminium open interest dwindles from 2011 peak* "Squeezes" likely to be a feature of the marketBy Susan Thomas and Josephine MasonLONDON/NEW YORK, Feb 21 The $80 billion aluminium market is starting to crack under the weight of finance deals that have locked up millions of tonnes of the metal as collateral in warehouses. For years, financial institutions have been buying physical aluminium and simultaneously selling futures. Stock financing is particularly attractive for banks and other such institutions, which have access to cheap funding to pay for the inventory. The strategy relies on the futures market remaining in a "contango" structure, where the price of a futures contract tends to decline as it approaches the delivery date. The aluminium market, which was in contango for most of last year, whipped into the opposite structure, called backwardation, in December, when spot prices were at a $44 a tonne premium to prices in three months' time CMAL0-3. And backwardations are cropping up at regular intervals along the aluminium forward curve this year. This would normally mean market tightness and consumers scrambling for metal. But not in this case, analysts and traders say."These kinks in the curve are not fundamentally justified," Barclays analyst Nicholas Snowdon said. There is currently a glut of aluminium. Instead the tightening in spreads is reflecting a lack of urgency in hedging by consumers along the curve for 2013, which means forward selling pressure from inventory financiers and producers that has not been offset by buying, Snowdon said.
There are backwardations along the forward curve in June-July, September-October and December 2013-January 2014. Most stock financing deals are executed for a few months at a time and must be periodically rolled forward. The financier must buy back its short position ahead of maturity and then sell futures contracts for a date further ahead. The need to buy back short futures positions as part of the roll leaves the financier vulnerable to a squeeze.
"If there's a lot of demand for metal for financing, there's got to be someone on the other side of the deal. Traditionally there had been a lot of money coming in from long-only indices, and I'm not sure that is still the case," Citi analyst David Wilson said."It does suggest that there is no longer enough liquidity for the amount of metal in financing. This is the bigger issue."In a typical stock financing deal, the financial institution counts on being able to buy back the short futures position for less than it originally sold the position for, making a profit. In the event that the market moves into backwardation, and the futures position costs more to buy back than it was sold for, and the financial institution may have to deliver the physical warehouse metal against its short position. Any geniune tightness in aluminium supplies would be likely to appear as a backwardation near the front end of the curve and that is not the case this year.
"We're forecasting a big surplus this year. Moreover, if there was tightness it would come out in front-end time spreads," Snowdon said. "This is more a reflection of the transactional imbalance caused by people undertaking inventory financing and in turn participants pre-positioning for those financing deals being ultimately rolled forward."In other words, traders say, it has become easy to squeeze the aluminium market, but it's not a typical squeeze."June-July has tightened up since January because that's where people are pushing these forward hedges to," said a London-based metal trader."You need discrete lenders of June-July and they don't exist any more. All it takes is someone to borrow 1,000 lots and suddenly the market gets tight and the market squeezes itself because there's a lack of liquidity."A big hedge fund has been mentioned by several metals traders as being behind a squeeze in June-July, but many said the identity of the protagonist is not relevant."The name is not important. What's important is the fact that the aluminium market has become easy to squeeze," said a London-based aluminium trader. Whoever it was, they did not need to take a sizeable position to prompt the backwardation, the traders said."It seemed to develop a life of its own because panic sets in between those having to roll financing deals, CTAs