First there was Copper Fingers. Then there was Choc Finger. Later we had The Whale.
What all of these traders respectively had in common (and no, they weren’t all Bond villain rejects) was that they all became the markets they were trading.
On that note we’re very excited to inform readers that a fourth name could possibly be joining the merry rabble soon.
For now, we’ll call him the ‘Tin man’….
From John Kemp’s Reuters colleague, Andy Home, on Thursday:
LONDON, Sept 27 (Reuters) – Tightness has returned to the London Metal Exchange (LME) tin contract with the benchmark cash-to-three-months spread flaring out to $120 per tonne backwardation at one stage this week. That period has eased a little since then, valued last night at “just” $40 backwardation, but there are good reasons for believing that the minnow of the LME base metals pack is in for a prolonged period of tightness.
“Tom-next” , the shortest-dated of LME spreads and a useful warning light for spread woes, is still flashing red, trading this morning at $10 per tonne backwardation.
The entire tin curve is now in backwardation, although this being tin the curve extends only 15 months forward in time.
And here’s the key bit:
Market positioning reports show a dominant long position holder controlling 40-50 percent of LME stocks and the potential for long-short battles on the next three monthly prime prompt dates. The player short to the tune of 20-30 percent of open interest on the November third-Wednesday and the long equivalent to over 40 percent of open interest on the December date are just two stand-outs in a congested banding report.
So what we’re seeing in the tin market is effectively a tug of war… between a guy who owns 40-50 per cent, and a guy who’s short 20-30 per cent.
And the backwardation is err… naturally only the reflection of a super tight and under supplied market.
Yet here’s another interesting twist to the story. As Home reports, the tin market has been perceived to be in deficit for a long while now. But nearby spreads have budged only very recently:
That’s even after on-warrant tin stocks in the LME warehouse shrunk from 20,000 tonnes in August 2011 to 5,000 tonnes in August 2012.
As Home explains, weirdly enough spreads went ‘supernova’ in 2009 even as stocks were built up. (In the chart, the lower the orange line, the greater the backwardation.)
In normal times this would be construed as totally counter-intuitive because backwardation tends to be accompanied by destocking, not stockbuilds.
Of course, in the new commodity world, some sense can be made of this. Stock accumulation is, after all, the market’s natural way of regulating oversupply. A trader sees too much supply, so starts to hoard stock until prices are supported. Except that… usually, it only pays for him to do so for as long as the forward curve is in contango. The point at which the contango gives way is usually the point at which traders are discouraged to keep hoarding.
During this episode, backwardation seemingly did not discintivise stockpiling.
Which might instead be explained by the market collectively wanting to budge the clearing price of tin higher.
Or it’s possible that the market over-compensated to such a degree that the spread had no choice but to blow out to epic backwardation levels.
Either way, as Home points out, things did eventually end in tears as spreads reverted to a mild contango.
Nevertheless, the mystery as to why it’s taken backwardation to creep back in — despite stocks having been greatly diminished for a while — is now the curious question.
Reverse cancellations
Home, however, does find one interesting clue in the stock situation in Malaysia. As he explains:
Just one location, Johor in Malaysia, has accounted for an ever-rising percentage of total LME tin stocks, as shown in the next graphic: http://link.reuters.com/xet82t
At the end of August, the 5,080 tonnes of on-warrant tin stocks in Johor represented 90 percent of all on-warrant LME tin tonnage.
The ratio is constantly changing because of another highly anomalous development, the continuous shuffling of metal on and off warrant at Johor.
“Reverse cancellations”, where LME metal that had been cancelled in anticipation of physical drawdown is placed back on warrant, are by no means unusual.
But the frequency and the scale of shuffling at Johor, shown in the next graphic, is unprecedented for any LME metal: http://link.reuters.com/wet82t
Cancellation activity, both ways, totalled 8,110 tonnes over the course of August. Actual movement of tin stocks in Johor was, however, a single 45-tonne departure on Aug. 16. This month has seen a 100-tonne delivery of tin into LME sheds in the port, dwarfed by 5,940 tonnes of “shuffle metal”.
What’s going on? Is the “Johor shuffle” a by-product of the escalating warehouse wars? Is it driven by high-frequency arbitrage fluctuations with China? No-one seems quite sure, but some sort of secondary market seems to have evolved, breaking down the relationship between LME stocks cancellation activity and actual drawdowns. Analysts are conditioned to view cancelled tonnage as a leading indicator of stocks movement. On this basis the fact that over half of the LME tin stocks, a total 6,865 tonnes are cancelled, is a “bullish” signal. But not when most of them are at Johor and not when nothing really leaves.
What we may be seeing is the emergence of exactly the same type of warehouse shuffle that was brought to our attention by Traderight’s Steven Spencer in the copper market.
The game is simple. When it makes sense for you to hide stock from the market you take it off market into the ‘dark-inventory zone’, something that supports prices. When it makes sense to cash in on the price rise or a contango, you bring the stock out of the dark and back into observable inventory.
If you have good relations (or even own the warehouse in question), you don’t even have to physically move the metal. It only takes a label change to suddenly make your inventory disappear.
The reason the cancellations confuse the market is usually, this stock would be leaving the warehouse. But as Home notes, at Johor “nothing really leaves.”
Related links:
Let’s count the copper with dust on it - FT Alphaville
The curious case of un-cancelled warrants – FT Alphaville
Commodity encumbrance and Joseph’s storage play – FT Alphaville
The dawn of systemically important commodity traders - FT Alphaville
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