Barring its brief May spike above the $3,000 per tonne level, when aluminium was buoyed by the copper-fired exuberance that seized all the LME metals, the light metal has been the under-performer of the complex this year. And justifiably so, in our opinion. A dramatic U-turn in the alumina market, still fast rising Chinese production, a stubborn refusal to die by some of the West's highest-cost smelters and, more recently, concern over the expected slowdown in global growth have combined to keep the market under pressure.
But forget about all that for now. Aluminium broke up out of its 5-month trading range last week to gain a foot-hold above the $2,700 level, basis 3-month metal, and seems intent on keeping its December appointment with the $3,000 level.
Shorts Punished
What at first sight seems an illogical contrarian move is in fact a direct function of the recently-formed bear consensus about the light meta's likely fortunes next year.
We’ve warned in this weekly column for some time now about the potential for a technical spike before the year’s out and last week we saw that vague threat starting to take tangible form.
This is all about catching out the many bears—the CTA systematic fund community, the LME option market-makers, banks and proprietary desks and a few producers along the way. The easiest target for the contrarian bulls are those CTA fund shorts. The "black box" community went collectively short of aluminium in early June, based on the negative chart picture created by that May spike, and they've stayed short ever since. At one stage in August the collective short position is estimated to have been around 50% of potential capacity or the equivalent of around 1,125,000t. By the beginning of last week it had been trimmed to around 36% of capacity but that's still a sizeable collective exposure.
In September we highlighted the big call options open interest up to $3,000 over Q4 with the bulk of it concentrated on December and on the $3,000 strike itself. Those that sold the options—presumably comfortable in the expectation that aluminium had already had its day in the sun—become more exposed the higher the underlying price rises. The erosion of time as we tick down the days to December just exacerbates the delta-hedging requirement to cover that exposure.
Somewhere between the CTAs and the options exposure further up there appear to be a host of other short positions put on by both funds and trade players, again fully in the expectation that after its May failure to hold the highs, aluminium was destined never again to reach the giddy heights of $3,000 in this part of the cycle.
For someone, it appears, this has been just too tempting a target with consumer trade-pricing during what is always a seasonally robust time of the year providing a useful lever with which to force prices higher, causing increasing pain among short position-holders, who in turn are forced to cover, providing further upwards leverage, etc etc. Throw in a squeeze of the market's nearby structure—particularly that key December date, where there is a big accumulation of open interest—and you can see why a nervous London "street" is now starting to eye warily levels above the market which haven't been mentioned in polite company since the Q2 bull run.
These are the mechanical levers that explain why aluminium has been able to make steady upside progress from its Sep lows down towards the $2,400 level with the momentum building sufficiently last week for it to break up above the $2,700 level, which has defined the top of the trading range since May.
It's been steady rather than spectacular progress with the light metal having to make it through a band of extremely heavy producer forward selling, even though the usual fun-and-games on the forward spreads have forced producers to choose their timing carefully. Tuesday's first break of the $2,700 level ran into exactly such resistance as well as a
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