MI WEEK IN REVIEW: Just when everyone thought it was safe, LME aluminium saw a sharp re-tightening in the nearby structure last week, which in turn spurred a short-covering rally back above the $2,800 level (basis 3-month metal).
Elusive Contango
In this column last week, we noted the return to contango of every part of the cash-to-3-months period with the exception of cash-to-March (today is the prompt date).
The result had been a steady contraction in the overall backwardation to "just" $3-4 over the end of the previous week and the first two days of last week.
However, aggressive borrowing reappeared on Wednesday and the backwardation spread through the full cash-3s period with all components back in backwardation by Friday's close. The full period was valued at $22 backwardation, compared with $4 back the previous Friday.
The re-tightening of the spreads puts into question a growing market consensus that the dominant long position holder, who has graced the LME's compliance reports for many months, was about to exit via short positions accumulated on this week's March prime prompt.
Actually, last week's spread action doesn't necessarily negate that theory. Rather, spread plays were all the rage across several of the LME metals last week. Copper was the most spectacular beneficiary but even zinc saw a flip back to backwardation as the week unfolded.
Predator funds seem to have borrowed the spreads of several metals as something of a seasonal play, trying to capitalise on what is the usual peak demand season for industrial metals as well as the existence of big speculative short positions on copper, aluminium and zinc.
The strategy has already paid dividends in the likes of copper and aluminium. The CTA systematic community was in full retreat as the week unfolded, cutting its short exposure to the light metal from over 40% of historic capacity at the start of the week to around 33% as of Friday, according to our fund-watching sources.
That in turn helped 3-month metal break up through the $2,800 level Friday after tracking a $2,700-2,800 range for the prior four days.
Trading had been jittery with more macro-economic woes coming in the form of the markets' new hot spot—the US sub-prime mortgage sector, where defaults have risen as have the financial woes of the some of the market's biggest names.
This time the contagion didn't spread beyond the equity markets but LME trading was still characterised by occasional rumours of hedge funds in trouble and a lack of consistent passive investment fund flow, which seems to have been put on hold for now.
As such, it was the spread action that drove outright prices higher on Friday. For aluminium the weekly close at $2,814 marked a week-to-week gain of $96, or 3.5%, after two consecutive "down" weeks.
Power Problems
The lurking market bulls even got a bit of positive supply-side news last week in the form of several smelters facing power and environmental issues.
In Ghana Valco suspended all operations due to falling water levels in the hydro system that feeds the 200,000tpy plant. It was the 11th time this smelter has been forced to suspend or curtail activities due to power problems since being commissioned in the late 1960s. Indeed, it was only re-started in 2005 and was operating at only around one-third of capacity prior to the suspension.
In Tajikistan the 520,000tpy capacity Tajik Aluminium smelter also had to cut its output by around one third due to lower hydro power levels. The smelter has not produced at that capacity figure since being built in the dying stages of the Soviet Union but it has managed to steadily improve production levels in recent years—output in 2006 was 414,000t—and its target of doing so again this year now looks questionable.
Meanwhile, Venezuelan producer Alcasa is playing a game of political cat-and-mouse with the government after being ordered to close around 20% of its
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