MI WEEK IN REVIEW: Aluminium knocked lower as options clock ticks

The London aluminium market remains caught between two opposing forces—its own well-signalled tryst with those big June upside call options and the general complex-wide selling coming from technical and systems-based funds.

Last week, it was the funds who (again) had the upper hand, although this particular fight still seems to be far from over.

Bears Return to the Attack

The modest recovery the previous Friday after several days of consistent fund selling had many on the London “street” believing the worst of the storm had passed. LME 3-month aluminium had picked up slightly to $2,850 at the Friday close and that recovery extended to $2,869 at Monday’s close, thanks to light profit-taking by short-term short-position holders.

By Tuesday morning, aluminium seemed to be gearing up for a renewed attack on the upside with locals chattering about those big call option positions on June and the need by options shorts to delta-hedge-buy metal as the underlying price rose.

The battle with producer sellers at $2,900 had hardly got going, however, before the fund bears returned to exact more punishment on the LME metals.

As in the previous week, the next three days brought successive waves of fund selling with most contrarians wisely moving out of the way of what one local called “the freight train”.

The selling reached its climax on Thursday afternoon with technical bears targeting key weak spots in both the copper and aluminium markets--$2,800 in the case of the light metal. A break there saw sellers hit a buying vacuum with a consequent super-swift collapse to $2,750 in late trading.

There was renewed weakness on Friday morning before the predictable reaction to the action in the form of a part-recovery to $2,792 at the weekly close—a week-to-week loss of $58 and the third weekly fall in succession.

Quite what exactly has triggered this massive fund switch of positions is still hotly debated. Our own take is that it has come from a combination of seasonality (“sell in May and go away”), portfolio re-weighting (no coincidence in our mind that this sell-off started around the time of the last meeting of the US Fed’s interest-rate-setting committee) and technical performance (an over-extended copper market in particular).

Once set in motion by longer- and medium-term funds, however, the move becomes self-feeding with each leg lower sucking in more and more short-term systems funds. That was particularly evident on the break of $2,800 last Thursday.

The scale of the fund turnaround has been enormous. Our sources estimate the CTA systematic fund community has switched from collective long of around 20% of historic capacity in the second week of May to something close to 20% short of historic capacity as of last Friday—equivalent to a 900,000t shift in position.

Tension

As such, what has happened in aluminium is simply a part of what has played out through all the LME metals—even super-tight nickel was not immune last week to this fund attack.

However, there is still a tension in the light metal centred on the continued presence of a dominant long position-holder in the LME’s daily compliance reports and those big call options in June—only a week away from the declaration date (Wednesday, June 6th).

That tension is bubbling away in the form of a small backwardation on the third-Wednesday prime prompt date in June (the 20th). It’s masked by the fact that the full cash-to-3-months period is in comfortable contango--$33.25 at Friday’s valuations.

But it’s a sign that the June game is by no means over, particularly if a fast run on the upside can be engineered—sellers of those options will have shed their futures cover as the market came off last week, meaning they are again vulnerable to any accelerated rally (they will have to buy again).

Much will depend on whether the bear funds can defend