MI WEEK IN REVIEW: Bears use global risk rout to renew attack on aluminium

Aluminium had been making heavy weather of the upside even before the latest risk reduction rout erupted out of the credit markets into foreign exchange, stocks markets and, at the end of a long interconnected chain, the LME complex. Technical bears needed little excuse to get the knives out again for the light metal and last week they were given a big excuse. Riders On The Storm Almost from the Monday-morning off, LME 3-month aluminium was under pressure, throwing a last, fleeting look at its previous Friday close up at $2,856 before sliding to $2,825 at the Monday close. Support around the $2,820 level held over much of Tuesday, albeit in fairly unenthusiastic trading conditions, before the “sub-prime” mortgage canker eating away at the troubled US housing market burst the banks of the credit markets and spilled over into just about every other global financial market. In our eyes, the symbolic, if not the actual trigger, for the financial market turbulence over the second part of last week came from comments made by Angelo Mozilo, chief executive of US mortgage bank Countrywide, which released its Q2 07 results late Tuesday. “We are experiencing home-price depreciation almost like never before, with the exception of the Great Depression” was the sound-bite that cuts to the heart of the sliding US housing market. Within that market, the “sub-prime” mortgage canker—increasingly defined as “lending to those that could never afford to borrow in the first place”—has been slowly eating away at the credit markets in the form of downgrades of collateralized “sub-prime” debt and the resulting list of financial casualties, to which another two Australian hedge funds were last week added. The canker erupted with dramatic impact with a flight to safe havens—the dollar, the T-bill market and the yen—and a fire-sale of just about everything else. UBS Bank said that its risk-aversion index—largely a measure for foreign exchange trading—had reached levels not seen since just after 9/11 and the LTCM hedge fund disaster in the late 1990s. And boy, didn’t everyone else know it. Aluminium found pockets of bargain-hunting and consumer buying first at the $2,820 level and then, when that was breached on Wednesday, at the $2,760 level. Neither support held and the market slumped all the way to a Friday low of $2,710 before some aggressive buying just prior to the closing bell propped the light metal up for a close at $2,755. That, however, still marked a week-to-week loss of $101, overshadowing the previous week’s timid $64 gain. The close also marked a downwards move through all four major moving averages monitored by LME locals, which is likely only to add fuel to the technical bear fund fire. Our fund-watching sources estimate the collective short position held by CTA systematic funds ballooned over the course of the week from under 30% of historic capacity to just under 50%. Over-Supply? Unlike copper, aluminium has little in the way of short-term fundamental support, even if technical traders were in any mind to notice such things anyway. An ultra-wide contango on the front part of the curve—the cash-to-3-months period ended last week valued at $57.50 contango—speaks volumes as to the market view on short-term availability of metal. LME exchange stocks rose last week back towards the recent 2007 highs, largely due to renewed inflow at Asian locations, where freer metal units are a function of China’s huge exports of “product” over the first half of 2007. The Japanese market is currently in the doldrums, with products shipments sliding year-on-year and physical premiums softening. Maybe some of that negativism was behind Mitsubishi Shoji Light Metal’s prognosis that the global market is set to record a surplus of 290,000t this year after a deficit of 300,000t last year. It foresees that surplus widening both in 2008 and 2009 before the market returns to deficit. A rare contrarian view came from Logan Kruger, chief executive of US producer Century Aluminum. Speaking on the company’s Q2 analysts’ call, Logan said there was a possibility of the market recording a deficit this year…but, and you just know there’s got to be a “but”…only if Chinese consumption maintains its super-strong H1 performance and if the authorities have some success in reining in both exports and production. There is no doubting their intent—the all-powerful National Development and Reform Commission said last week that its priority in the second half of this year would be tackling over-heating parts of the economy and curbing blind investment in excess capacity. The still-booming primary aluminium sector seems to be the prime example of the latter, but whether the new raft of measures being planned is any more successful than the last series remains very much an open question. However, all is not quite what it seems in this market’s dynamics either. Visible exchange inventories remain high—stubbornly so in the case of the LME—but below the surface stocks are being eroded. The International Aluminium Institute’s monthly figures on producer inventories at the end of June showed producer stocks of unwrought metal shrinking at an alarming rate, particularly in North America. Those in Europe remain close to historically low levels. This is a feature that several producers have already drawn attention to in their Q2 conference calls but it is not one that has reached the surface of day-to-day trading on the LME, where still-high inventories allow technical bears plenty of lee-way to keep prices under the cosh. The size of that technical short position, though, is huge and it is starting to look increasingly risky given the continuing slide in stocks everywhere but on the LME itself. The legion of bear technical funds would do well to start paying heed to the under-currents in aluminium’s fundamental dynamics or they could be in for a nasty bout of risk reduction of a very different kind.