MI WEEK IN REVIEW: Short-term pain, long-term gain for aluminium?

"Contagion" was the buzz-word in the markets last week, with fears resurfacing about the fall-out from the troubled US sub-prime mortgage sector. New financial casualties were claimed—Germany's IKB joining the growing list—stock markets crumbled and more money flew to safe havens such as US Treasuries and the yen. All the LME markets were caught up in the latest bout of risk aversion, particularly on Friday itself when technical bears went on the attack across the complex. But in the case of aluminium, the latest global jitters seem to have just accentuated an already strong trend—the out-performance of long-dated prices relative to short-dated ones. Pain First the pain bit. LME 3-month aluminium's early-week strength—thanks to stronger copper and a temporary lull in the sound of crunching coming from the credit market—lost momentum at first pegged resistance at the $2,760-2,770 level. The subsequent drift back on Wednesday and Thursday was limited to immediate support at the $2,720 level. But the cross-complex late-Friday bear attack saw that level broken and a super-fast slump all the way to $2,640 and a weekly close at $2,645. London locals had been eyeing the stock markets with increasing alarm as the week progressed and it seemed no coincidence that the Friday afternoon slump coincided with a sell-off in the S&P 500. Technical funds had already been lifting their short exposure after the early-week failure at resistance and they simply surged through the technical gap on Friday. Our sources now estimate the CTA systematic fund community has lifted its collective short positioning to around 65% of historic capacity last week—which is possibly the biggest it's ever been in this part of the cycle. Technical funds can keep upping the ante without fear of any nasties lurking in the nearby spreads, unlike several of the other LME metals. The cash-to-3-months contango flexed a little wider still last week to $61.25 at Friday's valuations. Short-term supply is not an issue apparently with LME stocks hovering near four-year highs and total exchange stocks (LME plus NYMEX plus Shanghai) rising by 32,461t to 897,438t over the course of July. The year-to-date net increase now stands at 158,945t, which seems to conform to the consensus view—reiterated by Alcan on its Q2 results conference call—that the market is due to record a modest 200,000-300,000t surplus this year. Short-dated aluminium seems to be implying the same thing. Friday's close marked a $110 decline, hot on the heels of the previous week's $101 decline. Three-month metal is now showing a year-to-date decline of $158, or 5.6%. Gain But Alcan also drew attention on its conference call to the relative out-performance of far-dated aluminium. This, it suggested, reflected "the longer-term outlook for higher energy costs and increasingly high cost structure of smelters in China". Remember that even with rapidly accelerating production growth this year China is still widely expected to switch to net importer of the light metal in the medium-term. If it does, it will mark a tectonic shift in aluminium's fundamentals and investor buying of far-dated aluminium has been around for many months now, at least partly on the gamble of that shift in trade patterns happening. However, that trend was accentuated last week with the fresh institutional money to hit the market at the start of the new month largely going into the forward part of the curve and simply by-passing the nearbys. So, while 3-month metal slumped, far-forward prices moved in the opposite direction. December 2011, for example—long a favoured month for far-forward buying—rose by $95.50 week-on-week to $2,434. The result is a further flattening of aluminium's forward curve, which has become a hot talking-point among LME locals. Will it flatten completely as happened to oil prices a couple of years ago? Or even move to contango structure? No-one seems very sure, but with investment money still flowing freely into the back end of the curve and some big battles between funds being fought out there, the short-term betting seems to be that there is further shape-shifting potential in the light metal's market structure. Right now aluminium is managing to be both bearish (short-term) and bullish (long-term) without any apparent tension between the diverging trends. Very curious indeed…