Dominant holder highlights problems in aluminium market

For years buyers of aluminium have put the metal in warehouses, borrowed against it, and waited for prices to rise. It was an obvious trade.

Now the metal is finally starting to leave warehouses, but much is still held up in long queues. That has opened up space for large trading bets that have raised questions over how efficiently the market is functioning.

Aluminium is one of the world’s most important metals, used in cars to cans and aeroplanes and valued for its lightweight properties. It is being used increasingly by US carmakers to meet fuel-efficiency standards. The London Metal Exchange acts as a source of metal at times when aluminium is in short supply elsewhere.

Exchange data shows that at the end of November one entity had accumulated an aluminium holding of between 50-79 per cent of the metal on the LME, the world’s largest metals exchange. The appearance of a dominant holder highlights how persistent problems with the working of an official warehouse system have allowed for the placing of large trades.

These trades, which are effectively bets on the spread between spot and futures prices, could also give holders increasing influence over prices just as demand for aluminum has picked up due to rising use by the car industry, while supply has tightened following the closure of smelters.

The dominant holder drove the November 27 spot price $31 higher than the price for delivery in three months, the highest spread since December 2012. It has since come back down, as rumours that one large trading house had been squeezed by the dominant holder faded.

“Queues restrict the lending capacity of the market, which leads to a further tightening of the available liquidity,” Robin Bhar, an analyst at Société Générale says.

Stocks of aluminium on the LME have fallen 21 per cent this year to 4.3m tonnes, yet over half of that is sitting in warehouse queues waiting to be loaded out. The actual so-called “free float” metal, in storage and available to trade, is even smaller, say market particpants.

In LME warehouses in Detroit, for example, only 16,075 tonnes of stock are in storage, whereas 928,700 tonnes are waiting in the queue.

“The person who is effectively building the dominant position only has to go for the free float, and you remove the liquidity from the LME,” one trader says. “By definition you control all the stock that is freely available.”

The dominant holding in aluminium has mirrored what has happened in the copper market, where a single entity has also accumulated a majority holding, starting in September.

The aluminium market has been the subject of heightened scruntiny in recent years. During a hearing of the US Senate investigation into banks’ commodities business this month, investigators queried how Goldman Sachs came to own about 1.5m tonnes of aluminium in 2012, worth $3.2bn, and more than 25 per cent of annual North American consumption at the time. Goldman said it had acquired the large position to meet demand from clients.

Low interest rates after the financial crisis and a market that has spent long periods in “contango” — where futures prices are higher than current ones — led to mass storage of aluminium in warehouses. Buying and borrowing against the metal and paying warehouse rents while waiting for higher prices provided relatively risk-free returns of up to 7 per cent.

Users of the metal have claimed that this inflated costs for consumers, and reduced metal for actual consumption.

Indeed, premiums for delivery of physical aluminium in the US, Europe and Japan have risen to record highs this year. Queues for warehouses in Detroit owned by Goldman Sachs and by mining company Glencore in the Netherlands are still over 550 days.

Analysts say this is nothing to worry about as the market self-corrects after the appearance of a dominant holder. In addition LME rules require that holders with positions greater than 50 per cent must lend metal at fixed rates.

“The LME constantly monitors its markets to ensure that trading is orderly,” the LME said in response to a question on aluminium.

The LME has also vowed to reduce queues and next year will introduce a contract allowing users to hedge the high aluminium premium. Yet the reduction in queues in Detroit and in the Netherlands is likely to take years, analysts say. Large holders are also likely to continue to appear to squeeze the market.

“From a historical standpoint things are definitely not back to normal. The LME for the consumer remains dysfunctional,” Jorge Vázquez, managing director of Harbor Aluminum Intelligence, says. “Today consumers can’t really use the LME as a market of last resort. Maybe conceptually they can but in practice they can’t.”

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