London metal traders are still trying to extricate themselves from last month's "demon nickel" farce, but there may not be much time for them to recover: metal inventories on the London Metal Exchange (LME) have fallen to dangerously low levels and prices for everything from aluminium to zinc are likely to rise further.
Available inventories of LME's six major metals contracts have fallen to their lowest level since 1997, according to Bloomberg. The state of multiple metals is frightening: Goldman Sachs warns that copper is "sleepwalking towards inventory depletion"; free-flowing zinc banks have fallen by more than 60 per cent in less than three weeks; and nickel itself is at risk of further instability.
"at the moment, the London Metal Exchange seems to be facing a new squeeze every week," Michael Widmer, head of metals research at Bank of America, said in a telephone interview.
Low inventory aggravates the risk of short selling
With global industrial activity recovering after the outbreak last year, LME metal inventories are already falling, while global logistics and shipping systems are still in disarray.
In Europe, metals such as aluminium and zinc are under particular pressure as soaring electricity prices make some smelters unprofitable and close their doors. At the same time, supplies from large Russian metal producers are becoming less desirable and more difficult to transport in the wake of the recent conflict between Russia and Ukraine.
Low exchange inventories make the market more vulnerable to short selling. In physical delivery contracts, as in the history of LME, every short position held until the contract expires must be delivered in physical metal. In the case of LME, these physical metals must be stored in the LME warehouse in the form of registration.
When LME inventories are low, traders with short positions have less registered metal available to deliver, so they must either bring new metals into LME warehouses or close their positions by buying LME contracts, if the world is also in short supply. And the latter this kind of competition to buy contracts, is precisely the trigger to force the short market.
Although LME recently scrapped the requirement for holders of short positions to deliver metal immediately, the penalty for non-delivery-the daily equivalent of 1% of the contract value-is still severe.
The continuous reduction of inventory has brought more and more problems to LME and its users. The exchange faced fierce criticism last month for its improper handling of the epic nickel short market. At the time, the exchange suspended market trading and cancelled billions of dollars of trading after nickel prices soared 250 per cent. British regulators launched an investigation into LME this week.
At the same time, as investors and traders have recently reduced their exposure, open positions in the overall market have fallen, and LME metals trading is facing the risk of increasingly volatile price volatility against the backdrop of shrinking liquidity.
Metal market "undercurrent surging"
Trafigura, the commodity trader, and other companies are withdrawing large amounts of zinc from Asian warehouses approved by the London Metal Exchange to make up for their own supply shortages after production cuts in Europe, according to people familiar with the matter.
Orders for zinc extraction from LME warehouses have risen by more than 45000 tonnes since the end of March, bringing the metal's available inventory to its lowest level in more than a year.
LME said the exchange had noted the current tension in zinc. It is closely monitoring all metals to ensure that market activity remains orderly, it said in a statement.
The recent sharp decline in zinc stocks clearly bears parallels with a similar decline in copper stocks last year, when available copper stocks fell to their lowest level since 1974, sparking supply panic.
In recent weeks, the LME has overhauled its rules, in part to address the risk of running out of inventory, including the introduction of rules that allow holders of short positions to avoid delivery. In the wake of the "demon nickel" scandal, LME now caps its metal prices by 15 per cent in a day, and the exchange requires banks, brokers and their clients to provide more transparent over-the-counter positions.
These measures are likely to slow the rise in metal prices, but many analysts still believe that metal prices will continue to rise rapidly in the future as shortages in LME and the broader spot market intensify.
As inventories fall, copper prices, which are now near all-time highs, will easily soar further, Goldman said on Thursday.
"Copper is sleepwalking towards inventory depletion," Goldman Sachs analysts led by Nicholas Snowdon said in an email, referring to the risk of complete inventory depletion. "We believe that higher prices are inevitable-only in this way can we stimulate more scrap copper supply and accelerate demand disruption to balance the market."
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