(The opinions expressed here are those of the author, a
columnist for Reuters.)
By Andy Home
LONDON, Feb 13 There was a time when the global
aluminium market could be seen as two parallel universes, to
borrow a phrase coined by Klaus Kleinfeld, chairman and chief
executive of Alcoa.
There was China. And there was the rest of the world.
The great dividing wall was China's 15 percent export tax,
effectively preventing the flow of primary metal out of what was
already the world's biggest volume producer.
There was always an element of wishful thinking in
Kleinfeld's parallel vision, ignoring as it did the flow of
semi-manufactured aluminium products out of China. But in terms
of physical and paper trading of commodity-grade aluminium, the
analogy just about held, until only a few years ago.
Alcoa has since divided itself into two separately listed
companies but the two parts of the global aluminium market have
moved ever closer.
The physical export flow of "semis" has steadily increased
with over four million tonnes leaving China in both 2015 and
And, equally significantly, the two main trading venues of
London and Shanghai have started to connect, with the eastern
universe exerting increasing influence over the western.
Graphic on Shanghai aluminium: price, open interest and
THE RISE OF SHANGHAI
Arbitrage between the London Metal Exchange (LME) and the
Shanghai Futures Exchange (ShFE) has been long established in
markets such as copper.
But in aluminium it's a newer phenomenon dating to the end
That's when the Shanghai aluminium contract experienced a
step-change in usage with market open interest and volumes
At the time it looked like one of those crowd trades that
have roiled other Chinese commodity exchanges at various times
over the last couple of years.
Producers lashed out at "irrational" speculation as prices
collapsed under a torrent of short-selling.
And maybe it was.
But Shanghai's new aluminium friends have stayed with it
ever since. Volumes almost doubled last year and market open
interest remains a multiple of what it was prior to the fourth
quarter of 2015.
That in turn has generated greater connectivity with the
The clearest manifestation is the higher trading volumes
during the overlap between the Shanghai and London trading days,
according to the LME's "Insight" team of analysts.
So-called LME "Asian hours" trading jumped from five percent
of the daily total in the third quarter of 2015 to nine percent
in the fourth quarter of that year. That ratio held pretty
steady last year, averaging eight percent.
Moreover, "the LME-ShFE arbitrage has swung more
aggressively since Q4 2015 and LME prices have been more
volatile in Asian hours," particularly during times of high
Shanghai turnover, according to the LME. ("LME Aluminium: West
to East as Asian influence rises")
The precise origin of this liquidity boost is unclear.
It may well be that the increased flow of semi-manufactured
products out of China has generated increased arbitrage between
the two markets.
But as the LME's Insight analysts concede, "a genuine
increase in intraday activity suggests the relationship has
widened beyond just merchants hedging physical profits."
"On-screen traders are increasingly trading the aluminium
arb or, at least, allowing the direction of one market to
influence trading on the other."
Liquidity, in other words, begets more liquidity. This is
true of all exchanges but maybe particularly true of China where
speculators hunt in packs.
Graphic on LME aluminium stocks by region:
Working in parallel, as it were, with this increased trading
connectivity has been a steady shift in the location of LME
stocks away from the United States and Europe towards Asia.
As of the end of January over 60 percent of "live" LME
stocks, meaning those not in the form of cancelled warrants,
were located at Asian locations.
It's the highest ratio since 2007, although the historical
comparison is muddied by the fact that LME stocks were much
lower prior to the 2008-2009 global financial crisis.
This in part may also reflect that steady stream of
semi-manufactured product leaving China. If it is displacing
primary metal in the rest of the world, it is logical that the
hardest impact would be in the closest geographical region.
But in part it's also down to the LME's own policy of
targeting excessive load-out queues at some of its locations in
Europe (Vlissingen) and the United States (Detroit).
Recent tightness in the LME contract's time-spreads have
incentivised physical deliveries into the exchange's warehousing
network. With some queue-affected operators elsewhere reluctant
to take in more metal, the default delivery location has shifted
from west to east.
In terms of physical liquidity of underlying stocks the LME
aluminium contract is shifting towards China just as Chinese
exchange trading is exerting ever more influence on Western
In some ways aluminium is still catching up with other base
"Asian hours" trading of LME copper accounted for 16 percent
of daily volume last year and nickel an even higher 17 percent,
according to the LME.
Copper in particular has been periodically rocked by trading
surges on the Shanghai Futures Exchange, forcing LME traders to
wake up to the power of Chinese money when it's on the move.
Aluminium looks set to follow the same path as the two
In November last year "Asian hours" trading on the LME
aluminium contract surged to over 14 percent in response to
heightened activity in Shanghai.
"The average price range for aluminium in the London morning
more than doubled" to hit a peak of 1.2 percent, according to
the LME's Insight team.
The problem for the rest of the world, which has grown used
to aluminium's relatively low level of volatility, is that all
this is happening just as the Chinese aluminium market becomes
Now accounting for well over half of the world's production
of the light metal, future Chinese output trends are in danger
of becoming increasingly beholden to government policy.
Aluminium smelters were included in a proposal to switch off
key industrial sectors over the winter months to alleviate
Beijing's choking smog.
This is still a proposal and it remains to be seen whether
it translates into smelter cutbacks.
But if it does, you can be sure there's going to be a
reaction in the Shanghai price.
And increasingly that's going to generate a reaction in the
(Editing by Susan Fenton)