(The opinions expressed here are those of the author, a columnist for Reuters.)
* LME copper stocks and spreads: tmsnrt.rs/2F4thXU
* LME copper stocks in S Korea and spreads: tmsnrt.rs/2CTha9Y
By Andy Home
LONDON, March 2 (Reuters) - The London Metal Exchange (LME) copper price has risen 26 percent since the start of January 2016.
That month saw a five-year downtrend bottom out at $4,318 per tonne. Three-month copper on Friday was trading above $6,900.
The lift in price has been part of a broader revaluation of the base metals complex but also reflects specific concerns about the potential for supply disruption to mined production and scrap flows this year.
What’s curious, however, is the movement in LME copper time-spreads over the same period.
The benchmark cash-to-threes period CMCU0-3 was pretty much flat back in January 2016. As of Thursday’s close it was valued at a contango of $35.50 per tonne.
Barring two flips into backwardation, one in September and one in December 2016, the trend has been one of widening contango.
There’s no cast-iron rule that rising prices must be accompanied by tightening time-spreads, but the level of copper contango is still an increasingly anomalous bear signal in a generally bullish picture.
Graphic on LME copper stocks and spreads:
Graphic on LME copper stocks in South Korea and spreads:
Within the broader pattern of loosening time-spreads on the LME copper contract, one period stands out.
In September last year the LME cash-to-three-months contango flexed out as wide as $60 per tonne, a level unseen in at least a decade.
Oliver Nugent, analyst at ING, argues that this unusually wide contango points to a specific driver in the form of LME stocks stored in South Korea. (“Copper: what’s it going to take to flip the curve?”, March 1, 2018)
The steady ratcheting up of tensions on the Korean peninsula over 2016-2017 coincided with a sharp rise in the amount of LME-registered copper stored in South Korea.
As insurance and financing costs rose in tandem with the escalating U.S. rhetoric about North Korea, “revolving stockholders hastily offloaded South Korean stock by selling nearby LME positions (which) in turn perpetuated the copper contango”.
The super-contango of September came just before a mass movement of LME stocks out of the three South Korean good delivery locations of Busan, Gwangyang and Incheon.
LME copper inventory in South Korea plummeted from over 100,000 tonnes at the start of October to just 21,150 tonnes at the end of November.
While South Korean stocks churn might explain the peculiarities of the spread in the tail end of 2017, it can’t account for the bigger two-year trend.
In broad-brush terms, the consistent lack of tightness within the LME copper spreads is a sure signal there is no shortage of deliverable metal.
That much should also be evident from the repeated “arrivals events” that have characterised LME copper stock movements over the last couple of years.
Since December 2016 there have been six such super-charged deliveries of copper onto LME warrant, the most recent occurring in January this year.
What has come into the LME warehouse network has tended to turn around and head back out in double-quick time, leaving an LME copper stocks chart looking like a badly drawn zig-zag.
It’s noticeable that the front part of the LME copper curve has largely ignored such stocks “noise”, implying that spreads have consistently priced in the existence of significant off-market tonnages that could be delivered into the LME system.
It’s also worth noting that despite all the ins and outs of LME copper stocks, part of a long-running battle between bear and bull players, total exchange tonnage has been fairly steady over the last couple of years.
At a current 324,900 tonnes, LME stocks are up by 13,075 tonnes on the start of 2017 and 85,500 tonnes on the start of 2016.
This is not just an LME phenomenon.
The forward curve on the CME copper contract is even more pronounced, the contango between the March and June contracts currently running just in excess of $100 per tonne.
That reflects what ING terms the new copper stocks “beast in the States”.
CME copper stocks, historically a marginal component of the global exchange stocks picture, have mushroomed from just 20,000 tonnes at the start of 2015 to a current 209,000 tonnes.
What started as a domestic U.S. market phenomenon morphed into a bet on U.S. trade duties and is now a major international refined copper flow.
Much of what is in the CME warehouse system is located in land-locked Salt Lake City in Utah and Tucson, Arizona.
A combination of rising freight rates and anaemic physical premiums, particularly for Chinese delivery, has effectively trapped this metal.
CME inventory and the contango structure on the futures curve could prove to be a lot “stickier” than on the LME contract, subject as it has been to periodic stocks churn.
Quite evidently, loose time-spreads haven’t stopped the outright copper price from rallying over the last two years.
They do, however, act as a braking mechanism, making it more costly for longs to roll forward positions and less dangerous for shorts to sell as well as stimulating producer forward selling.
Moreover, they are acting as a reality check on bull expectations.
The copper price is where it is at least in part on expectations of a tightening supply-demand picture, bulls pinning their hopes on the large number of potentially disruptive labour contracts to be negotiated at key mines and threats to the flow of copper scrap into China this year.
Time-spreads right now, however, are telling us there is no shortage of copper in refined, exchange-deliverable form.
This tension between spreads and outright price looks set to become more acute as the year progresses.
As ING notes, “whilst prices can and do rally without backwardations forming, it is harder to see funds sticking with the bullish copper narrative if, come Q4, markets are yet to show tightness and keeping a long position remains a costly business”.
Whether you’re bullish or bearish copper, keep an eye on the copper spreads. They’re flashing a warning sign that copper is not yet on full bull script.
Editing by Dale Hudson