Aluminium: Grinding higher with a self-fulfilling case from ShFE
Some factors that fuelled the market rally in 2Q20 have continued, including a stronger run in the Shanghai Futures Exchange that has propped up arbitrage buying in London, which has helped to reinforce expectations of robust China demand. We think the ShFE bull run is increasingly likely to be a self-fulfilling case
Prices still grinding higher
The strength in aluminium prices have continued with London Metal Exchange 3-month prices touching US$1,747/t yesterday - the highest since mid-February before the major outbreak started outside of China. This is in spite of the fact that the LME on warrant inventories have risen to the highest since April 2017 – the latest reported at 1.6 million tonnes and the nearby spreads had moved to a deeper contango structure.
Yesterday's strong gain was sparked by a fresh dose of optimism coming from the better-than-expected PMI reading from the US.
More promising news came from a rise in P2020 aluminium premium in Rotterdam at the latest US$90-95/t, the first time since the Covid-19 pandemic took hold of Europe according to Fastmarkets, and it noted that sellers have seen increased interest from consumers. Looking at its peer in the Shanghai Futures Exchange (ShFE), the strength there is even greater and the prices continued to climb with the most traded third-month contract prices rising by over 3.3% year-to-date.
ShFE aluminium continues to rise amid a mild decline in inventories
ShFE’s bull case – a self-fulfilling one?
Recent ShFE aluminium has maintained its buoyancy fuelled by inventories that are still on a downwards trend against expectations. In early July, we noted that if the destocking trend holds, it may lead to arbitrage buying in London – a theme that we had previously expected to continue unfolding (Aluminium: Still standing, for now). There are signs suggesting that physical flows may have continued to find its way to China in July as was the case in June.
Meanwhile, we think the ShFE bull run is increasingly likely to be a self-fulfilling case, and there may be a technical element at play. Notably, the warrants traded in ShFE are backed on aluminium ingots that have to meet a certain standard established by the exchange – it has to be able to be delivered. Some smelters, however, are reported to have been incentivised to produce more billets instead of ingots. And there are reports that some 'strong hands' are holding a large part of warrants in the market that further reduced the warrants availability in circulation. However, the physical prices have been largely in premium and the ShFE market remained stubbornly in backwardation. This suggests difficulty for the bears to roll short positions in ShFE and particularly when it comes to physical delivery. The implication is that as long as all these stay in place, there are fears of risks in shorts being squeezed, which in turn could reinforce a bull case on the ShFE paper market. Hence it seems the ShFE’s bull case is a self-fulfilling one.
But this is not without support from the billet market as inventories of this type of product have also been drawing down, and in our view, this is actually more of a convincing indicator than the primary in terms of the China demand picture, which has not yet darkened. What we fear is that even if billet inventories start to pile up, this may not lead to an immediate ‘debug’ i.e., ShFE deliverable warrants (backed by ingots) rising and hence allowing a bear trend to set in. Then it will become adverse for those strong hands who are reportedly holding a large portion of warrants if it's true. This will need smelters to be disincentivised by scaling back from billets to more ingots that are physically storable and exchange deliverable instead of billets.
ShFE aluminium market remains in backwardation
"THINK Outside" is a collection of specially commissioned content from third-party sources, such as economic think-tanks and academic institutions, that ING deems reliable and from non-research departments within ING. ING Bank N.V. ("ING") uses these sources to expand the range of opinions you can find on the THINK website. Some of these sources are not the property of or managed by ING, and therefore ING cannot always guarantee the correctness, completeness, actuality and quality of such sources, nor the availability at any given time of the data and information provided, and ING cannot accept any liability in this respect, insofar as this is permissible pursuant to the applicable laws and regulations.
This publication does not necessarily reflect the ING house view. This publication has been prepared solely for information purposes without regard to any particular user's investment objectives, financial situation, or means. The information in the publication is not an investment recommendation and it is not investment, legal or tax advice or an offer or solicitation to purchase or sell any financial instrument. Reasonable care has been taken to ensure that this publication is not untrue or misleading when published, but ING does not represent that it is accurate or complete. ING does not accept any liability for any direct, indirect or consequential loss arising from any use of this publication. Unless otherwise stated, any views, forecasts, or estimates are solely those of the author(s), as of the date of the publication and are subject to change without notice.
The distribution of this publication may be restricted by law or regulation in different jurisdictions and persons into whose possession this publication comes should inform themselves about, and observe, such restrictions.
Copyright and database rights protection exists in this report and it may not be reproduced, distributed or published by any person for any purpose without the prior express consent of ING. All rights are reserved.
ING Bank N.V. is authorised by the Dutch Central Bank and supervised by the European Central Bank (ECB), the Dutch Central Bank (DNB) and the Dutch Authority for the Financial Markets (AFM). ING Bank N.V. is incorporated in the Netherlands (Trade Register no. 33031431 Amsterdam).