So, copper remains in a cash-to-three-month backwardation on
the London Metal Exchange.
Not that many years ago, that almost seemed like the natural
state of affairs.
But then the LME lending guidance was introduced, and the idea
of artificially created backs seemed to be a thing of the past.
So is what we see at the moment a true reflection of global
supply and demand, or are there other forces at work?
Certainly, the recent very large jump in cancelled warrants,
which now stand at 73,600 tonnes, seems to imply a level of
activity not totally connected with the physical world.
It seems likely that the purpose of that cancellation is to
adjust a dominant position to bring it below the threshold that
requires compliance with the lending rules.
The possibility of such manoeuvres has always been a weak point
in the lending guidance, but this is probably the most
pronounced example of such activity.
Does the dominant position holder own a warehouse and can it,
by judiciously managing its cancelled versus live warrants,
keep the game and the backwardation alive?
This is a big question when the power gets concentrated in an
ever-decreasing number of hands.
And there is no reason that copper should be unique. While the
warehousing and financing trade remains the only really big
game in town, I cannot see why the same pattern will not be
replicated across the metals.
And since financing and storing metal has traditionally been an
activity subservient to the trading and consuming of it, it
seems to me that this warehousing-backwardation play is an
example of the tail wagging the dog.
In other words, gone are the days when warehousing was just a
part of the supply chain - getting the metal to the right place
for it to be used.
I have stressed before that I am not criticising the
practitioners: in the particular set of economic circumstances
in which we find ourselves, it would be naive not to play the
game, and indeed would probably be a dereliction of duty to the
shareholders, whose returns are central to the business.
But the reality is that the finance/warehouse trade is the
biggest factor in the market at the moment, and that
undoubtedly changes the dynamics.
If the production of metal for delivery to consumers in order
for it to be used is of less significance than its production
simply to be stored as a buffer against government-sponsored
inflation, then it seems to me reasonable to assume that the
traditional supply vs demand dynamic of the market will also be
Thus, whereas in the past periods of high stocks would be
unlikely to provoke a backwardation, and indeed a backwardation
would be likely to attract new stocks and thus sow the seeds of
its own destruction, I don't think that is the case any more.
The conglomerates which own the metal in the warehouses - and
largely own the warehouses as well - have the financial clout
to keep the game alive for a very long time.
If prices start to drop, then by playing with their warrant
holdings they can engineer a backwardation, which will probably
also have the effect of supporting the price.
So there's a double bonus - a backwardation when you're long of
metal, and the price being held up as well.
Of course, although we may have this world to look forward to,
where prices do seem to be able to be held at levels
inconsistent with the true consumption demand in a generally
weak global economy, I do keep thinking of a historic parallel:
The banks thought they were leading us all to a new world,
where they could lend money to people who appeared unable to
pay it back, supported by an ever-rising property market, which
negated the inability of the borrowers to repay.
Now look again at the copper backwardation: a slowdown in
Chinese economic growth will be the first big sign that the gas
is beginning to leak out of the bubble; soon after that, be
ready for the banks to be crying for another handout of
billions of dollars, as they, once again, rediscover that
nothing goes up for ever.