Traders Scramble for Aluminum in a World Saturated With Supply

  • Aluminum borrowing fee jumps to highest in almost four years
  • One company holding at least $952 million worth of metal

The world is awash with aluminum, but on the biggest metals bourse it can be hard to get.

At one point this week, the metal was so scarce on the London Metal Exchange that traders paid the highest fee in four years to roll forward their short positions for one day. That shows the difficulty of buying back aluminum in a market where warehouse inventories are shrinking and one company controls at least half of the available stockpiles and short-dated positions.

The difficulty that metals traders experienced in finding aluminum on the LME may seem odd considering the abundant global supply of the metal. Harbor Intelligence estimates more than 13 million tons of aluminum are held in warehouses outside the LME’s network, enough to supply the U.S. for at least two years.

The problem comes down to a complex, but popular trading strategy on the LME that’s dominated the aluminum market since the financial crisis. It works like this:

Traders have amassed large quantities of metal in warehouses outside the LME to take advantage of a market in contango. They use a strategy known as a cash-and-carry trade that involves buying short-term contracts and sell later-dated ones to capture a profit from the spread.

The aluminum contango has shrunk since March, and some contracts even shifted into backwardation this month, making the strategy unprofitable.

So when the long-term short positions expire, traders either have to deliver metal on the exchange or cover by buying metal on the LME. When there’s not a lot of metal available, they can get squeezed, which is what happened this week.

"It’s the rush to cover, the rush to close those positions," Jorge Vazquez, Harbor’s managing director, said by phone. "The bottom line is that there is not enough metal in the LME system. There are so many shorts that are part of those financing deals that are expiring in the same date, that that is intensifying the situation."

"The backwardation is getting worse because of this heavy concentration of shorts that are expiring," Vazquez said. "There is not enough metal to satisfy their demand for warrants to close their positions."

Aluminum for immediate delivery was at a $1.50 a ton premium to the contract for delivery in three months on Thursday. Last week, it reached as high as $13.75. That compares with a discount of $19 in September.

The fee to borrow aluminum for a one day was $1 a ton on Tuesday. It jumped to $18.15 the day before, the highest since December 2012.

One company held 50 percent to 79 percent of available inventories and short-dated long positions as of Nov. 21, according to the latest LME data. The exchange doesn’t disclose the name of the company behind the position. It requires holders of large positions to lend back the metal at fixed rates.

At current prices, the stockpiles controlled by the single company are worth at least $952 million, data compiled by Bloomberg show.

At the same time, there is a big shift in the aluminum market to store metal in warehouses outside the LME’s network. Because of logjams and long wait times to retrieve metal in the past, the exchange introduced new rules and tightened its oversight of inventory.

That means it’s often cheaper to keep aluminum in facilities that aren’t monitored by the exchange. LME-tracked inventories have fallen 26 percent this year to near the lowest level since December 2008.

"There is no physical shortage of aluminum," Steve Hardcastle, Sucden Financial Ltd.’s head of industrial commodities client services in London, said by phone. "There is a confluence of large positions. That’s the story."

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