October 12, 2018 / 12:36 PM / in 5 days

Commentary: LME Week metals puzzle is how to trade a trade war

LONDON (Reuters) - Donald Trump didn’t make it to LME Week, the annual jamboree of the global metals trading community.

File photo: An employee walks along aluminium ingots at the foundry shop of the Rusal Sayanogorsk aluminium smelter outside the town of Sayanogorsk, Russia. REUTERS/Ilya Naymushin

But the U.S. president was the hot topic at the myriad seminars, cocktail parties and private meetings across London this week.

The industrial metals traded on the London Metal Exchange (LME) have found themselves at the heart of the escalating trade tensions between the United States and China.

Physical supply chains have been stressed by tariffs and, in the case of aluminum, by U.S. sanctions against Russian producer Rusal.

Futures prices have been rocked by waves of speculative selling since the first round of trade tariffs was announced in June.

The tension between macro doom and micro strength in markets such as copper has become extreme.

Chile’s mining minister, Baldo Prokurica, summed up the views of many this week when he said: “Were it not for the trade war between the U.S. and China, we would have a much higher copper price.”

The trade war, however, cannot be wished away. Indeed, it shows every sign of intensifying in the short term.

The big question for the metals industry coming out of this year’s LME Week is how to trade that war.

PHYSICAL SUPPLY CHAINS SHOCKED BUT ADAPTING

The aluminium market has been weaponised this year, creating chaos in a traditionally super-efficient physical supply chain.

April’s U.S. sanctions against Oleg Deripaska and his Rusal empire ricocheted in multiple unexpected ways, at one stage threatening the closure of Western European smelters.

Aluminium along with steel was then used to fire the opening salvo in the trade war as the United States imposed 10-percent import tariffs on national security grounds.

China’s first retaliatory response included a 25-percent tariff on imports of aluminium scrap from the United States.

That, according to CRU’s Greg Wittbecker, speaking at the research house’s Tuesday seminar, has “killed” the flow of scrap between the two countries.

China imported 620,000 tonnes of U.S. material last year.

The back-up effect in the United States has been a collapse in the value of scrap relative to primary aluminium, according to Wittbecker. If you’re in the automotive scrap business, you’re trading like it’s the Global Financial Crisis of 2008-2009.

The scrap link in the aluminium supply chain is partly broken. Other parts of the chain are rapidly shifting shape as buyers collectively de-risk and rethink security of supply.

Everybody expects the sanctions against Rusal to be lifted some time between the U.S. mid-term elections on Nov. 6 and the extended deadline of Nov. 12. The aluminium price certainly thinks so. At a current $2,040 per tonne, it is almost exactly where it was before sanctions sent it rocketing to a 7-year high of $2,718.

However, the removal of sanctions will not change the hostile political landscape between the United States and Russia. Russian aluminium carries a new political risk going forwards.

Which is why Japanese buyers have been turning away from Russia towards India this year, imports from that country doubling in the first eight months.

And why Rusal itself is looking to expand its sales and marketing presence in China.

It’s not just the aluminium supply change that is having to adapt to the new reality of politicised markets.

Chile’s Codelco, the world’s largest copper producer, and China’s state-owned Minmetals, are looking to transform their current annual supply contract to a rolling three-year “evergreen” arrangement.

Supply security concerns are combining with the metals industry’s growing focus on sustainability to change physical producer-buyer relationships.

FUNDAMENTALS FIGHT-BACK?

In the metals futures market the trade war impact has come in the form of waves of fund selling.

The LME base metals have been trapped in a bear tariff narrative of dollar strength and weakened growth in China, a double-whammy of bad news for the likes of copper.

The LME base metals index slumped by 19 percent between June and September.

It has since stabilised and just about every metals analyst thinks the sell-off has gone too far and it is time for a fundamentals fight-back.

“Base metals are pricing in near a worst-case scenario on global growth,” JPMorgan’s Natasha Kaneva told the LME’s Monday Seminar.

The copper price, according to CRU’s Vanessa Davidson, has been “driven by investor positioning not fundamentals”.

Zinc, agreed Macquarie Capital’s Vivienne Lloyd, “has been beaten up the most” but “we like it nearby – it’s a really tight metal situation.”

And everyone still likes nickel, even if it has lost some of its recent electric-vehicle lustre as it too has succumbed to the broader sell-off.

This tension between robust internal supply-demand dynamics and investors’ negative view of base metals in the current tariff climate is currently playing out in LME time-spread tightness.

There are backwardations in the LME copper, lead and zinc markets right now with aluminium trading at a pinched contango.

TRADING THE TRADE WAR

However, if this LME Week’s mood has been cautiously upbeat for metal prices, Wednesday’s spill-over sell-off from collapsing stock markets was a chill reminder of the darkening storm clouds ahead.

The metals markets can take comfort from the current robust fundamentals and the promise of more to come from China’s use of infrastructure investment to cushion the impact of U.S. tariffs.

But this will be no re-run of the boom of 2008-2009. China is still deleveraging from that bonanza. This version will be more targeted and less ambitious, a stabilisation exercise.

Together with ominous signs of a slowdown in global growth, the cautiously bullish timeline runs out around the middle of next year. After then JPMorgan’s view would be “to get out of risk markets”.

Moreover, no-one’s holding out for a quick resolution of the trade war.

If it were just about trade, China’s ready to do a deal, in the opinion of Charles Li, chief executive of the LME’s owner, Hong Kong Exchanges and Clearing.

But “the America we thought we were talking to is not the same America that is now talking to us”.

This is no “classic trade war”, James Kynge of “The Financial Times” told the same LME Seminar, but rather “a strategic rivalry across many fronts.” And one that is only going to intensify, in his opinion.

There were few in London this week, including the many Chinese visitors, who would disagree.

Learning how to trade the trade war has only just begun for the metals sector.

The opinions expressed here are those of the author, a columnist for Reuters. 

Editing by Adrian Croft

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