'Normal Service' Back After A Long Gap
Something like 'normal service' was resumed on the London Metal Exchange (LME) copper market as this week drew to a close, after a long period in which concern about technical supply tightness had been distorting forward price patterns.
Having negotiated the last of the severely squeezed delivery dates the cash price subsided relative to the forward contracts, re-establishing the normal 'contango' situation, in which forward positions trade at premiums to the cash price.
Such premiums "" reflecting the storage and insurance costs avoided by buying forward and the interest income gained (or interest cost avoided) on the extra money a cash purchase would have required "" have only been seen very briefly and on a very marginal scale since early in 1995.
For virtually all of this period the market has been in backwardation "" so called because it is a reversal of the normal pattern "" with the cash price carrying the premium.
When a backwardation appears it is usually a reflection of fundamental supply tightness, with stocks low and the supply/demand balance in deficit. But that has certainly not been the case over the past 12 months, a period that saw stocks held in LME registered warehouses rise by nearly 70 per cent to 275,775 as of early this month. (Ironically, the return of the contango has coincided with a modest downturn in LME stocks "" they have fallen back by about 10,000 tonnes).
The tightness that has been distorting the market has been largely technical, reflecting futures and options operations that have left the 'shorts' periodically scrambling to meet their delivery obligations, or having to stump up exorbitant 'borrowing' charges to carry positions forward.
The cash/three months delivery backwardation peaked last December at about $330 a tonne, a level that alarmed the LME sufficiently for it to impose a limit on the cost of carrying forward 'short' positions. That level proved exceptional, but the premium
remained close to $100 a tonne before narrowing from mid-August.
The emergence of the new price pattern (or rather the resumption of the normal price pattern) began after Monday's pricing operations ahead of the third Wednesday settlement date removed previously tight delivery dates from the market's price structure.
While short-covering helped to boost the overall level of LME copper prices, the cash premium narrowed to the point of extinction and then turned into a discount.
At Saturday's close, cash copper stood at $1,899 a tonne, up $5 on the week, while the three months price was at $1,910.50, up $36 on the week.
Meanwhile forward price spreads at the end of this year and early in 1997, were narrowing significantly.
People are lending (exchanging positions for cheaper ones at longer dates) to get these backs (backwardations) before they go.