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FOCUS: Proposed LME Metal Warehouse Changes Likely to Affect Physical Premiums

By Debbie Carlson of Kitco News
Tuesday July 16, 2013 12:27 PM

(Kitco News) - Proposals by the London Metal Exchange to improve warehouse withdrawal times could have several implications for the base metals markets, with curbing physical premiums one of the most visible.

Earlier this month the LME, the world’s largest metals exchange, laid out a plan to improve delivery of stored metal from its network of warehouses. Metals users have complained for a few years now about waiting times to access stored metal, as some waits exceed 100 calendar days. Users said the delay in deliveries have pushed up premiums, particularly for metals like aluminum and copper.

Among the proposals are that warehouses must ship out more metal than they take in, based on a formula, the LME said in its proposal. The exchange is meeting with market participants now through Sept. 30 and the LME’s board of directors will discuss the plan in October. If approved, the new plan would be effective as of April 1.

The LME has a network of 765 warehouses, but several are heavily backlogged in moving out metal, particularly aluminum, analysts said. For instance, the line to move aluminum out of the LME warehouse in Vlissingen, Netherlands, is 365 days.

 “The LME believes its latest set of proposals will shrink existing queues in the medium term and prevent sustained long queues from forming in future. In theory, we agree, but in practice we are not so sure and this proposal could have unintended consequences,” said Robin Bhar, Head of Metals Research at Societe Generale

Several analysts said the biggest impact will be lowering the premiums paid on physical metal to store in the warehouses.

Barclays’ analysts, citing a report in the trade publication Metal Bulletin from last week, said already this is occurring, with the owner of Detroit warehouses cutting the premium to store aluminum by $30 a metric ton, to $195.

Analysts at Deutsche Bank agreed that the physical premiums would fall as the lines shorten to move metal out of storage. However, the premiums are likely to stay strong during the time market participants discuss the proposal and its implementation, which will be several months. Because of the time it takes to review and implement changes, changes to warehouse load-outs won’t happen rapidly, they said.

The impact the new proposals could have on spot prices is less certain, Bhar said. Spot prices could be pressured if there is a faster flow of metal from the warehouses, assuming it is not headed for a private warehouse or a financing deal, he said. However, he added, prices could be supported on the idea that movement of metal out of warehouses creates the idea of “artificial supply and demand,” he said, meaning that reduced volumes in warehouses give the illusion of demand.

The new proposal would also affect time spreads, Barclays analysts said. Time spreads are when an investor simultaneously enters a long (buy) and short (sell) position in the same commodity, but during different delivery months. Time spreads are sometimes called calendar spreads.

“Investors with short futures positions may find it more difficult to physically deliver against their position if warehouses in the location where they hold metal refuse to take delivery. This could lead to exaggerated backwardations, as short positions may have to be rolled forward or closed out using futures,” Barclays said.

If more metal comes out of the warehouses faster, aluminum smelter closures could increase, said both Barclays and Deutsche Bank. Aluminum prices are low and metals analysts said the market will likely be oversupplied for some time. Deutsche Bank said many producers are just at the marginal cost of production when combining the current spot price and physical premiums.

“The key question is whether the decline in premiums will result in the acceleration of closures announced by both the Chinese and non-Chinese producers,” they said.

If the proposal goes through, it may push an additional 2 million metric tons per year of smelter capacity into the red, Barclays said. For every $50 per ton fall in premiums, another 1 million tons annually of output capacity would be hit, they added.

“Subsequently, we would argue that in the medium term this could have potentially bullish implications for aluminum prices. However, we estimate that the equivalent of 5% of global production would need to be cut to restore inventories to ‘normal’ levels. Also, there is often a lag between the economic signal and a smelter finally cutting production so we would not expect the supply response to be immediate,” Barclays said.

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By Debbie Carlson of Kitco News; dcarlson@kitco.com,

Disclaimer: The views expressed in this article are those of the author and may not reflect those of Kitco Metals Inc. The author has made every effort to ensure accuracy of information provided; however, neither Kitco Metals Inc. nor the author can guarantee such accuracy. This article is strictly for informational purposes only. It is not a solicitation to make any exchange in precious metal products, commodities, securities or other financial instruments. Kitco Metals Inc. and the author of this article do not accept culpability for losses and/ or damages arising from the use of this publication.
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