FOCUS - Anger mounts over JP Morgan's squeeze on LME aluminium spreads

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Perrine Fayeperrine.faye@fastmarkets.comDeputy Editor-in-Chief; Head of Physical+44 (0) 20 7337 2140

London 23/10/2015 - The tightness in LME aluminium spreads, which has been in place for most of the year despite evident oversupply on the global market, is a source of growing frustration.

The industry's traditional discretion about who has been 'having a go' has been eroded: all are now openly pointing fingers at JP Morgan and are calling on the London Metal Exchange to act.

"It's a one-guy story now - previously several players were mentioned but no one else but JP Morgan is long LME spreads now," a trader in Asia said.

JP Morgan Chase & Co, which has not breached any LME regulation, declined to comment.

LME spreads were in backwardation in March-April this year and again in August-October and, while the nearby rates are now back in contango, the January-February dates look vulnerable to further tightness.

Spreads around the Jan-Feb dates were last between $1.4 backwardation and $6 contango while the benchmark cash/three-months spread is at $36 contango. Full-financing costs to hold onto aluminium stocks stand around $40 contango per quarter, according to market participants.

In the LME forward bandings data, the January date shows a major long holding more than 40 percent of the open interest, two longs at 5-9 percent at three shorts at 5-9 percent.

"JP Morgan is feeling the heat - now that the name is out, it may be difficult to do it again in Jan-March," another trader said.

"JP Morgan can't keep doing what they're doing - they are probably not going to squeeze as hard in March," a third trader said.

For quite some time, one entity has been holding between 50 percent and 79 percent of all warrants, Tom/next and cash positions.

JP Morgan does not have a proprietary business in base metals; instead, the US bank executes trades on behalf of its clients. It sold its physical commodities business last year, in part to Mercuria, but has continued to trade LME warrants and derivatives as well as finance stocks.

"There could be a degree of market envy," an industry source acknowledged. "The aluminium market is not working in the way many people would want it to but JP Morgan has found a way to make money."

There has been a series of changes in the aluminium market following the introduction of LME rules designed to reduce warehouse queues at a time when China started to export large tonnage of metal and global demand weakened in line with economic growth. This all combined to drive prices, premiums and warehouse incentives sharply lower.

Today, the market remains in substantial surplus but the excess metal mostly stays off-exchange in long-term financing deals, making it harder for holders of short position to find liquidity to delivery at settlement.

Still, some market participants have called for the LME to intervene and look at introducing position limits in addition to its current lending guidance system to put an end to the recurring technical tightness in aluminium.

Under the LME's lending guidance, a market participant can build a large position but must be prepared to lend at flat rates when the position becomes prompt if the latter exceeds 50 percent of warrants, TOM and cash.

Until now, the dominant long in aluminium has been able to comply with these rules either by rolling its positions prior to it becoming prompt or lending at flat rates when necessary - probably helped by the easy and cheap availability of money amid record low interest rates, industry participants noted.

"If there is only one long then they can be brave - I guess they have the money to pay the margin calls. The gross long is nearly 9 million tonnes or $13.5 billion in value. Thank goodness for cheap money," FastMarkets analyst Will Adams said.

Others in the market have suggested that the LME's forward bandings report should become live rather than being published two days in arrears as it is currently the case. Doing so would make the data more relevant and useful, allowing short position holders to be better prepared ahead of settlement, they claimed.

The LME has become too preoccupied with reducing or preventing warehouse queues and too nonchalant about technical squeezes on spreads, some industry participants said, even though the effect on pricing and liquidity was far worse.

"The LME will be on the back of anyone cancelling a large tonnage in case the intention is to feed the queue. But they don't seem to do much about someone messing with LME spreads," a trader said, calling for the technical squeezes to be investigated.

"The recurring tightness discourages CTAs and physical players to trade," another source noted.

Commodity Trading Advisor (CTA) funds are a major target because they typically roll their positions forward every quarter, which is when technical tightness has occurred this year.

The tightness has also affected stock movements both on the LME and off-exchange. LME inventories have dropped to 3.08 million tonnes from more than 4.2 million tonnes at the start of the year despite slowing demand, with metal being booked off-exchange with cheaper rent deals or more recently in long-term financing deals.

"Metal is being locked away for several years under fresh financing deals - the Dec-Dec spreads are not great but at $60-70 per tonne they are enough to make money and above all avoid exposure to the squeezes," a trader said.

The price, meanwhile, has fallen to multi-year lows below $1,500 on the LME - it was last at $1,514 per tonne.

The latest LME commitment of traders report showed the net long position among money manager dropping to 63,926 lots from 80,633 lots at the end of September via 6,985 lots of short selling and 9,722 lots of long liquidation.

The shorts hold 295,704 lots and the longs 359,630 lots, giving a net long position of 63,926 lots. This is down from a peak this year of 121,844 lots seen in February.

The low was 39,020 lots late in August, when prices spiked down to $1,506. The largest the short position has been this year was 322,443 lots, seen in early August.

(Editing by Mark Shaw)
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