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Trade war fatigue saps global base metals activity: Andy Home

The base metal markets are suffering from trade war fatigue.

Trading activity fell by 7% on the London Metal Exchange (LME) in the first half of this year as robust micro fundamentals were subsumed by the rumbling stand-off between the United States and China.

It’s not just London. Activity on the CME copper contract has fallen as well and even Chinese speculators appear to have largely given up on the base metals for now.

In a world of twitter politics, uncertainty rules and money has evidently left the sector for more exciting markets such as gold and iron ore.

The question is what might bring it back.

The base metals complex has been exhausted by the trade war rhetoric, according to Dr Guy Wolf, global head of market analytics at LME broker Marex Spectron.

It’s trapped in a reactionary state, “whereby every headline or tweet is seen as potentially meaningful yet, in practice, has been ultimately meaningless,” Wolf wrote in a July 3 note.

The news flows that sparked trade activity last year now lead only to “inertia and paralysis”, according to Wolf, who concludes that for base metals such as copper and zinc “the risk reduction has already taken place”.

Industrial players are standing aside, leaving much of the trading activity to what Wolf calls an “increasingly broad spectrum of quantitative strategies” and the rest of us would call “the algorithms”.

The current state of metallic play is clear to see from the LME’s first-half volume figures.

Total chargeable volumes, including unallocated trades, fell by 7%, or 6% on an average daily basis, over January-June. Only three smaller contracts saw trading grow relative to last year – tin, aluminium alloy and cobalt.

All three are below the investment radar and therefore partially insulated against macro turbulence. In the case of both tin and alloy, higher volumes accompanied time-spread squeezes.

Aluminium, the exchange’s most liquid contract, saw activity slide by just 3%, a respectable performance given last year’s volumes were boosted by extreme turbulence in April thanks to U.S. sanctions against Russia’s Rusal.

Investor favourites such as copper, zinc and nickel, by contrast, all saw activity contract by 9% in the case of the first two and by 10% in the case of nickel.

The LME, which last year turned around a previous three-year activity decline with underlying volume growth of 5%, finds itself collateral damage in the broader trade dispute.

The CME’s copper contract has seen significant fluctuations in speculative positioning as funds have tried to second-guess the outcome of the dispute, but that didn’t prevent copper futures volumes tumbling by 27% relative to 2018.

Base metals are equally out of favour in China.

The Shanghai Futures Exchange’s (ShFE) copper contract saw volumes contract by 24%. Activity across the ShFE base metals board was down with the single exception of zinc, which saw a 23% rise in trading.

Some Chinese punters may well have turned to the booming iron ore market, which has been on a turbo-charged rally this year on a combination of strong Chinese construction demand and disruption to Brazilian supply after Vale’s tailings dam collapse in January.

Trading activity on the Dalian Exchange’s iron ore contract picked up significantly from May with June volumes and open interest up 39% and 31% year-on-year respectively.

Surging prices have generated an investment crowd surge with steel-makers now calling for Beijing to “sustain market order”. It’s a reminder that on Chinese commodity exchanges liquidity can be a double-edged sword.

Iron ore fever spread to the Singapore Exchange, the major trading hub outside of China. Iron ore futures volumes mushroomed by 48% over the first half of 2019 and options by an even greater 86%.

The LME doesn’t offer an iron ore contract but is betting that it can get a foothold in the steel supply chain with the launch in March of two new hot rolled coil (HRC) contracts, expanding its ferrous suite to four.

The existing rebar and scrap contracts appear to have stalled so far this year but the new products for Chinese and North American steel saw a liquidity jump in June with volumes of 2,135 lots and 1,505 lots respectively.

A potential arbitrage beacon is the CME’s HRC steel contract, where volumes doubled in the first half of the year to the equivalent of 2.2 million short tons.

That’s the strongest trading performance since the contract was launched in 2010 and suggests futures trading is making gradual inroads in the world of steel pricing.

While the LME nurtures its ferrous products, the exchange remains heavily reliant on its established base metals suite.

And most of these are drifting in price with all but nickel, the outperformer, trading near year-start levels.

There is no defining theme to trade other than the exhausting on-off U.S.-China trade talks.

What might change, assuming no imminent resolution to the core U.S.-China dispute and its multiplying tariff effects?

Analysts looking for a fundamental stimulus, such as those at Citi, are pinning their hopes on China and renewed acceleration in total social financing, a wide net thrown to capture all sorts of credit flow. It was up by 30% year-on-year in the five months to May. (“Metals Weekly”, July 8, 2019)

China’s credit impulse, according to Citi, “is by a country mile the best lead indicator of an upturn in the global cycle over the past decade.”

The bank advises investors to wait for further impulse growth before “buying metals aggressively.”

Marex Spectron’s Wolf takes a more quantitative approach and argues that a surge in global trading liquidity at the start of July has already opened up the “best buying risk-reward for base metals so far this year.”

The broker’s “Liquidity Index” has been “an excellent leading indicator” for copper in recent times, suggesting “some positive months ahead” for many funds’ favourite base metals play.

There are more nuances to Wolf’s copper call, particularly in terms of timing, but his quant’s view boils down to one simple market truth.

While no-one can predict the outcome of the trade wars, “the time to bet on a positive scenario is when all hope has been lost.”

The world’s big three metal exchanges, first and foremost that in London, can only hope he’s right because a continuation of first-half trading patterns promises more “inertia and paralysis” ahead.
Source: Reuters (Editing by Jane Merriman)

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