(I really wish she hadn't done this)
From FT Alphaville:
Assessing the scale of metal warehouse trades
Earlier this week Morgan Stanley published an in depth look into the financing warehouse trades in metals — the ones most analysts have been in denial about (at least publicly) for at least five years — and why they are now, thanks to new LME proposals, finally easing.There is a reason that she (and we) dogged this story when most of the world either considered it to be too esoteric or, in the case of some maroons, wrong.
The note is titled: “Beginning of the end in warehouse trades: A game changer for base metals”.
There were three notable observations.
First, it’s not just banks that should be blamed for fuelling the queue and inventory over-financing problems. Part of the problem is related to the general demise of independent warehouse operators in the metals industry. That is to say, there aren’t enough warehouse owners who do not have conflicting interests as traders or bankers on top of their warehousing businesses:
As has subsequently become clear, domination of a good delivery point through the ownership of the majority of multiple warehouse units licensed to receive a particular metal in a given location is a necessary condition for controlling metal inflow, outflow and associated rental cash flow that is the foundation of warehouse rental and financing deals.......Third, all of this in many ways contributes to the scarcity amid plenty problem.
That is… inventory games are by and large confusing curve signals. And above all, it is the yield-related incentive to lock inventory away for significant periods of time which is creating a situation in which it pays to store and hoard, even if the curve moves into backwardation on occasion (since everyone’s storage and financing costs are not the same).
But also, and more relevantly, as the LME moves to unclog inventory and the financing trade unwinds, that we may end up in a situation in which the curve overreacts on the backwardation front, even despite ongoing surpluses in the market. Confusing and counterintuitive to say the least....MUCH MORE
For Izabella I believe the story was an intellectual challenge to piece together disparate bits of information into a coherent matrix while battling the forces of darkness (seriously, the word murky doesn't do justice to these markets) and disinformation.
For me it was how to approach the profit possibilities; much in the same way Grandmother would quiz: "Your initial conditions are 'The sky is falling, the sky is falling', what is your course of action?" to which I'd reply "I'm this many: ||||, four" and she'd say, "No silly, your course of action is 'Short sky'"
Here we had an initial condition of overabundance of the metals yet the price was not acting as one would expect. That was an anomaly and anomalies can be profitable if you see and understand them before the crowd.
The price action to look for is: first up (although some of that has already occurred), and then, a picture even a four-year-old can understand: