The paradoxical price response to the loosening of LME rules is playing out as Izabella predicted.
We used her thinking to make some money in oil back in August.*
From FT Alphaville:
An aluminium supernova which the LME never saw coming
Forcing LME warehouse operators to comply with faster aluminium load-out rates was supposed to bring down excessive spot premiums for fabricators and end-users.Sadly, the price received by the homeless guys has not reflected the premiums.
The idea very loosely was that if end-users could get their hands on metal, which was otherwise trapped in the inventory system, they would not be beholden to the higher prices charged by producers for the privilege of direct delivery. Everyone would be a winner – yay!
And yet, as FT Alphaville pointed out on a number of occasions, we thought the LME’s solution — by misdiagnosing the problem — would not be successful. If anything we worried the premiums could get worse before they got better, since a lot of the inventory rather than making its way to market would only be shifted into private dark inventory stores instead.
This we put down to a fundamental misunderstanding by the LME and the market (though, ironically, not by Aloca and Rusal’s Deripaska) that the hoarding and queue problem was the result of intentionally-fabricated delays by warehouse operators, when in fact it resulted from warehouses becoming chock-full of financially-encumbered aluminium, serving the purpose of alternative stores of value for yield-hungry investors.
As long as the market was served by a contango, the synthetic yield on storing aluminium in a warehouse was very attractive compared to alternative money market investments. Consequently, this meant that pre-financed and hedged supply would be shifted into private warehouses outside of the LME system rather than unwound into the market.
It’s really not that difficult a concept to understand.
And yet, it seems, many in the market have been caught out on a massive scale by the fact that the very opposite of what was supposed to happen, has happened. Namely, as Reuters’ Andy Home reports on Thursday, aluminium premiums instead of going down have gone supernova instead....MORE
*It doesn't get much better than this:
The Future Price Trajectory of Copper and Aluminum and the Implications for Oil
In Which Our Hero Explains the Importance of Recent Events and Their Impact on the Cost of Day-to-Day Living
(I really wish she hadn't done this)
From FT Alphaville:
Assessing the scale of metal warehouse trades
...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
....
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.
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:
