Trade war truce brings relief for metals, but bear-bull battle rages on

Is it a ceasefire, a truce or the opening to a lasting peace deal? The jury is very much out on exactly what Presidents Donald Trump and Xi Jinping agreed during their talks at the G20 summit in Buenos Aires. But for industrial metals it's enough.

The London Metal Exchange (LME) suite of base metals is today enjoying a relief rally after weeks of bludgeoning from bearish funds.

Speculators have been running short positions across the board, according to LME broker Marex Spectron. It estimates the spectrum runs from marginal in copper to an extreme 40 per cent of open interest in nickel.

The LME base metals index has fallen by 14 per cent since the start of the year.
 

Macro-driven price weakness has contrasted with positive micro signals from the physical marketplace, particularly falls in visible stocks.

This tension has been playing itself out in LME time-spreads, most eye-catchingly in the zinc market, where the premium for cash metal has hit record highs.

Any ceasefire in this metallic bear-bull battle is going to be over a lot faster than the 90-day pause before more US tariffs are imposed.

Macro headwinds remain

The Chinese version of this weekend's meeting, however, was curiously silent on the 90-day hiatus.
 

Other than noting that "the two sides decided to avoid escalation of trade restrictive measures", official Chinese news agency Xinhua did not go into many details at all.

This narrative gap leaves markets both uncertain about whether the truce can hold and beholden to news flow from the planned US-China consultations.

Discretionary money is unlikely to recommit to industrial metals on the long side until the smoke signals become clearer.

Fund managers, meanwhile, have another reason to be negative about metals.

One of the reasons metals such as copper were sold so heavily when the trade tensions began to escalate around the middle of the year is because of their sensitivity to China's economy. And even as the threat of further tariffs recedes, a Chinese slowdown looms ever larger.

The country's manufacturing sector stalled for the first time in two years in November, the purchasing managers index sliding to the dividing line between growth and contraction.

The metal markets are looking for Beijing to respond with infrastructure-heavy stimulus. Until it does, "demand conditions may well worsen" through year-end, to quote analysts at BMO Capital Markets.

They noted, moreover, that "wider activity across Asia put a dampener on economic prospects, with factory activity and export orders weakening across the region in November".

There are bullish voices out there, most noticeably Goldman Sachs, but Julius Baer probably speaks for the consensus when it says it remains neutral on cyclical metals.

Against this backdrop the G20 "agreement" may be enough for bearish funds to reduce short positions, but it is unlikely to turn them bullish. Nor will it persuade the uncommitted that now is the time to buy into metals.

Stressed spread

Timing is everything in markets and funds turned negative on metals just as physical signals started to strengthen.

The disconnect has been manifest in contracting LME time-spreads with shorts having to manoeuvre in a shrinking LME stocks landscape.

The tightness has become extreme in the LME zinc contract, the benchmark cash-to-three-months spread closing Friday at an unprecedented cash premium of $113 a tonne.

Funds sold out of zinc's bull rally in the first quarter and have been collectively short ever since.

However, the supply-side driver of that rally - a shortage of mined production - is still working its way through the physical marketplace. New mines may be starting to refill the supply pipeline, but the refined metal part of the chain looks stressed out.

Most disconcerting for LME shorts is how little metal is being delivered to exchange warehouses, even with such a high cash premium.

Total inflow last month amounted to only 8,475 tonnes, not enough to stop headline inventory sliding to today's 10-year low of 112,575 tonnes.

The cancellation of another 4,250 tonnes leaves on-warrant stocks at 84,350 tonnes, most seemingly owned by one entity, according to the LME's positioning reports. <0#LME-WHC> The same theme is playing out, albeit a little less acutely, in the copper market.

The cash-to-three-month LME copper spread closed Friday at a cash premium of $29 a tonne.

More copper has been arriving in LME sheds, but it hasn't been enough to stop inventory sliding to a multi-year low of 134,200 tonnes with on-warrant stocks lower still at 91,850 tonnes.

There is always more metal beyond the LME storage network, but it's not a lot of use to anyone shorting the time-spreads.

Moreover, the combination of multiple copper smelter outages, both planned and unplanned, and still-robust Chinese imports is reducing physical availability.

Aluminium and lead have both traded in persistent backwardation at times this year and both look poised to do so again.

The aluminium cash-to-three-months spread tightened last week from a contango of $14 a tonne on Monday to a contango of only $0.75 at Friday's close.

The same time-spread in lead contracted from $25 to a $10.50 contango.

LME lead stocks have also been dwindling daily. The headline figure is now at its lowest in nearly 10 years at 105,125 tonnes, with no inflow registered over the course of November.

Bull-bear battle ontinues

Such micro details have done no more than mitigate the price downside for metals such as zinc and lead over recent months.

But they continue to cause pain for LME shorts trying to roll positions in the face of low stocks liquidity, dominant stock holders and the resulting spread volatility.

This micro-macro tension has been a running theme of the LME market this year and looks likely to continue a while yet.

The macro picture may have brightened just a little after the weekend meeting of the US and Chinese presidents. But signs the global economy is losing momentum, and the Chinese economy in particular, do not bode well for metals demand.

Funds are unlikely to change their broadly neutral-to-negative positioning. And until micro signals start agreeing with them, LME time-spreads will remain dangerously unpredictable.