Aluminium used to be something that made aeroplanes and drinks cans. Now it is a financial instrument.
Between 75 and 90 per cent of the world’s physical aluminium stocks are tied up in financial arbitrage deals exploiting the difference between the spot and forward price, according to several industry insiders. In November of last year, Klaus Kleinfeld, chief executive of Alcoa, described the stocks tied up in financial deals as “almost all”.
Aluminium is the most extreme example of how some industrial metals are strengthening their role as “hard asset” investments in the aftermath of the financial crisis. But in the process they have become less tethered to basic industrial demand, raising concerns that today’s prices are unsustainable and susceptible to unprecedented volatility.
In aluminium, physical stock levels on the London Metal Exchange have quadruped in the past 18 months to about 4.5m tonnes. That amount, enough to build approximately 68,000 Boeing 747s, implies gross oversupply, especially as the pick-up in manufacturing remains slow in developed economies. Yet prices keep rising.
(source: “Speculation heats up aluminium trade,” William MacNamara, Financial Times, February 17, 2010.)
This is the “Inventory Illusion” in action. Inventories are swelling around the globe in not just metals but energy as well. But it is an illusion because those inventories are held by financial players that are engaged in arbitrage transactions. So they are not available for sale to physical consumers of the commodity.
As money pours into passive commodity index investments like the S&P – Goldman Sachs Commodity Index and the Dow Jones – UBS Commodity Index, as well as Commodity Exchange Traded Funds (ETFs), they have pushed up spot prices but they have also pushed the futures curves into contango. This occurs as other speculators anticipate these passive longs’ need to continuously roll forward their derivatives positions.
It also occurs in order to give financial players an incentive to sell the futures to the passive longs. By this process synthetic hoarding in the futures markets becomes real-world hoarding of essential commodities. We have a slow-motion cornering of the markets occurring in most commodities.