The Great Copper Squeeze Isn't Over Yet

(Bloomberg) — Short-term copper contracts are once again trading at a huge premium to futures in London, in a sign that last month’s unprecedented tightness in spot supplies is far from over.

While futures prices are tumbling as the outlook for demand deteriorates, surging premiums for spot contracts point to a supply shortfall on the London Metal Exchange, with inventories near a multi-decade low. Premiums for spot contracts hit record levels last month, in a condition known as backwardation that signals spot demand is far outpacing supply.

As was the case during the October squeeze, buyers on the LME are again paying huge premiums to roll forward front-month contracts. The spread between and November and December contracts spiked to $275 a ton at the close of trading on Monday, in one of the biggest backwardations ever seen on the bourse.

The steep spot premiums and dwindling supplies of metal on the LME and other exchanges stand in stark contrast to mounting worries over demand that are dragging futures prices lower. Three-month prices have fallen about 10% from last month’s peak, fueled by a manufacturing slowdown in China and mounting debt risks in its property sector.

“It is fair to say that there is some sort of storm brewing for the metals,” Malcolm Freeman, a director at brokerage Kingdom Futures, said in an emailed note. “The key question is when will it break?”

The backwardation in the front two monthly contracts surged to a record $1,060 a ton during last month’s unprecedented squeeze, prompting the LME to introduce emergency measures in an attempt to restore order. While those steps may prevent the backwardation from reaching such extreme levels again, buyers could yet come under further pressure ahead of the expiry of the November contract in just under two weeks time.

LME data shows there are still more than 17,300 contracts outstanding that will need to be settled before the November contract expires, meaning sellers will either need to buy the contracts back or find copper to deliver into LME warehouses. The open interest in November contracts is equal to 433,775 tons, nearly 14 times the amount of metal that’s available to buyers in the LME’s warehouse network.

Even with the backwardation rising, copper and other base metals came under fresh pressure on Tuesday amid the concern about a slowing Chinese economy and elevated inflation. While the global energy crisis keeps throttling metals supplies, headwinds to China’s growth are building due to the power crisis, real-estate deleveraging and coronavirus outbreaks.

That’s stoking concerns about the strength of the broader rally in commodities that pushed a Bloomberg gauge of raw materials and the LME’s index to record highs last month. The overall market sentiment soured as traders awaited key central bank decisions amid concerns about inflation. The dollar was little changed ahead of a key Federal Reserve meeting, where an announcement is expected about plans to taper its massive bond-purchase program.

LME copper fell 0.4% to $9,516.50 a ton by 11:37 a.m. local time, while zinc paced declines with a 1.2% drop. Aluminum was 0.9% lower at $2,695.50 a ton, reversing earlier gains of as much as 1%.