By Andy Home
LONDON — Nickel last week experienced an extraordinary, turbo-charged rally.
London Metal Exchange (LME) three-month metal jumped 14 per cent to a 16-month high of $16,690 per tonne (or more than US$7 a pound) over the course of Wednesday and Thursday. It has since dropped to $15,700 as of Friday.
Nickel’s April 2018 price spike, equally ferocious, was fueled by market fears, unfounded as it turned out, that U.S. sanctions against Russian aluminum producer Rusal would be extended to nickel giant Norilsk.
This time it’s all about Indonesia and whether the country will bring forward a planned ban on exports of nickel ore.
Well, that’s the official market version.
The violence of the price action in London suggests a more brutal reality, a targeted bull assault on those holding short positions with waves of collateral damage and a strong suspicion that blood has been left on the LME floor.
As the law stands, Indonesia will reintroduce a ban on exports of nickel ore in 2022, having extended it by five years to encourage miners to build processing capacity.
The speculation in the nickel market is that the Indonesian government is thinking about bringing the ban forward to next year or even this year.
It wouldn’t be the first time the Indonesian authorities have caught out the market. Ever since the ban was originally introduced at the start of 2014, the country’s minerals policy has seen a series of abrupt zig-zags.
Moreover, it’s clear there’s a very active debate going on in the Indonesian government, judging by the amount of public lobbying taking place. The country’s nickel miners association on Friday urged the government to keep its original 2022 plan.
Indonesian ore exports help feed China’s giant nickel pig iron (NPI) sector, so nickel supply would undoubtedly take a hit if the ban were implemented sooner than expected.
Even allowing for China’s NPI producers buying more ore from other countries, analysts at BMO Capital Markets “anticipate a drop of around 80,000-100,000 tonnes in overall refined nickel output,” leaving the market “in a meaningful deficit.” (“Indonesia the Nexus for Another Nickel Rally,” Aug. 8, 2019)
The important caveat, though, is BMO’s conclusion that “the market has more than fully priced in a ban already.”
This is because the Indonesian rumor-mill has been spinning for many weeks. Indeed, it was the supposed reason why nickel surged through the $14,000/tonne level in mid-July, laying the chart foundations for this week’s action.
It turned out that the Indonesian smoke machine was masking large physical purchases on the LME by Tsingshan, the Chinese steel group that has pumped massive investment into Indonesia, building out NPI and stainless steel capacity.
And behind the swirling Indonesian smoke signals, something else has been playing out this week.
LME trading can itself be a confusing hall of mirrors, making it hard to see who is doing what to whom, particularly when trading becomes wild.
The LME “Street,” however, knows a battle when it sees one, even if the protagonists are obscured by the fog of war.
Indonesian-related buying may have started the move higher but “the buying built (up) pressure until it exploded (Thursday) early in the morning with rumors of forced close-outs of positions and someone getting caught short of September options in particular,” Malcolm Freeman of Kingdom Futures said in a note.
“Today will see who has and has not paid margin calls or quite simply cannot take any more pain and closed out more positions,” Freeman added.
Short-position holders, in other words, have just taken a ferocious beating to the point of capitulation.
As ever with such dramatic intraday moves, options traders have experienced particularly acute pain.
The implied volatility for September nickel options jumped from 30 per cent to more than 40 per cent, according to Kingdom Futures.
That speaks of panic among those short of upside call options as the underlying nickel price hurtled up through key strike prices. Early Thursday morning nickel rocketed from $15,535 to $16,690, a price-span covering over 10,000 tonnes of September call options exposure. The largest component, just over 7,000 tonnes of market open interest, was sitting on the $16,000/tonne strike.
Great news for the holder of the call option, which gives the right to buy at that level. Distinctly bad news for whoever was short the option and had to cover their exposure by hedge-buying nickel in runaway market conditions.
Such covering of options exposure only adds to the price momentum in the underlying market.
The timing of Thursday’s move, between 2:30 a.m. and 3:30 a.m. London time and 9:30 a.m. to 10:30 a.m. Shanghai time, tells you where this particular fire was lit.
The fast-burning fuse was the arbitrage positioning between the LME and the Shanghai Futures Exchange (ShFE).
The battle in the LME market is being replicated in China.
The Shanghai market has this week hit life-of-contract highs. So too have trading volumes.
Market open interest has mushroomed from just under 400,000 contracts at the start of July to a Thursday peak of 806,352. That’s been eclipsed only once, briefly in March 2017, since the ShFE nickel contract started trading in March 2015.
Quite evidently there’s a bull surge taking place as speculators bet on the Indonesian supply disruption story and bigger players lock horns on the long and short side.
This rally has been as much about the weight of money as nickel’s fundamentals.
But it will be the fundamentals that now determine what happens next.
The Indonesian story has been interwoven into the nickel price since the beginning of July, even if it has not always been the price driver.
Now, however, that price is dependent on what decision the Indonesian authorities take. A lot of money is riding on the ban coming soon.
If it doesn’t, it’s potentially a long way down from these price levels.