Aluminum prices could surge if fund tightens grip

LONDON (Reuters) - A huge aluminum holding by a U.S.-based hedge fund could squeeze supplies and trigger a price surge, market sources said on Tuesday, especially if that fund manages to boost its holdings.

The sources declined to name the fund for publication.

But they said one player has recently built a dominant position and now controls between 50-to-80 percent of available -- on warrant -- stocks of aluminum at London Metal Exchange (LME) warehouses.

John Kemp, metals analyst at Sempra Metals said that someone could just be looking for quality material.

"The other possibility is, somebody basically wants to get a grip on the short term market. The market could potentially get very tight."

Tight supply and steady demand could send aluminum -- used in transport, construction, packaging and consumer goods -- toward the record high of $3,310 a ton hit on May 11.

Fuelling the debate about the short-term direction of aluminum prices is the nearly 10,000 outstanding option contracts to buy three-month aluminum <MAL3> at $3,000 a ton, about $150 below the quoted price on the LME.

Options give holders the right to buy or sell an underlying contract at a set price in the future.

"Somebody with real clout could come in and try to push the price up today," a UK-based hedge fund manager said. "If you're in that deep then you've got to take the chance."

The options have to be exercised on Wednesday by 1130 GMT. Traders expect the fund could try to ramp up aluminum futures prices so the options can be exercised and add about 275,000 tonnes to its stock of aluminum.

Available aluminum stocks at LME warehouses on Tuesday stood at 628,100. If for example the fund controls about 75 percent, the options could take its holdings to nearly 750,000 tonnes, more than eight days of global consumption.

CONFLICT AND VOLATILITY

Market players reckon the large options and stock positions could be held by a hedge fund that uses the global macro strategy of making directional bets using economic analysis.

They think commodity trading advisors, which trade using buy and sell signals from black-box computer models, many months ago would have abandoned any long positions as aluminum since May has mostly traded below $2,700 a ton on the LME.

LME aluminum futures have retreated since then as the market started to fret about excess supplies. But on Tuesday they hit a peak of $2,851 a ton, the highest in more six months.

So far this year, aluminum prices are up around 20 percent compared with more than 150 percent for nickel <MNI3> and around 60 percent for copper <MCU3>.

Analysts expect demand and supply -- at around 90,000 tonnes a day currently -- to mostly stay unchanged.
"There are so many players who just think, well, it hasn't gone up much, so it should, and so they're trying to push it up," said Stephen Briggs, economist at SG Corporate and Banking.

"But the fact of the matter is its underperformance is justified by its relative fundamentals, and it's going to be a battle between those two forces."

The conflict is likely to heat up as expiry approaches and could create a lot of volatility.

"It just needs one push, if it starts moving toward $2,900 and gets over it, those options will be called," a Swiss-based hedge-fund manager said. "It's a self-feeding process."

The move higher could also be exaggerated by traders who have written or sold the options. They typically cover their exposure by buying or selling the underlying future as prices move up or down.