LME Aluminum Short Finances Fund's Copper Moves - Sources

LONDON--A U.S. hedge fund holding a dominant London Metal Exchange aluminum short is using profits from the position to help finance its activities in copper, metals market participants in London and New York said Friday.

This has made it imperative for the fund that the timing of the aluminum market's move from backwardation to contango is nothing short of perfect.

Last year, the fund was extremely successful in copper, particularly in China, but its activities in this market have taken a back seat to aluminum of late.

The fund has turned its copper attentions toward helping a troubled Chinese brokerage firm, market participants in London and New York said. The pair already had a reciprocal relationship: the fund usually handles the Chinese firm's LME financing and margins, while market participants said the broker takes care of the fund's trading activities on the Shanghai Futures Exchange.

According to these people, because the fund has assumed some high price positions through various LME brokers on behalf of the Chinese firm, it is relying on the profits from its aluminum play to keep a positive revenue stream.

This nearby tightness in aluminum has been building for several months. Back in September, while all eyes were on the action in the bull runs of copper and nickel, the fund began 'hoovering up' LME aluminum warrants in an attempt at a squeeze on the market. Much of the material is located in warehouses in Europe, according to warehousing sources and physical traders in Europe.

The same fund built a large net short position on the LME, opposite to its physical long, these sources said.

"The backwardation will continue until the dominant position has the warrants it requires to cover its LME short," one London broker said. "After this, the backwardation becomes undesirable," he added.

LME Aluminum Short Shows Up In Data; Position Rolled

Observers can see an LME aluminum short exists from data released by the exchange, which reveals a player or consortium of players has a dominant short position of over 40% for the March prompt date.

Given the high cost of financing to hold physical metal in a backwardation, it is expected the hedge fund will soon start to lend in order to help push the nearby spreads into contango, London traders said. Until then, the short position is expected to continue to be rolled.

Traders in London said "more high-premium aluminum is likely to be flushed out of the system" in the interim. In this instance, the hedge fund short picks up the premium warrants first at a cost, and then starts to finance.

The nearby tightness is continuing to attract aluminum into LME warehouses, with stocks up27,775 metric tons this week to 722,250 tons.

"There's enough material around that players don't need to hold onto it, so they're putting aluminum into warehouses and living more hand-to-mouth while the backwardation remains," a physical trader in Europe said.

In the midst of this activity, brokers in London say several large commercial funds have taken a punt on the aluminum market and entered large net short positions with no physical metal behind them.

"These commercials will have to bite the bullet but the timing will be crucial for the main hedge fund short," one trader said, adding the market will collapse into a large contango situation once this happens.

As of 1545 GMT, LME three-month aluminum was trading at $2,710/ton with the tomorrow-next spread trading in a backwardation of $1/ton.