Rising nickel stocks keep bull story under wraps

LONDON – For a market supposedly facing an imminent and dramatic supply shortfall, there sure is a lot of nickel around.

 

London Metal Exchange (LME) stocks continue to power relentlessly upwards, every couple of days bringing a fresh record high. At 324,714 metric tons, they have risen by over 63,000 metric tons, or 24 percent, since the start of the year.

 

And this despite what must be one of the greatest supply shocks in any commodity market in recent history. As of January this year Indonesia's ban on the export of nickel ore effectively removed almost a third of global mine supply at the stroke of a presidential pen.

 

Even allowing for preemptive stocking by Chinese nickel pig iron (NPI) producers, who previously depended on Indonesian ore as their primary feed, some sign of supply stress might reasonably have been expected by now.

 

This apparent dichotomy has stalled nickel's previously stellar bull run. After storming to a two-year high of $21,625 per metric tons (1.1023 tons) in May, LME three-month metal has spent the last couple of months churning around either side of the $19,000 level.

 

Yet the bull story hasn't gone away. The flow of raw material from Indonesia to China has been halted and the resulting pressures are building.

 

It's just that different parts of the nickel supply chain are signaling different things right now.

 

Indonesian nickel ore flows collapse

Despite persistent scepticism in the market that the Indonesian government would stick with the ban on unprocessed minerals, it has done so.

 

The horse-trading with the country's copper producers has grabbed the headlines but it's not relevant to nickel since copper concentrates exports were never banned in the first place. Rather, that dispute has been over what level of export tax should be payable until the time that they too will have to be processed within Indonesia.

 

There has been no sign whatsoever of any Indonesian policy-maker wanting to reverse the export ban on nickel ore or bauxite.

 

And the proof is in China's trade figures.

 

The country's imports of Indonesian nickel ore have collapsed. The trickle of material that does appear on the official customs figures is likely as not nickel-rich iron ore being erroneously classified.

 

China's imports of ore from the Philippines have surged in compensation, as was widely expected. Yet it is well known that this is lower-grade material that will not fully fill the gap of Indonesian supply.

 

Raw materials markets tighten

There are plenty of other clues in China's nickel trade figures as to the stresses running through the raw materials chain.

 

The country's importers are trying to tap new sources of feed, as evidenced by newly-emergent inflows of concentrates from places like Brazil, Zimbabwe and Vietnam.

 

Imports of ferronickel are also booming, near doubling to 159,000 tons in the first seven months of this year.

 

Pricing tensions are also there, but they too are evolving in the twilight zone that is the nickel raw materials market.

 

The price of 1.8-percent nickel ore in Chinese ports may have retreated from its May peaks above 1,000 yuan per metric ton, but at a current 795 yuan it is almost double what it was when the Indonesian ban first came into effect in January.

 

Scrap prices, expressed as a discount to the refined nickel price, are also up.

 

According to analysts at Citi, discounts are currently trading at 83-86 percent and as high as 90 percent in Asia, up from 70-75 percent at the start of this year. And that despite what should be a period of scrap price weakness during the northern hemisphere summer doldrums.

 

"Chinese stainless mills are substituting in imported scrap units for lost NPI nickel units and we expect increasing volumes of stainless scrap to be sucked into China in H2 2014." ("Nickel-suffering a credibility gap," Aug 8, 2014).

 

All of which is evidence that the effects of the Indonesian ban are bubbling quietly away beneath the surface of the nickel market.

 

Refined nickel market eases

That surface is defined, first and foremost in terms of LME pricing, by the market in refined nickel.

 

And here, quite evidently, a different dynamic is at work as shown by those steadily rising exchange stocks.

 

The key driver is again China, which counter-intuitively seems to be destocking refined nickel units even as it scours the world for more nickel raw material units.

 

The country's exports of refined metal have surged by 113 percent to 63,000 metric tons in the first seven months of this year.

 

Indeed, the country turned significant net exporter of refined nickel in June for the first time since anyone can remember, while imports and exports virtually canceled each other out in July. Excluding Hong Kong, the two largest-volume outbound flows have been to Malaysia (12,000 metric tons) and South Korea (9,000 metric tons). Both are LME good-delivery locations.

 

Even those figures may understate the level of Chinese supply to the international market, if metal is being released and shipped out of bonded warehouse. It won't appear on the official export figures since in terms of payable duties, it wasn't "imported" in the first place.

 

Whether such metal has been pulled out of China by a positive LME arbitrage or pushed out by the post-Qingdao clampdown on collateral financing is a moot point.

 

But it is clear that the refined nickel market is spinning in a different direction from the raw materials nickel market right now.

 

Timing options

Such divergent trends can't co-exist for long, probably only as long as China's NPI sector can survive on stockpiled Indonesian ore and lower-grade Philippine ore.

 

Citi believes the time is fast approaching when raw materials pressures translate into NPI capacity closures.

 

After holding steady at around 225,000 metric tons in the first half of this year, it forecasts China's NPI output to contract by 38 percent year-on-year in the second half.

 

It's not an outlier view. In the latest Reuters poll of analysts only two out of 12 offering a market balance view for next year expect anything other than deficit.

 

It's just a matter of timing.

 

But until there is tangible sign of scarcity in the refined part of the nickel market, the LME three-month price is going to struggle to resume its bull run.

 

That's not to say that the bulls have gone away. It's just that rather than betting on a stagnant outright price, they've switched their money into the LME options market.

 

As the chart below shows, there has been a steady increase in market open interest for December call options, which confer the right to buy, and a lift in the strike prices of those options.

 

The collective betting appears to be that by December, the disconnect between raw materials and refined parts of this market will have closed. – Reuters