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The Aluminum Contango Bodes Ill for All Commodities

I thought I’d regurgitate an article on aluminum (aluminium to you Brits) that appeared in the Financial Times last week, which echoes the concerns I raised about the vanishing contango in oil. You’ll remember that this involves buying at the spot price of $2,050/tonne, selling forward, and reaping returns now running, in aluminum’s case, at an annualized 5.85%. This works because the financing cost is effectively zero, and storage costs in warehouses has been depressed by the Great Recession. Some 75% to 90% of the world’s physical aluminum stocks, or some 4.5 million tonnes, are now tied up in the trade, enough to build 68,000 Boeing 747’s. This suggests that the arbitrage has driven smelters to produce aluminum far in excess of real demand. There can’t be that many Bud Light drinkers out there. All fine and dandy, except, what happens when interest rates rise, the first baby steps of which we saw on Thursday? Answer: instead of rolling expiring contracts forward, they dump metal on the spot market, causing prices to crash. The trade shows the lengths to which money has fled into all hard assets of every description, not just aluminum and oil, and the risks that come along with this. When you hear commodity traders whine about how divorced prices have become from real demand, this is the reason. So much of the economy has become addicted to free money, that weaning could prove to be a painful and even violent affair.