AMU: Did aluminum markets price in peace too soon?

Financial markets increasingly trade on expectations before those expectations are confirmed.

That appeared to be the case throughout June as aluminum prices retreated from conflict-driven highs.

During the month, the US and Iran announced a preliminary memorandum of understanding intended to establish a framework for ending military clashes.

Even then, the scope of the agreement and the path toward implementation remained unclear, leaving market participants to interpret how quickly conditions in the region might normalize.

Diplomatic negotiations between the US and Iran and an apparent ceasefire shifted attention toward restoring commercial navigation through the Strait of Hormuz, one of the world’s most important maritime corridors for primary aluminum, energy, and other bulk commodity trade.

Price movements

The London Metal Exchange (LME) Cash settlement price declined to $3,141 per metric ton on July 8, down 14.4% from a month earlier. The three-month bid price fell 12.6% over the same period.

The cash-to-three-month spread also moved from backwardation into a modest contango, which typically indicates traders assign less value to immediate metal availability than future supply.

Delivery premiums also moved lower from their recent highs. CRU’s US P1020 Midwest Premium declined about 8.5% between the June 4 and July 2 assessments before rebounding in the July 9 assessment, partially owing to renewed tensions in the Middle East. CRU’s monthly spot premium for 6063 billet declined by roughly 10% between the June 4 and July 2 assessments.

That said, price action is only one measure of market conditions.

The question is whether aluminum prices discounted a normalization of trade flows faster than developments in the Strait of Hormuz justified.

Conflict escalation

Events during the first week of July presented a different picture than the one implied by declining aluminum prices.

The UK Maritime Trade Operations (UKMTO) issued multiple warnings between July 5 and July 7 after commercial vessels reported attacks near Yemen and the Strait of Hormuz.

Two tankers were struck by unidentified projectiles. Another tanker reported being hit by an unmanned aerial vehicle. Although the incidents caused limited physical damage, UKMTO continued advising vessels to transit the region with caution.

US Central Command (CENTCOM) announced retaliatory strikes on July 7 after stating Iran attacked three commercial vessels transiting the Strait of Hormuz in violation of a ceasefire. One day later, CENTCOM announced another round of strikes, stating the operation targeted additional Iranian military infrastructure intended to reduce Tehran’s ability to continue attacks on commercial shipping.

Physical indicators

LME inventories have continued declining even as aluminum prices moved lower.

Exchange inventories stood at 290,825 metric tons of closing stock on July 7, down 11.3% from one month earlier and 27.6% below levels recorded three months earlier.

Warehouse stocks continued moving lower even as aluminum prices fell through June and into early July.

Inventories alone don’t determine prices, and the relationship between LME warehouse stocks and aluminum prices appears to have untethered in recent years.

LME inventories have generally remained well below historical norms during the past five years despite periods of lower aluminum prices. Even inventory peaks during that period have remained far below the levels seen in the mid-2010s, when exchange stocks approached 5.5 million metric tons.

Even so, declining LME inventories have remained one of the market’s most frequently cited indicators of tightening prompt availability during the recent really. Their continued decline therefore appears less consistent with the degree of normalization reflected in futures prices.

The forward curve also changed direction during the past month. The market that previously paid a premium for prompt delivery returned to a slight contango as nearby concerns moderated.

Shifts in financial participation

The latest Commitment of Traders report published July 7 and covering positions for the week ended July 3, showed investment funds, the largest reporting category by open interest, reduced long positions by 24.8% from the week ended June 5.

While total reported positions also declined 9.9% over the same period, indicating overall market participation moderated, the larger reduction in investment fund long positions implies speculative bullish exposure contracted more quickly than participation across the broader market.

Daily futures trading activity also tempered.

Daily futures trading averaged 248,823 contracts through July 8 and 278,960 contracts during the previous trading week, compared with average daily volumes exceeding 400,000 contracts during the trading weeks that included June 8, about one month earlier, and April 8, about three months earlier.

In other words, both the investment length and trading activity declined, which would point to a drop in financial participation as prices moved lower.

Final thoughts

After months of elevated geopolitical tensions, market participants might have been willing to accept any evidence supporting a return to normal trade flows.

While ceasefire announcements fit that narrative, repeated Iranian attacks on commercial shipping and two consecutive US retaliatory strikes doesn’t.

Commercial vessels continue receiving security warnings and LME inventories continue trending lower than they were one and three months ago.

Those conditions don’t necessarily signal tighter aluminum supply tomorrow, as they don’t measure material outside the exchange warehouse system.

That said, they do hint at the idea that the market may have assigned greater confidence to a normalization of Middle East trade than events have confirmed so far.