Metal markets mull Malaysian delivery puzzle: Andy Home
theedgemarkets.com
By Andy Home / Reuters | March 18, 2015 : 7:46 PM MYT
LONDON (Mar 18): The London Metal Exchange (LME) dropped something of a bombshell on its users last Monday when it warned it may have to suspend warranting activity at its Malaysian warehouses.
The problem is Malaysia's introduction of a new Goods and Service Tax (GST) from April 1, 2015 and specifically whether it applies to LME-registered metal.
After a "number of months" seeking clarification from the Malaysian authorities, the LME said in a notice to members there were several issues which remain "unclear".
Since a prerequisite for LME good delivery points is that metal stored there doesn't attract local taxes, the exchange said it may have to suspend the issue of new warrants at both Johor and Port Klang effective July 1.
This could turn out to be a false alarm. The LME may have issued its warning as a way of kick-starting what appear to be stalled discussions with Malaysia's authorities. And, sure enough, Malaysian tax officials have today been making soothing noises that things will be sorted out by the April deadline.
But there is a lot of LME metal sitting in those two Malaysian delivery points. In the case of tin, for example, they account for almost 85 percent of the total tonnage in the LME warehousing system.
Analysts and traders are now puzzling over the possible implications for stock movements, spreads and outright price.
A KEY HUB
Johor joined the list of LME good delivery locations in 2004 with Port Klang added in 2009.
They have since become major storage and delivery hubs for all the major LME-traded base metals, particularly tin, nickel, lead and copper.
This table shows the amount of LME metal held in Malaysia relative to total global LME stocks as of today's report.
Tin Nickel Lead Copper Zinc Aluminium
Johor 3,275 213,390 46,050 55,075 4,650 26,125
Port Klang 5,325 0 35,525 9,700 15,300 16,075
Pct of Total 84.5 49.5 34.9 19.0 3.8 1.1
Pacorini, the warehousing arm of Glencore, is the dominant LME storage player in both locations with holdings of 305,400 tonnes in Johor and of 40,900 tonnes in Port Klang as of the end of February.
However, Steinweg and H&M Warehousing also hold significant tonnages at Johor, while Edgemere Terminals stores the second largest concentration of metal at Port Klang.
Johor in particular has been associated with some pretty aggressive warehousing incentives, which tend to amplify natural stock distribution patterns.
SHIFTING FLOWS
In theory, of course, nothing changes much until April 1 and indeed nothing will change at all if the LME gets an exemption from the new tax.
In practice, though, markets tend to act preemptively and, to quote Leon Westgate, analyst at Standard Bank, "the affected markets of nickel tin and lead, and to a lesser extent copper, will likely behave as if the LME rules will change." ("LME Malaysian mess muddling metal waters", March 17, 2015)
The issue is not one of future metal flows. There is no shortage of alternative delivery points in Asia for LME users.
The puzzle is what happens with the metal already in Johor and Port Klang, whether it be on LME warrant or sitting in the same locations off warrant.
The GST doesn't seem to apply to anyone taking delivery of LME metal with a view to exporting it from Malaysia.
But it may apply for inter- and intra-warehouse deliveries, which is significant given the amount of metal, nickel in particular, that gets shuffled between on-warrant, cancelled warrant and off-warrant at Johor.
The two most obvious reactions would be warehouse operators trying to get as much metal as possible into their sheds and physical players trying to get as much metal as possible out of the country before the deadline.
Today's LME stocks report certainly shows heightened activity in Malaysia.
A total 44,225 tonnes of copper were cancelled at Johor and another 5,425 tonnes at Port Klang.
Each also received significant inflows of lead, Johor 1,325 tonnes and Port Klang 6,550 tonnes.
Neither development may have anything at all to do with the tax change, given we are currently working our way through the prime third-Wednesday February prompt date.
But the copper cancellations are an obvious stand-out against the recent overarching trend of accelerated inflows and rapid stocks build in LME holdings.
SPREADS AND PRICE
This week's prime prompt date also makes it a bit difficult to read too much into either spreads, generally tighter across the board, or outright prices.
There are often liquidity holes and resulting spread volatility around the LME's main prompt dates.
But there are certainly implications, albeit unclear right now, of so much LME tonnage remaining available for LME settlement but not for physical delivery, other than for exports.
Standard Bank's Westgate argues that nickel spreads may split between full finance contango at the very front end of the curve but tightness on forward spreads given the lack of in-warehouse delivery options for the huge tonnage located in Johor.
"The impact on tin would be even more dramatic, particularly with the current go-slow/stoppage in Indonesian exports," he notes.
Or maybe holders of LME-warranted tin and nickel in Malaysia will simply sell?
Both markets had down days yesterday and LME three-month tin has slid further this morning to a low of $17,125 per tonne, a level not seen since August 2012.
It's too early for definitive answers as to how this Malaysian puzzle will play out but there's already plenty of circumstantial evidence, those copper cancellations in particular, that there will be significant ripple effects.
(The opinions expressed here are those of the author, a columnist for Reuters.)
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