Will Shanghai squeeze revive lead’s fortunes?

It looked as if that was it for the lead rally. After hitting a six-and-a-half year high of $2,685 per tonne on February 2, the London Metal Exchange (LME) price beat a steady retreat all the way back to $2,241 in early May.The bull flames were damped by the late-February delivery of 22,125 tonnes of metal onto LME warrant at warehouses in Antwerp.It was a physical reality check for a market that was riding high on expectations of acute supply shortfall.There has been a steady trickle of lead arrivals ever since and headline LME stocks are now down by just 8,000 tonnes on the start of the year at 134,200 tonnes.Last week, however, the London market was forced to sit up and pay attention to what was happening in Shanghai, where bulls have been surging into the Shanghai Futures Exchange (ShFE) lead contract. Based on past “flash” squeezes in Shanghai, this one may not last long.But by reopening the arbitrage window with London, it may tighten physical supply outside of China.Open interest on the ShFE lead contract grew from 80,000 contracts to 133,000 between the middle of April and May.The most active contract surged by 13% to 20,225 yuan per tonne and time-spreads tightened over the same period. Underpinning this bull charge is the low level of stocks registered with the exchange.They have fallen by 29,322 tonnes since the start of January to just 12,676 tonnes, the lowest level since February 2016. Physical availability in China is being disrupted by Beijing’s rolling environmental inspections on the secondary lead processing sector.Smelters producing refined metal from scrap have been closed in Guizhou, Jiangxi and Guangdong provinces, according to Shanghai Metal Market. Some are already reopening but others are still awaiting clearance.The clean air bandwagon, meanwhile, has moved on to Shandong province with one lead smelter closing ahead of the June 9 Shanghai Cooperation Organisation (SCO) summit in Qingdao. It is logical that these outages would have tightened the local market with stocks being tapped to fill supply gaps. However, we’ve been here before, both in November 2016 and September 2017. And in both cases the rallies lasted barely a couple of weeks before bulls booked their profits and stocks were replenished.Will this time be any different? Unlikely, according to Oliver Nugent, commodities analyst at ING.“Whilst respecting the physical tightness..., we don’t think such a quick pace of Shanghai open interest is sustainable,” he says.“If the exit is as quick as before then Shanghai lead prices are sure to drop which will, in turn, knock on to LME levels,” he warns.Nugent points to subdued physical premiums in Shanghai as a warning sign that the physical market may not be as tight as the paper market suggests. Holders of physical metal may simply be biding their time before delivering into ShFE warehouses.However, even if the Shanghai squall blows over, it may already have made its impact by reopening an import-friendly arbitrage window with the international market.This was the outcome of the 2016 Shanghai squeeze.China’s imports of refined lead jumped from just 1,075 tonnes that year to 78,000 tonnes in 2017.It was the first time China had been a major net importer of lead in refined form since 2009. How much of what was “imported” made it beyond China’s bonded warehouses is a moot point.Only Chinese-brand metal is deliverable against the ShFE lead contract and what was imported last year may still be trickling into the mainland market.So far this year, the trade pendulum has swung back in favour of small net exports, but that was before the arbitrage window flexed open.And last week saw Shanghai’s bullish mood infect the London market.The trigger was Wednesday’s cancellation of 21,250 tonnes of lead in LME warehouses in the Dutch ports of Rotterdam and Vlissingen.Neither is an obvious shipping point for China but then again most of the LME lead stocks, 69%, are located in Europe. * Andy Home is a columnist for Reuters. The views expressed are those of the author.