Carry Trade Boosts Aluminum – WSJ.com
In crude terms, a bank borrowing at the London interbank offered rate could buy a metric ton of aluminum for $1,994, fund it 80% with debt, and sell three-month futures at $2,028. Factor in storage costs of 25 cents per metric ton per day, and the implied return is 1.9%. That doesn't sound much, but the trade is virtually risk-free and the three-month return from holding Treasury bills is basically zero.
The upward-sloping futures curve, or contango, suggests anticipation of economic recovery. Contango occurs when near-term contracts are cheaper than contracts for delivery in the future. But Jim Southwood, president of CRU Price Risk Management, said, “the price today is fully incorporating a full recovery back to 2007 or 2008 levels by the middle of 2010.”
That long money, which often invests in futures, may explain why the contango yield extends years into the future, rather than the more usual matter of months. Similar carry-trade and dollar-hedging activity in energy markets also boosts aluminum prices.
For the likes of the Federal Reserve, aluminum offers a case study in what zero interest rates and quantitative easing do to asset prices. The inflationary implications also ought to worry central bankers. Conversely, should policy makers unexpectedly decide to act on those worries, and raise rates, the carry trade underpinning many commodities could unwind quickly.