Backwardation

Sometimes a backwardation doesn't mean physical tightness.

During LME week, there was no overarching theme of a tight physical zinc market. Yes there is some planned maintenance that is seeing some zinc move across the Atlantic, but nothing overly ominous.

Today, the cash-3's zinc spread moved to over $320 backwardation, the tightest c-3s zinc spread in 28 years! This means that someone holding a short futures position, either needs to find zinc warrants to deliver against it, or pay $320/mt in borrowing costs to move the position.

Now of course, the market could ease if whoever is long decides to take some profits, but that's a huge risk for the short holders to take, considering that just yesterday the same spread settled at $230 back - that's an tightening of nearly 50% overnight!

To make matters worse for the shorts, there is only 37 thousand tons of zinc on LME warrant, meaning that lending guidance does not apply, so this could get considerably worse for the short holders.

Without corresponding tightness in the physical market, this suggests the current moves are purely a derivative play, and once again the risks of being short time-spreads have been highlighted. With contangos capped at full finance, but no such cap on backwardations, the risk-reward is skewed heavily in being long spreads rather than being short spreads.