Is Aluminum Headed for a Fall?

by on

Aluminum is looking vulnerable. Although the market has been in oversupply for at least the last two years and exchange traded stocks have risen to record numbers, prices have been supported by a financing game that goes like this. Banks and large trading houses can buy or take delivery of primary aluminum ingot at spot or up to three months forward prices and sell that metal for delivery 15 months out on the LME. The 15 month forward price has been consistently higher than prices for shorter time frames, by virtue of a strong forward price curve or contango, as the following graph courtesy of the LME shows:

For much of the first half of 2009, the difference between 3 month seller and 15 month buyer prices was 8-9% of the 3 month price, leaving room for a little profit after warehousing costs, insurance and finance if you can access the ultra low interest rates that have been available based on Fed/Central bank rates of 0.25% or so as the banks and major traders can. Major central bank rates have not crept up yet although there is expectation that Fed rates will have to rise later this year in the US if the economy continues to sustain its current promise. But the forward price curve has been flattening as the metal price has risen such that now the difference between 3 month seller and 15 month buyer is just 4%. Even after this weeks drop and compared to the cash or spot price the difference is only 5%. As the margin has narrowed investors have kept the ball rolling by taking metal out of comparatively higher priced LME approved warehouses to store it in cheaper off market premises. The approx US$ 45-50 per ton reduction in costs sustained the trade through the third quarter but towards the end of last year and early this year it would seem the game was winding up.

Signs of spot market weakness are beginning to show with Japanese physical premiums down 5% quarter on quarter to US$ 122-124/ton according to a World Aluminum review of the second quarter contract negotiations. With the US dollar looking much firmer this year than last there is less of an incentive to invest in metals as a hedge against a falling dollar, not that aluminum was a principal beneficiary of that trade, copper rose on dollar weakness more as a result of its stronger fundamentals. Even Rusal’s announcement this month that they are looking to park 1 million tons of aluminum into a physically backed electronic exchange traded fund can be seen in light of the closing of the long term finance window as an attempt to find ways of maintaining production rates in an over supplied market.

Some analysts now predict an easing of aluminum prices this year, a position we took in our Price Perspectives report in Q1. That would be welcome for consumers but a blow to the nascent recovery in the distributor market which has just been getting accustomed to a few months of gradually rising prices and volumes. A drop now would bring demand from distributors to a halt as buyers up and down the supply chain revert to wait and see.

–Stuart Burns

Comments (6)

  1. Sivaprasad says:

    Hi Stuart Burns !
    Excellent analysis. Can you guess the highest LME price for Aluminium during this year (2010) ?

    1. stuart says:

      I think we have seen it at $2500/ton, I cannot see any justification for prices to stay in the $2400-2500 range going forward.

  2. N Thevan says:

    Well done Stuart.
    But, as I can see, the aluminium alloy ingot prices in most of the Asian countries are not really following the LME trend recently, as a result of raw materials shortage. How do you see this situation?

    1. stuart says:

      That’s a very interesting question and worthy of further research – there may be a blog to follow. My understanding is scrap arisings fell off in 2008/2009 when the aluminum price crashed and are only gradually picking up stimulated by higher prices in Q4 2009 and Q1 2010. Meanwhile Asian demand for Al alloys (due mostly to automotive growth) has been rising fast, putting a squeeze on scrap supplies. It should ease as the year goes on and more scrap becomes available but it’s an interesting situation, what are you seeing in your local market?

  3. N Thevan says:

    Well, in Malaysia the Aluminium Alloy prices are very much unpredictable at the moment as a result of growing global demand for commodities, esp in automotive industry, coupled with ongoing raw material supply shortages. We believe that the total industry volume (TIV) in Malaysia for automotive industry this year could exceed the Malaysian Automotive Association’s (MAA) forecast of 550,000 units and even Malaysia’s all-time high of 552,316 units in 2005. Apart from that, we are also expecting the Malaysian currency will strengthen further as a reflection of its strengthening economic fundamentals. The Malaysian ringgit strengthen against the US dollar, trading at around 3.20 to one US dollar. Not long ago, it was 3.50, representing an appreciation of around 9%.

  4. Excellent analysis and comments by all. A key point though is that stocks reflect LME standard ingots/sows only and does not reflect so many other very important and significant forms (sheet, coils, rod & extrusion billet). For example there is tightness in some locations for one type of the above and an overproduction in another. These go unreported and unseen since stock levels and trades are always reported for ingots & sows.

    It would be very interesting to get market & stock data for these other forms too.

    Cheers.

    Laith

Leave a Comment

Your email address will not be published. Required fields are marked *

This site uses Akismet to reduce spam. Learn how your comment data is processed.