The Aluminum Market Demand and the VIX

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Yesterday I had the pleasure of attending the 3rd Annual Harbor Aluminum Conference right here in Chicago. The conference runs for another half day but so far the content has been superb. We will write a series of posts on the aluminum market covering the following: a price outlook and forecast, the role of urbanization in China and what it means (or does not mean) for aluminum growth, a piece on the Middle East, perhaps some additional supply and production trends and an analysis of several key end markets including extrusions, can stock, automotive and housing sectors (e.g. flat rolled products). Jorge Vazquez, Founder and Vice President of Harbor Aluminum Intelligence Unit kicked off the day with several interesting points. We’ll summarize a few of those here.

The first interesting comment Vazquez makes involves the correlation between the VIX (the Fear Index) and global aluminum apparent demand. He notes when confidence is up, the demand side of the aluminum equation functions properly. He proceeded to show a graph depicting the correlation between what the VIX does and aluminum demand (they move in tandem). He goes on to show the somewhat close (I wouldn’t use the word tight) but somewhat correlated look at the VIX against Aluminum LME 3M prices.

The second point to note involves the role of speculative buying specifically Vazquez makes the case that this type of buying played little to no role in the price rise for aluminum seen earlier this year. Instead, market fundamentals including global visible inventory and real LME 3 month prices are tightly correlated. We can see this within a five year analysis (though it becomes even more obviously using a 20 year analysis):

Other key points Vazquez makes involve aluminum industry growth rates. He claims underlying demand is growing at the highest rate since 2004 and LME aluminum inventory has declined in both Europe (more noticeably) and the US. In addition, aluminum scrap markets appear tight with US scrap levels falling and China buying up as much aluminum scrap as it can from the US.

We at MetalMiner spend quite a bit of time talking about “variables that impact pricing. Vazquez offered up several warning signals that his firm examines to gauge downward price direction. We won’t list all nine of the warning signals here (you can get that by subscribing to their reports) but several have been “turned on in recent months. These include: the USD closing above the 200 day “EMA (Exponential Moving Average) two weeks in a row, the Shanghai stock market in a bear mode, oil prices closing below the 200 day EMA and aluminum prices closing down below the 200 day EMA. Currently four of nine signals are turned “on.”

Where does that leave the market from a price forecast perspective? Vazquez didn’t call out specific price ranges but Mark Liinamaa, from Morgan Stanley did. He predicts a Q3 price drop (which also has historically proved to be the weakest quarter for metals demand according to Liinamaa) but with Q4 prices will reach $2100/ton, provided the economy does not double dip. Liinamaa echoed many of Vazquez’ findings particularly around absolute inventory levels, “they have dropped substantially since September 2009. His other comments relate to China which we will cover in a follow-up post.

–Lisa Reisman

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