This has got to be the dumbest idea to come out of China in a while.
Not that I am suggesting China has a monopoly on stupid ideas, we have more than our fair share of them at home, but reports last week that six major Chinese companies are considering forming a joint venture company that will purchase primary aluminum and hold it in stock — for what ultimate end use or for how long isn’t clear — but the suggestion is it would support the market price. That stupidity will take a lot to beat.
Indeed, one analyst at China Merchants Futures went so far as to laughably suggest that “if they stockpile 500,000 metric tons in the first half of this year, the Chinese market may have a supply deficit,” according to Reuters.
Let’s Stockpile Aluminum!
The six companies involved comprise four state-owned firms and two private enterprises including Aluminium Corp of China (Chinalco), State Power Investment Corporation, Yunnan Aluminium, Jiugang Group, Jinjiang Group and Weiqiao Aluminium & Electricity, the state research company Antaike is reported. An early report suggested they were seeking finance to support the program but a China Daily report suggested that each company will simply put a certain amount of their products together to realize a centralized reserve, with the intention that they will not then be forced to sell it onto the market and further depress prices. Presumably, at least.
The idea that taking 500,000 mt of aluminum inventory out of the Chinese market and, overnight, put it into deficit presupposes all of the capacity closures talked about and promised actually happen. Which, based on past performance, is highly unlikely. Companies such as Chinalco, for whom many mills are underwater, will have to drastically restructure, close production or persuade the State Reserves Board to buy metal off them at inflated prices because, by most reports, they can only continue to lose money at current prices.
The new mills springing up in the low-cost power regions of the northwest can make money even at current prices. have recently commissioned new plants and probably see no reason why they should now shut down.
New state-of-the-art capacity will continue to churn out metal and will do so profitably. At least marginally profitably, which is all the incentive that is required when you have start-up loans and investors to pay back.
What Could Possibly Go Wrong?
Even the domestic market didn’t seem overly impressed by the idea. Prices ticked up briefly but then fell back on the Shanghai Futures Exchange this week, and it hasn’t moved the needle for the LME, either. Possibly because the market is aware that part of the doom and gloom that has pervaded the aluminum market since the financial crisis is due to the ominous stockpile that has overhung the market — both visibly in terms of the LME but, more importantly, in the undefined volume sitting with the stock and finance trade in off-exchange warehouses. This is believed to be in the region of 5-10 million metric tons.
What, the market has repeatedly asked itself, will happen to prices when that metal flows back into circulation? As a result, spot prices as represented by LME plus physical delivery premiums have reacted in response to supply and demand by a responsive physical delivery premium, but the underlying exchange price has failed to respond.
Warehouse queues were only ever part of the problem. Some would suggest a symptom rather than a cause, since the stock and finance trade also played their part. Building up further inventory in China will only add to the sense that even if producers eventually cut back, there will continue to be millions of metric tons of metal around.