Speculators Just Love the Aluminum Story

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The abrupt rise in the aluminum price this month has caught many by surprise.

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Aluminum had been trading sideways for much of this year. Although the market was rife with rumors that China intended to close smelter capacity that was not carrying the required permits and approvals, most treated the prospect that such curtailments would be pursued with any rigor with some skepticism.

Past attempts to curtail excess production capacity among China’s manufacturing industry have been poorly pursued and often frustrated by local State governments keen on maintaining employment and tax revenues.

This time does genuinely seem to be different.

That realization finally set in when China Hongqiao, the world’s largest aluminum maker, confirmed it would cut annual capacity of 2.68 million metric tons, about 30% of its total, this month.

Following restrictions last month that the Shanghai Futures Exchange (SHFE) put on the trading of iron or steel futures by raising margins, speculators were looking for new investment opportunities just as concerns about aluminum supply became widespread. The rapid rise in the aluminum price, leading the Shanghai Futures Exchange to a six-year high, is now recent history.

According to the Financial Times, JP Morgan is forecasting that prices have another $100 per ton to rise in the fourth quarter, despite aluminum inventories in China more than quadrupling so far this year.

Although Beijing is following its policy of closing un-permitted production with considerable vigor, the resulting high prices are encouraging every smelter that has approvals to operate at 100% capacity. As a result, production has never been so high, with much of the surplus metal going into store.

Trade unions at producers outside of China who have been suffering by the flood of semi-finished Chinese aluminum exports called earlier this year for a global forum to address the issue. But before such a forum can be gathered, it seems likely that China’s high SHFE aluminum price may curtail exports as domestic mills struggle to compete internationally based on high-priced domestic primary aluminum.

Citigroup estimates China’s unlicensed aluminum production capacity to be in the region of 4 million tons a year — more than 10% of China’s total 2016 output.

The price rises have undoubtedly been exacerbated by speculator activity, as hot money has flowed into aluminum and zinc. The aluminium price is up 27% in Shanghai and 23% on the LME, with the zinc price rise not far off at 24% in Shanghai, driven by the same fundamental concerns over shrinking supply. Some skepticism remains about how vigorously Beijing will pursue its policy of closing “polluting industries” in the northern provinces during the winter heating period. But following the miscalculation of how robustly environmental enforcement would be pursued this summer, the market is rapidly reassessing the prospects of significant closures during the November-March period.

In reality, China is not short of primary aluminum, stocks are considerable and although demand is rising, supply is adequate. The narrative of supply shortages is a strong one that speculators seem intent to run with for as long as they can.

Under the circumstances, Citi may well be right that the current firm trend has some way to run and we can expect higher prices in Q4 and H1 of next year.

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