Is Aluminum Not as Strong as it Should Be?

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You may be excused for wondering quite what is happening to the aluminum price. Base metals have continued in a robust rally since the recent volatility knocked prices sideways along with equities and the associated havoc in the bond market.

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But having fallen, aluminum prices are making meager gains compared to the robust bounceback in nickel, zinc and copper prices. Indeed, after much hype during the middle part of last year about the impact of China’s environmentally inspired crackdown on legal and illegal aluminum smelting, the price has largely fluctuated within a narrow band off plus or  minus 5% since the end of the summer.

One explanation for the weakness of aluminum’s price recovery this week has been the delivery into LME warehouse almost a quarter of 1 million tons over the last five days. Andy Home writing in a Reuters article last week suggests the arrival of 265,475 metric tons is not so much the arrival of physical metal as the simple rewarranting of metal that had been sitting in LME warehouses but was previously off warrant.

Storage costs would have been less for material not warranted on the LME system and this metal represents only a small part of the approximately 7 million tons of off-market aluminium estimated to be held in inventory around the world by the stock and finance trade. As the LME’s inventory has fallen from a post-financial crisis high of 4.13 million tons to a current 1.30 million tons, so too has the level and distribution of off-market inventory.

Previously estimated at around 10 million tons the geographic distribution has moved from previous concentrations in Detroit and Vlissingen to far Eastern locations like Port Klang and Johor in Malaysia, Singapore and Busan in South Korea. All these recent “deliveries” where at warehouses in Malaysia and Singapore.

Although the sudden appearance of this metal has had a depressing impact on the aluminum price, Home suggests it could be short-lived.

One theory is the metal has simply been parked on warrant during the Chinese New Year holidays and that in early March it will disappear from the system again.

Neither the arrival of this metal nor its possible subsequent disappearance actually means there is any more of a surplus or deficit in the market than there was a month ago. China is certainly in surplus, as relentlessly rising Shanghai Futures Exchange inventory shows, but the rest of the world has been in deficit for some time and a gradual drawdown of off-warrant metal is one manifestation of that deficit.

Interestingly, Home goes on to suggest the dwindling of off-market inventory is the cause of the LME aluminum benchmark cash to 3 months spread, which has been whipping in and out of backwardation, in his opinion, as borrowers of prompt metal fight it out with lenders. This instability has also been a key driver of outright price, Home reports, saying that at key price barriers, shorts have not been able to borrow metal and prices have consequently broken on the upside.

If physical premiums continue to rise, this underlying tension between LME stocks and off-market inventory is set to continue. At critical points, this will create price volatility and unpredictability for cash to three-month spreads in the year ahead.

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As such, current prices may represent a buying opportunity for short- to medium-term demand. If Home is right — and he often is — prices could more closely follow the rest of the base metals complex higher next month. It is certainly set to be an interesting year for aluminum; with so many dynamics at play in the market, reading price direction has never been more challenging.

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