Aluminum’s Short-Term Fundamentals are Less Than Promising

The short-term fundamentals for aluminum do not look promising, if Alcoa’s latest report is to be believed.

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The major primary producer is struggling to create positive net cash flow, a measure of the firm’s ability to pay down its substantial debt, reporting a negative free cash flow of U.S. $7 million on its $2.7 billion second-quarter revenue. The firm posted a net loss of $402 million, or $2.17 per share, although it should be added this included a $319 million one-off cost to divest its interest in the Ma’aden Rolling Company (MRC) in Saudi Arabia (plus $81 million in other special items).

Beyond Alcoa’s ongoing woes, its comments regarding the current state of the market and its view of the second half of this year make interesting reading.

New York investment bank Jefferies is quoted as saying a primary aluminum capacity overhang globally and limited supply constraints are concerns going forward, especially in an environment where demand is likely to be relatively weak.

The aluminum price has drifted lower this year, depressed more by investor fears of a slowing global economy and, in particular, by the impact of the ongoing trade war on the world’s top producer and consumer, China.

In the case of alumina, a small market surplus has the bank concerned prices will continue to drift lower yet, even at current levels of around $350/ton spot. Primary producers’ margins are under pressure, with the LME price in the $1,750-$1,850/ton range. The bank says prices of around $2,100/ton are needed to provide an adequate return; if alumina prices and primary aluminum prices do not find a more equitable equilibrium, more smelter closures may ensue.

Alcoa is currently trying to close or sell two smelters in Spain, following closures across Europe over the last decade in France, Germany, Italy, the Netherlands and Britain.

Yet in the medium term, prospects for aluminum look promising.

Global demand is growing, albeit not at the level it was earlier in the decade. The market remains undersupplied, as demand is exceeding production to the tune of some 1.5 million-1.7 million tons per year.

The shortfall is being met by shadow stocks held by the stock and finance trade, which built up following the financial crisis of 2008 and are gradually returning to the market. In Jefferies’ estimation, global inventories are reaching lows not seen since 2007. So far, this has not impacted either metal prices or investor appetite for the metal.

Looking ahead, S&P is quoted as predicting prices will average $2,000/ton and $2,100/ton for 2020 and 2021, saying the longer-term fundamentals are robust, underpinned by expectations of a continued supply deficit, low inventory and solid aluminum demand growth globally.

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Whether S&P’s longer-term optimism trumps Alcoa’s short-term gloom remains to be seen. Much will depend on global growth and mature markets avoiding a recession in 2020.