We are not claiming any particular foresight on this, but a recent Reuters article yesterday covers a topic we wrote on last week concerning the disconnect between China’s aluminum smelters, which managed to raise output by 2.4% during the troubled first two months of this year, and the downstream aluminum semi-finished product producers, which all but shut down due to the enforced government lockdown in many parts of the country.
The result we and Reuters report is SHFE stocks have mushroomed from 185,127 metric tons at the end of December to 519,542 tons now, as smelters churned out metal that no one could use.
Reuters adds that may be just the tip of the iceberg, with more metal trapped at smelters by logistical bottlenecks.
Downstream producers are only gradually getting back to full production; a disconnect between production and consumption is expected to persist into April, the article states. Even worse, unless there is a dramatic surge in domestic demand — which seems unlikely given the cautious return to work and still perceived risk of a new surge in infections if measures are relaxed too quickly — stock levels could continue to rise into the summer.
Not surprisingly, primary metal prices in China are sliding faster than in the rest of the world.
The Shanghai aluminum price has fallen by 12% since the start of January, while that in London is down by “only” 6% to the current $1,652 per metric ton.
The usual relief valve for overproduction in China is the export of semi-finished products, but export markets are likely to be in recession due to a demand collapse for the first half of this year. Unless China takes drastic and immediate action to curtail primary metal production, we could be facing a rerun of the 2008-2009 financial crisis as seen from an aluminum perspective, which means a massive run-up of global inventory (only this time with much of it located in China), Reuters suggests.
It has taken us 10 years to work down the millions of tons of exchange and off-exchange inventory built up during that period, creating a de facto cap to aluminum prices, even as other metals surged in the following years.
Chinese aluminum producers have a chance to act. Inventory has risen dramatically, but with a comprehensive return to work and sufficient government stimulus it could be worked through in a reasonable time frame.
The concern is neither Beijing as the arbiter of last resort, nor the industry in its loose federation takes the necessary steps soon enough and aluminum defaults through lack of action into a prolonged period of low or stagnant pricing that ultimately causes the demise of many more Western smelters and product producers overwhelmed by low-cost supply coming out of China.