Aluminum prices have been on an upward trend the last week or two, currently holding comfortably above $1,500 per ton for spot cash after months in the $1,400s.
The market, though, is undergoing convulsions.
The spot price is being driven up by physical demand for metal from traders exploiting a price arbitrage between the LME and China’s SHFE price. In addition, the price is also receiving support from physical demand from the stock and finance trade looking to buy spot, sell long dated forward and taking the profit between the two prices (meanwhile locking metal away in warehouses for the interim).
All this would be highly positive for aluminum prices moving higher if it were not for the fact the reason both the arbitrage and the stock and finance trade have taken off is because the world is awash with aluminum. Smelters have continued to churn out metal during lockdowns and industries that consume the light metal are only gradually come out of hibernation – think automotive, aerospace, building trades, etc.
The dynamics are highly fluid and which of these drivers predominates will determine to what extent aluminum’s rise continues and whether there is any collateral damage to physical delivery premiums, metal availability for downstream consumers, or rising contract prices if LME benchmark numbers continue to rise.
Predicting the next few months is at best a guessing game, but understanding what is going on helps.
Firstly, let’s focus on the LME-SHFE arbitrage play. The LME has been depressed by oversupply and a pandemic-induced decimation of the demand situation. Conversely, the SHFE price has been supported by rising activity levels in China and aided by investors piling in to taking positions and hyping the price.
With the LME around $1,511/ton spot yesterday and the SHFE price around RMB 13,020/ton ($,1832/ton), there is scope to buy LME metal in southeast Asian warehouses, ship for a few tens of dollars a ton to Shanghai, pay the tax and deliver to consumers or investors, taking a margin — not huge but sufficient enough to drive 100,000 tons of imports in May and an anticipated 120,000 tons in June, according to Reuters. We would be surprised if this arbitrage window stayed open for long, plenty of global supply and a huge domestic production capacity will likely see China’s squeeze satiated later this quarter.
The second dynamic is the stock and finance trade. With spot currently in the low $1,500s and 18 months (December 2021) at $1,655, the $145/ton delta is equivalent to a 10% margin, from which an investor could finance at low-interest rates, store, insure and take a profit. Metal is flowing back into stock and finance deals at the fastest rate since after the 2008-2009 financial crisis, the last time such an opportunity presented itself.
Supply, as we have said, is in massive surplus, at least outside China, according to the World Bureau of Metal Statistics. The calculated market balance for primary aluminum for January-February 2020 was a surplus of 684,000, compared to a surplus of 492,000 recorded for the whole of 2019. The situation got even worse in March and April as pandemic lockdowns decimated demand.
Nevertheless, concerns have been raised, reported in the Financial Times, that a combination of arbitrage and stock and finance demand could actually cause a shortage of metal and deny semi-finished producers of rolling slab and billets. No evidence has appeared yet of that happening. A rise in physical delivery premiums could be an early indicator, but there appears to be little evidence of that to date.