When is an Aluminum Stock not an Aluminum Stock?

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There is something very funny about the aluminum market at the moment. On the one hand, the price has been rising steadily from a mid February low of less than $1300/ton to an early April high of $1430/ton (cash buyer). Yet at the same time, LME stocks have risen by half a million metric tons. The two developments should in theory be contradictory. Stocks rise because demand is low. If demand is low prices should chase downwards. To better understand what has been going on, I spoke to some trader friends of ours and this is what they explained. Start by taking a step back to last year.

As sales not just declined but dropped off a cliff, producers were faced with tough choices. Do they mothball pot lines – not as simple as turning off a switch, it takes time to close and re-start a pot line if extremely expensive equipment is not to be irreparably damaged. At the same time, if they made the call today to produce in two weeks time would there be a buyer and at what price? Ideally, producers like to sell before they produce but that wasn’t happening much in the fall of 2008. Even some contract sales were being canceled. Since then, producers have been faced with the same dilemma – if they produce 100 tons, they may have a firm buyer for only 20 tons. But what do they do with the balance 80 tons? Well the answer is they store it, by delivering to the LME. Unfortunately, that carries a cost in warehouse rent and handling. In a quiet world the difference between spot and three or six or twelve months will be the cost of warehousing, finance and insurance over that period. Finance costs mercifully were coming down so the other major cost was warehousing. Rent as we all know on long term basis is lower if you are prepared to make a commitment. Warehouse companies agreed to lower floor rent and handling in return for a 12 or 24 month rental.   So if metal was removed then the supplier was obliged to replace it, essentially taking the material out of circulation even though it appears as a massive burden over hanging the market.

Then along comes China, and to a lesser extent India and other protected markets. The State Reserves Bureau SRB starts buying huge volumes of primary metal from domestic producers, 290,000 tons in December at 15% over the average domestic spot price, another 290,000 tons in February 5% over the average spot price, and so on. Estimates vary but it is believed purchases could be close to a million tons by now, so much so that mothballed domestic pot lines and new projects that were due to come on stream but delayed have been started and supported by cheap power deals brokered by the government.   Production is rising fast in China while it is still contracting elsewhere. To exacerbate matters, the Shanghai Futures Exchange has risen on the back of the premium prices paid by the SRB and a scramble by traders and consumers to re-stock as they saw the prices make an abrupt turn. The arbitrage window as it is called, the premium for the SHFE over the LME has been wider than the import and VAT costs for much of the first quarter sucking in imports. To try and stem the flow there are rumors of an import tariff being imposed next month. The SRB wasn’t planning on buying the whole world’s supply of ingot, just their own producers.

Everyone agrees that capacity still exceeds current levels of real consumption globally but the removal of large chunks of these highly visible stocks means on the ground consumers are struggling to get enough physical metal. Some producers have some markets on allocation and FOB premiums have been rising. Will it continue? Yes in the short term at least we understand it will. Eventually those stocks will be fed into the market as demand comes back on stream and in the process it will put a cap on aluminum’s ability to rise as far or as fast as other metals, but as a gravity defying stunt you have to say the last three months have taken some beating.

–Stuart Burns

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