So far this year, on LME aluminum trading, inventory levels have directly correlated with price direction. Aluminum demand has outstripped supply causing falling inventory levels, and many assume prices are due to rise, except they’re not.
According to a Reuters report, LME inventories fell steadily this year with total inventory down by 479,000 metric tons in the first four months of 2022. Aluminum prices have been on a bear run since the beginning of March, coming down from a high of $3839/ton to $2577/ton. These numbers sit below the start-of-the-year level around $2813/ton. The WBMS reports that the aluminum market swung into a surplus for the January to April 2022 period of 400k tons.
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Lower Aluminum Supply with Deceptive Pricing
The headline on-warrant exchange stocks does not point to a fall in inventory. Instead, it indicates a switch from expensive on-warrant LME warehouse storage to less expensive off warrant. This is also called shadow stock. The trend points broadly downwards across both on-warrant and shadow stocks. Only a short term up blip in April for shadow stocks (which retracted back down in May) occurred.
Why didn’t the marketing respond with higher prices? If inventory continues to fall that must mean demand outstrips supply. Metals prices would go up not down.
Over the last 10-15 years the LME price failed to reflect the true market price. Not only to judge the cost to consumers but the reality of market demand. The physical delivery premium remains the measure to use.
Aluminum Premiums Rise and High-Energy Prices Induce Stress
To no surprise, the LME introduced a suite of financially settled delivery premium hedging products back in 2019. This acknowledgement indicated that only part of the story consists of traditional metals contracts.
Today aluminum physical delivery premiums sit on a near record highs of $600 per tonne over LME cash in the European market and $750 in the U.S. Midwest, effectively removing any incentive to deliver onto the market. Such eye watering premiums sit available for physical delivery. The physical delivery premiums show why exchange inventories continue to fall.
Aluminum and zinc smelters are closing across Europe due to record high energy prices. As a result, there’s little prospect of physical delivery premiums falling. Exchange inventories may fall further, metal prices could ease further. However, delivery premiums emerge as the only metric giving a true picture of the tightness of the market.
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China COVID Lockdowns Ending May Effect Demand
The prevailing narrative shows demand is slowing and output is rising. The focus is on China gradually reopening after two months of COVID-19 lockdowns. However, there’s uncertainty if the Chinese economy will fully recover. SHFE price at a premium to the LME. Such exports only remain possible by the strength of the physical delivery premiums.
Continued high physical delivery premiums stands out as the likely trend. High power costs will likely sit here through 2023. If Chinese exports pick up further those delivery premiums could be at risk of a downside due to increased Chinese supply. Volumes are not sufficient enough to dent the localized metal scarcity in Europe or the USA. Demand will eventually hit recessionary forces which will reduce consumption. This will eventually lead to a softening of sky high physical delivery premiums. This will finally bringing metal prices, delivery premiums and inventory levels into some semblance and normality.