Aluminum's Future: A Mixed Bag

By Julian Murdoch

As always, gazing into the future of a commodity is an iffy proposition at best, but usually there is at least some general consensus on where the market's trending. For aluminum, however, that's not quite the case at the moment.

At the ISRI Commodities Roundtable Forum on aluminum last week, one analyst reportedly suggested that aluminum could rise to $3,000 per metric ton by May 2010 — quite a jump from this year's prices, which have fluctuated between just over $1,000 to just under $2,000 so far. Even looking historically, the highest price aluminum has hit in the past five years is comfortably under the $3,000 mark.

Many producers also have positive — albeit more conservative — estimates. Rio Tinto Alcan (RTP), for example, expects long-term aluminum demand growth to be along the lines of 4-6%. In the short term, though, executives are more cautious, stressing their current strategy of cash preservation instead of talking price.

But not all analysts are quite so pie-in-the-sky optimistic; Goldman Sachs' forecast is a downright downer. Goldman sees aluminum trading at a much more modest $1,700 per metric ton, or 78 cents per pound — below Tuesday's cash price of $1,864.50 per metric ton (84.5 cents per pound).

Why the Confusion?

Conflicting forces are at play in the aluminum market. On the one hand, you've got the general, though cautious, optimism of global recovery; a weaker U.S. dollar (pretty much always positive for commodity prices); and China's recent transformation into a net importer of unwrought aluminum.

On the other hand, current aluminum inventory levels at the London Metal Exchange are very high:

To offset this inventory overhang, the industry has announced "a significant amount of smelter curtailments." But even so, market demand has not been high enough to bring down existing inventories.

Besides, not everyone has closed smelters. And by "not everyone," I mean China.

China has consumed more aluminum this year than in 2008, and at the same time, it has also created new smelting capacity. According to a Reuters report, Chinese smelter capacity has grown at such a rate that utilization is only about 75%, which gives China plenty of room to keep on smelting.

Thus we're in this bizarre world of high inventories and increasing production. The International Aluminum Institute released figures this week showing August aluminum production increased by 0.3% (6,000 metric tons) to a total of 1.954 million tons produced for the month. So it looks like producers are banking on the global economic recovery.

Meanwhile, prices have recovered very well since the beginning of the year:

On the Horizon

In the future, we may need to consider more than just construction and manufacturing demand when looking at the aluminum picture: A bona-fide, physically backed aluminum ETF may soon become reality. Glencore International and Credit Suisse (CS) are currently in talks to create such an ETF, though at this point, when is unknown —1 month, 6 months, a year? It's too soon to tell.

Besides allowing investors to invest in physical aluminum like they can with gold and silver, the creation of such a fund would benefit commodity trading giant Glencore, by giving it another avenue to sell its aluminum inventory. While no official numbers on the subject exist, Glencore is believed to have over 1 million tons of aluminum lying around. I'm sure the prospect of offloading that to a secured location for the benefit of ETF investors has them salivating.

Right Here, Right Now

As for right now, investors who buy into the $3,000 prediction do have at least one option: the iPath DJ-UBS Aluminum Subindex Total Return ETN (JJU), which tracks aluminum futures contracts. Yet, with the recent rumblings against futures-based exchange-traded products and an extremely in-flux CFTC, a physically backed product may be more attractive to investors.

Alternatively, there are plenty of fairly pure-play, "buy-the-cow" options. Companies like Alcoa (AA), Rio Tinto, Reliance Steel and Aluminum (RS) and the Aluminum Corporation of China (ACH) all provide exposure to aluminum. Better yet, they may already be in your portfolio.

As you can see, Chalco (ACH), Rio Tinto and Reliance clearly outperformed this year, while Alcoa, the traditional play in the space, lags at the bottom of the chart, down there with the spot and futures returns for the metal itself.

The reason for the split: Those runaway freight trains of success — Chalco, Rio Tinto and Reliance — all have additional factors boosting their performance. In the case of Rio Tinto and Reliance, it's steel; for Chalco, it's China.

After falling long and hard last autumn, Alcoa has managed to partly recover as aluminum prices also rose. Its stock price has experienced a year-to-date increase of 26%. Whether or not Alcoa's stock will continue to perform will depend on third-quarter results, scheduled to be reported on October 7 — the start of earnings season. You can be sure that analysts will be asking tough questions about the company's outlook on the state of the aluminum market and the global economic recovery picture.

Comments

[cap3may:]

As long as China keeps dumping, AA won't succeed.

Sep 25 08:34 AM

[Ricard:]

I would think that anyone long aluminum should no longer be looking at AA...ACH is the up-and-comer. China has given numerous hints that this company is tied to its political fortunes. That means that if you are long China, then ACH would be an obvious bet.

Sep 25 10:39 AM

[ACEMAN:]

Y'all got that right about this shiny product that takes alumina, bauxite and an immense amount of electricity to forge it. But it just ain't supply and demand that has driven this metal and its produces--from the mining pits to the finished product, it's about the cost of inventory (storage) as well as the yield on inventory and of course the shrewdness of the traders and the supply-chain companies to contract and make deliveries on time. Y'all need to ask yourself why is China storing so much of the shiny ingots these past six months regardless of pricing? The answer is in the many deals with the supply-chain folks and the traders. Moreover, now you got sovreigns bidding against themselves to supply both raw resources as well as finished or near finished product. Example is Brazil and its control of Vale/Rio to add aluminum smelting to its gigantic one way trade with China. But never underestimate Glencore and its proxy CENX as it has reduced its CAPEX and sold off unproductive mines and smelters in the US and continues to grow its state of the art smelters in Iceland at low costs of production due to the low cost of electricity! If you look at trade routes for delivery, CENX and Glencore are in the right place. Now it's time to get over to Le Cafe du Monde for my sugar coated beignet's while I make money in aluminum.

Sep 25 12:34 PM

[ValueInvestor:]

I'm surprised you weren't all over aluminum in February when it was at an ALL-TIME REAL LOW. That was the easiest money you'll ever make in your life.

As a commodities trader I can tell you, whenever a commodity hits an all-time real low it has nowhere to go but up. Sure it can go lower in the short term, but it can't go much lower for very long. The economic forces at those prices would put every single producer on the planet out of business if nothing changes, but it will, so it naturally the price willl go higher. Buying long term calls would pay off handsomely.

Remember, a commodity isn't a stock, it can't go to zero. Also, investing in the commodity instead of a company means you don't have to worry about poor hedging techniques, management errors, strikes in foreign countries, credit problems etc.

Sep 25 02:34 PM

[makimono:]

Reliance is a great company, but it is not an aluminum producer. It is a wholesaler with diverse inventory, markets and subsidiary distributors. Reliance's exposure to aluminum is purely inventory. If the high cost stock is off the books, then Reliance is in good position to restock at low prices. Alternatively, prices may go much lower. Recent down trends have seen prices at $.55/lb. vs. the .84 range reported above.

Sep 25 04:19 PM