Each quarter FastMarkets and Sucden Financial produce an analysis and forecast report on the precious and base metals – The Sucden Financial Metals Reports, April 2016.
Below is the aluminium report, to download a PDF copy of the full report covering all the metals in pdf form click here.
Subscribers have access to these reports before they are published through the research tab in FastMarkets Professional.
Aluminium – Prices stronger than the fundamentals
Aluminium prices rebounded in the first quarter. Having set a low in November at $1,432.50 per tonne, prices have rallied 12 percent to a high of $1,605. The move followed even stronger rebounds in other base metals that averaged 26.1 percent. So aluminium was the laggard – and rightly so considering the fundamentals, we think. Prices in China, surprisingly, have rallied 26 percent. But production increases remain in the pipe line. The run-up will have given marginal producers another hedging opportunity, which is likely to mean the supply-side fundamentals will become even weaker in the months ahead. We expect prices to trend broadly sideways in the range $1440-$1600.
Overall trend – The dominant trend is to the downside, as the chart above shows. While aluminium’s attempt to rebound looks constructive, it was relatively weak compared with the rebounds in the other base metals; the fact so much of it was reversed so quickly suggests confidence in the metal remains poor. The relatively weak rebound in LME aluminium prices suggests the market remains well supplied; indeed, any tightness was seen only on the LME. The considerably stronger rebound in the Shanghai Futures Exchange (SHFE) price suggests the measures taken by China have caught the market off-guard, which has led to short-covering. As of late March, the forward curve in the SHFE was backwardated, with May prices at 11,740 yuan per tonne, falling to 11,640 yuan for the October contract, while the LME forward curve is in contango. With production in China likely to be very price-elastic on the way up, we expect the various agreements on cutting output to unravel. The extra danger is that the strong rebound will have given marginal producers an opportunity to hedge. The forward backwardation suggests forward selling, which is likely to mean production will be less price-elastic if the metal sells off again. In turn, this could mean prices end up falling even further.
Just too much stock – We see the problem in the aluminium market as the amount of stock that has built up over the past seven years. The output cuts of late show that producers are prepared to take action when prices are low but there is such a large producer base, especially in China, that they are unlikely to be able to engineer a big enough production deficit to erode the stock overhang. Global aluminium stocks may be as high as 10-15 million tonnes so a huge supply deficit is needed to rebalance the market but this seems very unlikely. When aluminium last faced such a glut in 1994, producing countries signed a memorandum of understanding (MoU) that ultimately created a deficit and led to a drawdown of stocks to rebalance the market. But another MoU is probably out of the question in today’s antitrust world, which means prices alone may have to bring about the adjustment. If the top level of marginal producers have been able to hedge and are therefore protected from lower prices for a while, prices may well have to fall to force the next tier of marginal producers (with even lower marginal costs) to cut.
So unless a strong economic recovery comes to the rescue, risk looks likely to remain to the downside. At some stage, availability could increase even more should US interest rates rise to a level that threatens the profitability of financing metal; in that case, more of the metal that is currently held off market may return to market as it is delivered against hedges. We feel this scenario lies ahead but, with the LME spreads back in contango, we do not see this situation unfolding over the next six months; if anything, more financing may support the market.
No shortage of metal but bouts of tightness still likely – The rebound in aluminium prices appears to have been driven by short-covering, as the tightening of the spread from mid-December to early March shows. In October and November, the c-3s spread averaged $19.25 contango but it then tightened, averaging $0.5 contango in December, $0.35 contango in January and a backwardation of $6.25 in February. The back peaked at $23.25 on February 29; it returned to a contango on March 9. The tightness in the spread attracted the delivery of just below 350,000 tonnes between early December and mid-March. As well, some 485,000 tonnes of cancelled warrants were re-warranted over the same period, no doubt also to enable holders of the metal to take advantage of the tighter spreads. Once new LME rules come into play that means rent charges will fall, the longer metal is in an exit queue, the instances of cancelled warrants being re-warranted may decrease. Bouts of tightness on the LME may then become even more acute. Cancelled warrants have ballooned since mid-March, jumping 120 percent to 1.233 million tonnes.
Outlook – Despite the first-quarter rally, it is too early to say whether the downward trend in prices is over. We tend to think it remains intact; the recent rally will also mean supply can be even more inelastic in the face of lower prices. We expect bouts of tightness en route but would not be surprised if prices retest the lows. We expect prices to trade in a $1,440-1,600 range in the first quarter; for 2016 as a whole, we expect an average of $1,500.
The rebound in prices in April has seen the forward spreads ease, which may well mean a pick-up in forward selling into the rebound. This could cap prices.
Cancelled warrants have jumped to 45 percent of total stocks from 20 percent in mid-March. If new warehouse rules discourage the rewarranting of cancelled warrants, liquidity in the LME may suffer.
Aluminium production in China appears to be falling fast but, with SHFE prices up 26 percent, we would expect output to rebound. Until then, the picture of falling production may well drive prices higher.
Physical premiums weakened in the first quarter – the backwardation encouraged merchants to destock – but with the return of the contango, premiums may edge higher again. We expect US premiums to remain buoyant.