Each quarter FastMarkets and Sucden Financial produce an analysis and forecast report on the precious and base metals – the latest are Sucden Financial Metals Reports for July 2016.
Below is the aluminium report. To download a PDF copy of the full report, please click here.
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Aluminium – Strong prices, a poisoned gift
Aluminium strengthened in the second quarter, lifting prices 9.1 percent in the year to date in contrast with a 19-percent fall last year. As well as the effective and expected Chinese supply response to falling prices, the rally was supported by a seasonal pick-up in demand and a global recovery in metals fuelled by speculative buying. But we believe that announced supply cuts are likely to be delayed or even reversed at current price levels, curbing the necessary rebalancing of the market and capping price upside in the second half. We foresee a range of $1,580-$1,750 for this quarter.
Overall trend – LME aluminium prices rebounded by 8.3 percent in the second quarter after a muted first quarter. Its solid second-quarter performance took place amid a broad-based recovery in commodities, improved seasonal demand led by restocking and a tighter Chinese market following supply cuts late in 2015. But at current Chinese price levels, most domestic producers are now profitable, which should boost the pace of production restarts that till now has been much slower than expected. The market rebalancing process should therefore take longer, capping international aluminium prices. In the third quarter, we see LME aluminium in a range of $1,580-1,750 per tonne.
A review of the second quarter – The strong rise in LME and SHFE aluminium prices in the second quarter reflected a tighter global refined market. Available LME stocks dropped 24 percent in the second quarter after being unchanged in the first, causing episodic tightness in spreads. SHFE stocks tumbled 44 percent in the second quarter after rising 11 percent in the first, resulting in backwardated spreads from late in April. While the sizeable drawdown in visible inventories indicates tightness, this was not necessarily reflective of stronger real demand – a significant proportion of the metal was relocated to non-LME warehouses in financing deals. Still, tighter spreads boosted speculative buying, which was reinforced by the recovery in sentiment in the base metals and expectations of meaningful supply cuts in China, underpinning aluminium’s rally.
Demand set to remain healthy – Aluminium demand has surprised on the upside in most regions so far this year and is seen growing five percent in 2016, slightly down from six percent last year. Chinese demand, which accounts for about half of total demand, should remain supported by the building and construction sector as well as the automotive and railway sectors. In North America, demand should also remain robust, mainly due to building and construction – the US housing market continues to enjoy a solid recovery. In Europe, demand is set to remain stable but downside risks are growing due to heightened post-Brexit uncertainty. Our aluminium demand outlook in the medium and long terms also is constructive, reflecting aluminium’s diversified demand profile.
But higher prices this year imply a longer rebalancing process – The steep fall in aluminium prices in 2015 triggered a firm response from the Chinese industry to tackle structural oversupply: the country agreed to cut capacity by 4.6 million tonnes per year. In June, Beijing issued a new directive to reduce overcapacity and boost state reserves to push capacity utilisation rates to normal levels around 80 percent. But those actions may be delayed in the near term given the sharp rally in Chinese prices to 12,500 yuan per tonne at the end of the quarter from a low of 9,750 yuan. The latest IAI statistics confirmed a further increase in Chinese primary aluminium output in May, up 4.13 percent from April, suggesting that idle capacity has already been restarted. So we foresee stronger Chinese production in the second half of the year due to potential restarts of an expected 1.3 million tonnes in addition to new capacity coming on stream in Inner Mongolia, Shandong and Xinjiang, estimated at 1.9 million tonnes, which should inevitably delay the rebalancing of the market.
Outlook – Speculative positioning in LME aluminium looks stretched on the long side, with the net long position up 72 percent in the year to date, suggesting that the market is pricing in underlying strength in the forward fundamentals. We take a slightly more bearish view, arguing that current price levels are unlikely to trigger the supply response from China the market expects, delaying necessary supply adjustments and leading to an unwinding of net long positioning, capping LME price upside. Still, we do not see a steep decline in aluminium prices because we believe that Chinese producers will remain sensitive to the 11,500-yuan level, which corresponds to the marginal cost in China, and will react if domestic prices fall below that level. Key downside risks to our LME forecast are a hard landing in China and a resulting fall in the yuan, which would deflate domestic cost curves and make the Chinese aluminium industry even more competitive.
The strong second-quarter price recovery caused an easing in the forward spreads, suggesting increased hedging activity. This may cap LME prices.
Total stocks have dropped 17 percent so far this year after a 31-percent drop in 2015. With cancelled warrants at a fairly high level (43 percent in the second quarter, up from 29 percent in the first), we expect stocks to fall further.
Chinese aluminium output seems to have rebounded significantly since March, perhaps due to restarts at domestic smelters that have come partly in response to the strong rally in domestic prices. Should this trend be sustained, the Chinese market should ease, undermining SHFE prices and then LME prices.
Physical premiums trended lower still in the second quarter. In Europe, rates averaged of $78 per tonne, down from an average of $90 in the first quarter despite easier nearby spreads, largely due to ample supply. US premiums revisited their 2015 lows due to continually strong imports. But if nearby spreads continue to ease, spot buying could pick up and support premiums in the third quarter.