Excited About Aluminum? Back to Boring May Be a Better Bet

(Bloomberg Gadfly) -- The most boring industrial metal has been looking a bit more exciting of late.

Aluminum's dispersed supply chain and huge exchange inventories have meant that for the most part, the price doesn't do much. While copper, zinc and nickel have whipsawed on strikes, deliberate shutdowns and political turmoil, the lightweight metal has plodded along between $1,500 and $2,000 a metric ton for the best part of five years.

Things seem to be changing. Aluminum is the best performer of the London Metal Exchange's major metals this year, up 17 percent as those exchange inventories head toward a nine-year low and China plans further smelter shutdowns in Xinjiang, the main growth region for capacity.

Even President Donald Trump is getting in on the fun, with his Commerce Secretary Wilbur Ross announcing late Wednesday an investigation into whether imports of aluminum are harming U.S. national security.

Put that together and you can imagine an argument for the metal going higher yet. The warehouses seem to be running low, even as Beijing plans capacity cuts in an industry that produces more than half the world's aluminum. Add the threat of a trade war, and it's easy to see how supply shortages could follow.

Hang on, though -- this is aluminum. It's probably worth double-checking before getting too excited.

Take those inventories. The decline in LME warehouse stocks looks impressive on a chart, but aluminum warehousing has been a dysfunctional business for many years.

Buyers have at times had to wait almost two years to receive metal they've booked to be delivered, due to bottlenecks at major storage sites. Partly as a result, the 956,000 tons of aluminum delivered to the LME's warehouses over the past 12 months represents about 1.6 percent of global output, so this probably isn't an infallible barometer of global trade.

Even at current, rather elevated rates of delivery out of warehouses, the LME's sheds could keep running through to September without needing a single extra ton. The forward curve is a little flatter than it's been in the past, but it's nowhere near the backwardation that typically would indicate genuine supply tightness.

What of the Chinese shutdowns? As with most industrial supply-side reforms, they're probably best taken with a pinch of salt. AME Group, a commodities consultancy, argues that they're better understood as a delay to the planned startup of new capacity than an outright shuttering of facilities.

That makes sense in the context of planned winter closures of smelters in eastern and central provinces, which have been blamed for northern China's choking December smog. There's a strong incentive for Beijing to avoid that public health crisis, but it's also keen to avoid shortages of raw materials and to ensure economic development in restive western provinces such as Xinjiang.

Moving China's metal industry to the sparsely populated west still looks to be the best way of achieving all those objectives -- and that suggests Xinjiang's aluminum sector will continue to grow, regardless of current disruptions.

With the state-owned giant Aluminum Corp. of China posting Wednesday its sixth consecutive quarter of profit, there's evidence that the perennially loss-making industry is in better health. While that's reason to discount fears of a plunge back toward $1,500 a ton, it's also good reason to doubt aluminum is going much higher.

China's aluminum capacity utilization, 2016

79%

Better prices are providing the smelters China wants to shutter (and the provincial officials who regulate them) with an incentive to thumb their noses at the central government. And with the domestic industry running at about 79 percent of capacity last year, Beijing doesn't have a good case for cutting deeply to avoid a glut.

Aluminum's charm doesn't tarnish, but it does look rather light.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

David Fickling is a Bloomberg Gadfly columnist covering commodities, as well as industrial and consumer companies. He has been a reporter for Bloomberg News, Dow Jones, the Wall Street Journal, the Financial Times and the Guardian.

To contact the author of this story: David Fickling in Sydney at dfickling@bloomberg.net.

To contact the editor responsible for this story: Paul Sillitoe at psillitoe@bloomberg.net.