July 12th, 2012
Spot aluminum prices fell sharply in the second quarter, as softer-than-expected global macroeconomic data and speculative short positioning in the futures market dealt especially strong blows to the base metal. After a feeble bounce in early July, aluminum prices seem poised to head lower again. There is some consistency among dealers about the reasons for the Q2 slide but strategists are lowering price forecasts and raising new grounds to remain cautious on aluminum in the second half of this year.
According to UniCredit Economics, FI/FX & Commodities Research, “The ongoing oversupply coupled with high stockpiles on the futures exchanges is exerting considerable downward pressure on prices. Any stabilization is only possible after significant production cuts, which could already materialize in the short term, since aluminum is trading well below its marginal cost of roughly $2,500. Since aluminum scrap is still relatively expensive, demand will probably now focus more strongly on primary aluminum. We expect a sideways move to around $2,000 per ton.”
At least part of the drop in aluminum prices in Q2 could seemingly be explained by slumping aircraft orders and production. In Q4’11, Boeing booked 390 commercial aircraft orders and the pace accelerated to 440 orders in Q1’12. In the latest quarter, however, Boeing booked only 36 orders, marking the worst Q2 in at least 15 years of IFR Markets records (see Boeing’s link for time period reports of orders and deliveries dating back to 1958). But a weak second quarter may give rise to a strong third quarter. In 2010, for instance, orders went from 88 in Q2 to 257 in Q3. And in 2011, orders jumped from 77 in Q2 to 301 in Q3. Additionally, United Airlines announced Thursday it is set to purchase at least 100 new Boeing 737 aircraft, with an option to purchase 100 more.
Metals and mining strategists at Goldman Sachs Global Investment Research consider aluminum to have been the biggest disappointment versus its Q2 commodity price expectations. They have subsequently lowered their aluminum price forecast for the second half of this year by eight percent to $0.96 per pound. “As we mark-to-market commodity price performance for the quarter, aluminum recorded an average price of $0.90/lb compared to our earlier estimate of $1.05/lb. Aluminum prices continue to be weak and despite curtailments announced by a number of producers, oversupply remains a problem, in our view.” Clarifying their outlook GS wrote, “We expect to see some improvement in the 3Q2012 aluminum price, increasing 6.7% over the 2Q2012 average to $0.96/lb, as we think much of the decline to current levels has been driven by macro and the use of LME aluminum as a global trading tool, not reflective of current supply-demand dynamics. Regional premiums remain strong, reflective of the tight physical market.” But while GS expects some increases in aluminum pricing going forward, they are largely negative on aluminum supply-demand fundamentals. “The slow rising annual aluminum price forecasts are principally driven by increases in cost of production, not pricing tension from a tighter market. We expect 2012 to be the sixth successive year of surplus in the global aluminum market. In our view, demand is not bad for aluminum but new-build smelters, mainly in China, are not being offset by enough curtailments of older and less competitive plants. Our global commodities team forecasts a structural surplus in the aluminum sector through 2016.”
The Metals Strategy team at Bank of America Merrill Lynch Global Commodity Research updated their base metal forecasts on Wednesday, lowering their 2012 average aluminum price call by 13 cents to $0.94; the dealer expects price to average only $0.86 in the current quarter. BoAML also lowered its 2013 aluminum price outlook, by 10 cents to $1.00, though that year’s third quarter is thought to have the highest price of the year at $1.09. Like Goldman Sachs, BoAML believes the physical market for aluminum remains “extremely tight” as physical premia have risen sharply in key consumption regions (e.g., Europe, the US and Japan). In this week’s Metals Strategist, BoAML wrote, “With the global economy slowing and the aluminum market structurally challenged, the metal’s price has fallen sharply in recent months, heavily influenced by a substantial increase of short positions. Looked at from a slightly different angle, aluminum has seen the biggest increase in short positions across all base metals in recent weeks. The balance in positions taken was tilted towards shorts, in our view, because bearish views from non-commercial market participants including CTAs brought new sellers into the market, while commercial buyers including manufacturers have not been adding new longs partially due to continued concerns over the global economy. The decline in aluminum quotations was even more remarkable when viewed against an increasingly tighter physical market, leading to a marked disconnect between prices and premia.”
In its Mining Quarterly Strategy released July 11, the Global Mining Research group at BMO Capital Markets expected a “summer of discontent” and downgraded its aluminum price forecast for 2012 to $0.89/lb, off 9% from its earlier forecast of $0.97/lb. The group’s revised 2013 aluminum price forecast is 18% below its prior projection. “Aluminum prices remain very weak and the industry structure suggests little real hope is possible, unless and until China emerges as a sizeable net importer.” Put more succinctly, “BMO Research recommends investors avoid the aluminum and nickel sectors.”
Morgan Stanley Commodity Research is fundamentally bearish on aluminum over the next two years “primarily on the back of very high global inventory and excess production capacity. Producers have not been aggressive enough in permanently reducing excess capacity – a point illustrated by the fact that much of this reduction resulted from involuntary cutbacks in the form of strikes and technical faults, as opposed to a price response. The sustained existence of inventory financing arrangements has kept metal availability tight, as reflected by the recent surge in regional premiums. These premiums have helped many smelters remain cash positive at a time when LME prices are well below the 50th percentile of cash costs. This situation is likely to persist while global interest rates remain close to zero. Pockets of strong demand for primary aluminum remain, particularly in emerging market packaging and transport. In the longer-term, energy efficiency and environmental standards in the auto sector will underpin greater aluminum use in the industry as producers continue to reduce vehicle weights to lower emissions and increase fuel efficiency.” MS expects the average LME cash price to be $0.95 this year, to rise 6.3% to $1.01 next year and 6.9% to $1.08 in 2014. Prices would thus not return to their 2011 average until 2015.
Even if dealers are not entirely negative on aluminum prices, they were surprised enough by the metal’s poor Q2 performance to downgrade their short- and medium-term forecasts. But as the directional trade has abated for now, a higher degree of volatility has already taken its place.