Another false signal for the aluminum market

LONDON: The latest snapshot on global aluminum production provided by the International Aluminum Institute (IAI) showed global run-rates stabilizing at 122,600 tons per day, an annualized 44.73 million tons, in October.
While output in the world outside of China rose by an annualized 109,500 tons last month, that in the world’s biggest producer edged lower by 126,400 tons.
It was the second consecutive decline in Chinese production. But the cumulative 377,000-ton annualized drop since August flatters to deceive.
China’s output of the light metal totaled 1.717 million tons last month, according to figures from the China Nonferrous Metals Association carried by the IAI.
That marked a 15-percent jump on October 2011, while cumulative production growth is still running at over 10 percent so far this year.
And whichever way you look at the raw statistics, China is still producing more aluminum than it can currently consume.
You don’t need to take my word on that. Take instead the word of the Chinese government, which is once again soaking up surplus units.
The State Reserves Bureau (SRB), the government’s stockpile manager, last week bought 100,000 tons of aluminum via a closed-door tender.
It may be the first of several with local observers suggesting some 400,000 tons of eventual purchases.
It also represents the first such intervention in the metal markets (the SRB also bought 100,000 tons of zinc) since early 2009.
Back then the world’s manufacturing industry was experiencing the full force of the Great Contraction and prices were even more bombed out than they are now.
The SRB bought 590,000 tons of aluminum, 159,000 tons of zinc and a significant but statistically hazy amount of copper.
Since its purchases pretty much coincided with the price trough for industrial metals, it is tempting to view the return of the SRB to the markets as a major bullish indicator.
Tempting but wrong.
On a macro level raw material prices at the start of 2009 were already responding to the promise of the massive infrastructure-based stimulus program announced by the Chinese government late 2008.
Any stimulus program on even remotely similar a scale is conspicuous by its absence this time around.
The Chinese government has limited itself to some fine-tuning of already-planned infrastructure spending and uncertainty about its likely impact is one of the reasons why metal markets are still see-sawing in well-trodden ranges.
At a micro level the SRB’s purchases of copper follow a completely different logic from those of other metals such as aluminum and zinc.
The SRB’s involvement in the copper market is strategic in the sense that copper is strategically important to the Chinese economy and China doesn’t have enough of the stuff.
This natural short position is why the SRB tends to be a lot cagier about what it is doing in the copper market, although even its announcement in late 2008 that it wanted to buy more was enough to halt the price slide.
It was a clear buy signal from the most influential buyer in the world’s largest collective buyer of refined copper.
However, China has no structural shortage of aluminum, or zinc for that matter. It is in fact the largest global producer of both.
So, when the SRB starts buying up metal from its own smelters, it is a different kind of “strategic” operation.
“Strategic” in the sense that the government doesn’t want some of its most established producers to go out of business.
Researchers at Macquarie Bank have drawn up a list of the producers participating in the latest aluminum tender.
All five featured in the 2008-2009 tenders and all might be considered national favorites, first and foremost Chalco, which supplied the largest tonnage, just as it did three years ago.
Chalco, it is worth noting, has just announced its fourth consecutive quarterly net loss.
Moreover, last week’s tender was awarded at a significant $100-equivalent premium to the domestic price as traded on the Shanghai Futures Exchange (SHFE). Also just like three years ago.
The Chinese government’s strategy appears to be two-fold, just as it was back in 2008-2009.
Firstly, it is a direct subsidy to loss-making smelters struggling to finance unsold inventory.
Macquarie estimates there are around two million tons of aluminum stocks in the country, only a small part of which is visible in the SHFE system.
Interestingly, the premium paid at last week’s zinc tender was even higher at around $200-equivalent per ton, apparently confirming accumulating evidence that China’s zinc sector is foundering in even deeper water than its aluminum sector.
Secondly, it is an attempt to bully up the domestic price to a level where even relatively high-cost smelters can eke out some margin.
This is why these tenders, although closed-door, are still highly public. Don’t expect similar light to be thrown on what the SRB is doing in the copper market, where it is primed to buy cheap on the international market at times of surplus and release metal in the domestic market at times of extreme shortage.
Evidently, if the government via the SRB is going to keep buying aluminum at above-market prices, it is going to achieve higher prices.
After all, who is going to bet against the Chinese government?
It may even provide a fillip for the rest of the world’s aluminum sector.
The SRB’s purchases in 2009 forced open an import-friendly arbitrage window, through which record amounts of metal flowed for several months.
But if there is a short-term price reaction, and that will depend on just how much aluminum the SRB is prepared to buy, it will be a false signal for the aluminum market.
Because these tenders are simply another sign that China regards its aluminum smelting sector as too big to fail.
Loss-making plants operated by influential producers will not be allowed to close, even as a host of new lower-cost plants ramp up in China’s northwestern provinces.
The tenders dovetail with other localized support mechanisms, such as a shadow inventory scheme operated by the government of Yunnan and power subsidies in provinces such as Guizhou, Henan and Guangxi.
Such government support will only encourage continued over-production and the continued build-out of excess capacity, precisely the twin problems plaguing the aluminum sector, both in China and the rest of the world.
Moreover, if Chinese government intervention overrides the top end of the global cost curve, prices elsewhere will have to go lower for longer if the market is going to rebalance.
Production cuts outside of China have now largely run their course, witness the pick-up in October run-rates.
Surplus metal in the West is being soaked up not by governments but by stocks financiers and the resulting squeeze on physical premiums is acting as a critical lifeline to struggling smelters just about everywhere.
The manifestation of this process, however, is the inexorable rise in inventory, only part of which, as in China, is visible in the London Metal Exchange warehouse system.
— Andy Home is a Reuters columnist. The opinions expressed are his own.