Japan hit by new aluminum dynamics

LONDON: Japanese aluminum buyers are locking up third-quarter supply deals at a physical premium of somewhere between $200 and $210 over London Metal Exchange cash prices.
Such a premium level is historically unprecedented.
It will be the steepest-ever quarter-on-quarter rise in a premium that should act as a benchmark for the entire Asian region. The premium for deliveries in the current quarter is just $121-122 per ton. And it will be the highest ever quarterly premium paid by buyers in what is the world’s largest single importer of the light metal.
What exactly has caused such a titanic shift? And will aluminum premiums carry on rising?
Beyond the mundane issues of freight and insurance, these quarterly Japanese premiums are supposed to be a fine-tune calibration of regional supply and demand over the coming three months.
So it is with all physical market premiums.
They are a way of reflecting different market dynamics in different parts of the world over and above the global reference price emanating from the LME.
What then has changed so dramatically in the Japanese market to justify a near 70-percent sequential jump in premiums levels?
Japanese demand has shown signs of recovery from last year’s double whammy of the country’s devastating tsunami and the subsequent flooding in Thailand, which disrupted regional supply chains in the key automotive sector.
But growth in shipments of mill products, a useful proxy for local demand, is still far from exciting at between just one and two percent in March and April. Moreover, there is considerable concern about the potential for Japanese manufacturing activity to be hit by power shortages over the coming months.
Japanese stocks, as reported monthly by trade house Marubeni, have been falling over the last few months but, at 234,800 tons at the end of April, they are by no means unusually low. The demand side of the equation, in other words, offers no obvious explanation for such a steep jump in Q3 premiums.
There are, it is true, more pressing supply-side issues in the region.
Norsk Hydro’s decision to idle fully its 180,000-ton per year Kurri Kurri smelter in Australia is not only a dent to regional supply but symptomatic of the pressures building across Australia’s smelter sector.
US producer Alcoa has already said it is taking a hard look at the cost profile of its Point Henry smelter, while Rio Tinto Alcan has put all three of its Australian smelters on the sales block as it retreats to its low-cost Canadian base.
But such developments are taking place against a backdrop of a globally oversupplied market, which is why the LME price is trading deep into the global cost curve.
This is of course one reason why producers are seeking the maximum physical premium level possible.
With margins compressed by the low LME price, the physical premium has become an important lifeline for many plants.
But suppliers to the Japanese market would not have been able to push through such an aggressive spike in premiums were it not for the fact that physical premiums are high just about everywhere else.
Indeed, at just over $200 per ton the Japanese premium has risen to match premium levels in both Western Europe and in North America.
The very fact that premiums are the same in a region heading fast into renewed recession and one still riding a manufacturing revival points to a disconnect between premium level and local supply-demand dynamics.
Japan is somewhere in the middle with demand growth positive but still pretty tepid. No matter. Japanese buyers will now pay pretty much the same as their counterparts in the US and Europe. The disappearance of such regional nuances in the coming quarter simply reinforces the message that physical premiums are becoming globally synchronized, reflecting not regional market dynamics but the global fight for metal between investors and manufacturers.
That fight is played out daily in the LME stocks reports.
Today’s showed stocks falling by 13,075 tons with heavy departures at locations such as Vlissingen in the Netherlands (3,000 tons), Detroit (3,275 tons) and Johor in Malaysia (2,475 tons).
Such flows reflect not manufacturers’ demand for more metal but investors’ demand for more stocks to finance. The size of that demand is evident from the departure queues at all three locations, 872,700 tons at Vlissingen, 687,550 tons at Detroit and 96,650 tons at Johor.
This metal is merely being moved to capitalize on lower-cost rental deals. Rent is the key variable in the stocks financing game and the cheaper it is, the greater the return on the trade.
Those seeking metal to actually make something useful out of it have been marginalized in the investment stampede and are now being forced to pay ever rising premiums to compete with the financiers.
In essence the effect of the stocks financing trade is to reduce dramatically the supply of accessible metal, forcing up the physical premium to a level symptomatic of a deficit rather than a surplus market. It is a new reality underpinned by the payment of incentives by some warehouse operators to attract more metal directly from producers and by the wall of metal awaiting load-out in the likes of Vlissingen and Detroit.
So much aluminum. Yet to get any of it apparently requires a physical premium of over $200 in all three major regions, as Japanese buyers are now learning to their substantial cost.
Will physical aluminum premiums just carry on rising?
Japanese buyers specifically will be casting a nervous eye over the six smelters in Australia, a key supplier to the local market. One is already about to be mothballed. How long before others join it?
But such regional factors are now secondary to the primary global driver of higher premiums, namely investment demand.
And it’s hard to see any imminent end to the stocks financing trade.
Indeed, the combination of renewed weakness in global manufacturing activity (more metal) and a whiff of more quantitative easing in the US (the promise of more free money) suggests both pillars of the trade are not only intact but likely to strengthen over the coming period.
Producers, meanwhile, can only be expected to make the most of the life-support offered by the physical premium component of their sales revenue. All that said, however, it could be that the newly-emergent global aluminum premium is approaching a potential tipping-point.
At $200 and above the premium is now equal to 10 percent and over of the LME basis price, a level that starts to challenge the returns offered by even the most cost-effective (read lowest-rent) financing deals.
There is talk that metal is starting to seep out of stocks-financing deals into the physical manufacturing market, particularly in North America, in which case physical demand and investment demand may be nearing some sort of tentative equilibrium.
But that merely offers aluminum consumers the possibility of an approaching upside cap on premiums.
A significant fall, by contrast, seems unlikely any time soon.
The stocks financing trade runs to its own fiscal cycle and until its dynamics change, manufacturers are going to have to continue paying up historically high premiums for their metal, whatever happens to the aluminum market cycle.
— Andy Home is a Reuters columnist.
The opinions expressed are his own.