Aluminum – Focus On The Bigger Picture

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One of the appeals of the SSR platform is that we are not forced to get into the weeds of the daily news flow and data points, and really only talk about them when they are relevant to a theme or an industry or company dynamic we are following. This is generally a good thing especially in cyclical stocks but we also follow the earnings reports to measure progress on the themes of our longer term investment outlook. When we wrote a somewhat non-consensus call on aluminum, and Alcoa as an obvious derivative, earlier this month, we were aware of the earnings calendar but nothing in our call related to this news flow. (Although making the call in front of the AA quarter opened up the risk for the stock to move against us in the short-term, while our call was fresh in the minds of investors.)

The reality was that a couple of central points that we covered in the research were confirmed. Firstly we suggested that the stock had found a bottom, having bounced around in a relatively narrow range (for a volatile stock) for almost a year, while economic forecasts weakened and while revisions were persistently negative. AA’s results were not great and the outlook for aluminum pricing remains weak, but the stock continues to bump along in the same historic range.

Second, and more central to our thesis, AA talked about 7% growth in aluminum demand this year, higher than we had forecast for the industry and well in excess of the historic average which is below 5%. Note that this is in a year of possible limited economic recovery, but one where global activity is still expected to grow well below trend. While the industry supply/demand dynamic looks terrible today, a couple of years of 7% demand growth will fix it – the chart has 5.5% demand growth assumption against around 12 million metric tons of new capacity over the next 5 years.

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As an industry, we have a habit of overanalyzing companies, industries, commodities when we look at the basic materials sector, but at the end of the day some of the more simple indicators can get you most of the way to a story.

• Overbuilding can ruin an industry with a robust growth rate – see our piece this week on petrochemicals • Strong demand growth can fix an industry that looks like it is on its knees quite quickly – this is often fueled by lower pricing driving substitution and new uses

o A good example would again be the petrochemical industry but after the crude oil price collapse in Q1 1986 – lower pricing and a recovering economy drove consistent high demand growth that caught everyone by surprise

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