Aluminum – NYT Article; Interesting but Perhaps Missing a Key Point or Two
The NY Times’ interesting expose on the Aluminum “Middle Men” and how much money they make by simply holding inventory and moving it around, illustrates a couple of things. It shows how an exchange can be misused, relative to its original purpose; in that while all exchanges give speculators access to markets they would otherwise be excluded from, inefficient markets can allow for exploitation or in some cases manipulation. It also shows what a big business this has become for financial institutions and how much money has been invested to give them the positions that they have today.
What it misses are some implications. Aluminum prices are low – see chart. The participation in these exchanges by financial institutions may have contributed to the transparency in the market and driven the price down to reflect marginal production costs. This is good for the consumer, even if the middle men have taken a larger cut. However, for the market for aluminum to be as weak as it is today, while speculative inventories have grown, speaks to the level of global oversupply and reinforces the equity markets very negative view of Aluminum equities, particularly AA.
The interesting issue of course is what happens next. Forcing some of this inventory back into the real market would put further downward pressure on pricing, further damaging the US aluminum industry. Possibly causing more shutdowns and job losses – consequently, we think such a move is unlikely. Simply arresting the growth in inventories will reduce apparent demand and that should keep negative pressure on pricing in the near term.
However, the speculators who own the aluminum are not invested just for fun. They are invested to make money and it will be interesting to see how metal prices react once demand growth improves and catches up with physical supply. Note that oil prices have been close to all time highs in recent years despite plenty of global supply and plenty of theoretical inventory – even taking out a “political risk” premium many would argue that the price of oil is much too high based on fundamentals. What role these inventories of aluminum will play in a better balance market, whether better because of improved real demand or improved speculative demand is unclear, but they could result in a very quick recovery in aluminum pricing once a turn is detected. This would benefit speculators and producers alike – and likely have a very positive impact on AA.
Our expectation for aluminum is that low absolute pricing and more importantly low relative pricing will drive end-use demand at a much higher rate that the market is expecting, closing the supply/demand gap more quickly (AA talked about auto demand being above expectations in its Q2 call). See our published research for more on this.