Aluminium prices continue to drift lower

Aluminium prices continued to drift lower over the past month and by mid-May were trading close to the lows of the year set in early January at just over $2,000/t. While macro uncertainties, particularly those re-emerging in Europe, have played the key role in guiding prices lower, the lack of supply response seen so far has also been an important factor.

While the latest set of corporate results certainly demonstrated the margin compression being experienced across the primary smelting industry, there were essentially no large-scale cutbacks announced. At current price levels with physical premia, we estimate just under 3Mty of capacity outside China is currently losing money, so such announcements appear inevitable, but the longer they take to occur, the less confidence market participants will have with perceived cost curve support.

Juxtaposing the flat price weakness, physical market conditions in both the US and Europe continue to tighten and support premia at close to or at new record highs. The strength of the contango in the forward curve has invigorated appetite for finance deals, while elevated cancelled warrant levels have driven lengthy queues at some LME warehouses. As such, inventory liquidity is extremely low in those two regions.

Combined with robust demand particularly from the US transportation sector, invigorated by lower flat prices, as well as some supply constraints (for example the 438Kty Alma smelter lockout in Canada continues), physical market conditions have become extremely tight, with no near-term unwind in sight.

In terms of China, anecdotal reports point to increasing utilisation rates in the fabrication sectors bringing the domestic primary market into balance after production surged ahead in Q1. Tighter SHFE time spreads, the import arbitrage window opening in April/May and stocks now starting to fall all support this conclusion that China will move into deficit in Q2.