Signals Camouflage Flaw in Aluminum Market

The aluminum market is giving all the signals of robust health: Prices have surged since the start of the year, and market participants are indicating they want to take the metal out of warehouses in record amounts.

But the signals camouflage a deeper flaw: Supply has gotten ahead of demand. Prices are rising because major producers have cut back production, squeezing supplies. And the withdrawal of aluminum appears to be a shuffling of the metal among warehouses, not a call from manufacturers.

"Since the start of the year, we have seen a big increase in prices, but that's not been driven by demand," said Standard Chartered commodity analyst Judy Zhu. The gains are "mostly supply-driven, due to cuts at smelters."

On Friday, three-month aluminum closed up 1.6%, at $2,240 a ton on the London Metal Exchange. It has risen 11% since Dec. 30.

Some producers that run smelters reduced their output after prices fell from highs in 2011. Alcoa Inc., the top producer of aluminum in the U.S., said in January that it would permanently close or idle 12% of its aluminum-smelting capacity.

Global supply is estimated to outweigh demand by 800,000 metric tons this year, according to analysts at the Royal Bank of Scotland.

"Demand is steady," said Edward Meir, a commodities analyst with INTL FCStone. "The U.S. economy is doing very well. But we're not sure about some other countries [such as Europe and Brazil]."

And while major producers such as Alcoa and Norsk Hydro ASA are cutting back, China is running at full speed. Barclays Capital estimates Chinese smelters will increase production by 11% this year to 21.25 million tons of aluminum, which equals about 44% of world production.

"Western producers are usually the ones that cut back," Mr. Meir said. "The Chinese are always the ones who say that they will but don't."

While the market bets on tightening supplies, LME data show aluminum owners getting ready to take metal out of warehouses in bigger volumes than ever before. But instead of manufacturers taking the metal to make cans or other products, analysts say some of the movement could be owners just seeking lower storage rates.

More than 30% of the total aluminum in LME warehouses all over the world, the highest-level ever, has been marked to leave the pool of metal available for trade on the LME. Warehouse companies are competing with each other to offer incentives for storing metals and by shifting metal controlled by their parent companies to their own sheds.