Barron's: Why Aluminum Price Will Bounce

By SIMON CONSTABLE
The cure for aluminum's low prices seems to be those low prices themselves. That's standard free-market economic theory, and it appears to be playing out in the real world. After years of overproduction of aluminum and steady price declines, producers are starting to manufacture less of the metal, which is used in everything from packaging to auto parts to airplanes. That could bring prices back above $2,000 a metric ton.
Benchmark futures, traded on the London Metal Exchange, are down about 34% from their May 2011 peak of $2,774 a metric ton, and recently traded around $1,820.
Aluminum production has exceeded demand since 2007, but that surplus is likely to evaporate this year, according to a report from French financial-services firm Natixis. "In Russia and the West, producers continue to curtail unprofitable smelting capacity," the report states. "In China, the growing influence of the price mechanism is likely to limit overcapacity."
Simply put, lower aluminum prices mean smelting operations that can't cover their costs are cutting production or are closing permanently. The process is curtailing the growth in global supply.
CHINA IS THE WORLD'S LARGEST producer of the metal, and it has been slow to reduce its overall output as the country's leadership emphasizes sustainable economic growth and secure access to raw materials.
In a recent report, Credit Suisse identifies more than two million tons of annual capacity reductions outside China since 2011, and more than 1.2 million tons within the communist country during the same period. Estimates vary but global aluminum output ran at 48 million to 50 million tons last year. Meanwhile, demand appears set to grow as tighter environmental standards for vehicles drive consumption from the automobile industry.
"Considering that aluminum has a lower density, compared with other raw materials like steel, it can be a material of choice to reduce a vehicle's weight," say analysts at Bank of America Merrill Lynch in a research report.
A car weighing 1.3 tons could be reduced to less than 800 kilograms (around 1,700 pounds) by using the maximum possible amount of aluminum, the report says.
Bank of America Merrill Lynch expects supply to fall short of demand by 586,000 tons this year, compared with a surplus of more than one million tons last year. The deficit is likely to increase to 1.1 million tons in 2015 as growth in demand outstrips production. For that reason, Bank of America Merrill Lynch expects aluminum prices to bounce higher in 2015, to an average $2,010 a ton, up from a projected average of $1,772 this year. Natixis predicts prices averaging $2,075 next year, from $1,880 this year.
That said, it's worth noting that not everyone is so sanguine about the path of aluminum's prices.


Credit Suisse says the "metal remains vulnerable to corrections." The Swiss bank says that Chinese smelters are planning capacity additions this year and beyond of around 4.8 million tons. When exactly that capacity comes on stream and affects prices remains to be seen, because Credit Suisse also believes that actual smelter construction is "likely to fade." 
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