Aluminum's Chinese Illusion
Something very strange is happening in China's metal markets. Buyers appear to be behaving the way U.S. shoppers do at this time of year: queuing up and pushing to get their hands on some product before anyone else can get a chance.
Aluminum has been in a state of backwardation on the Shanghai Futures Exchange for several months. That condition -- where contracts for near-term delivery cost more than longer-term ones -- is normally seen as an indicator of tight markets and fundamental demand. Sure enough, deliverable stocks of aluminum in exchange-monitored warehouses are bumping along close to their lowest levels in nine years -- but a demand-surge story still doesn't make a lot of sense.
Aluminum's seemingly perpetual global glut has made it the worst performer of the main London Metal Exchange metals this year, and China is still awash, with about 3 million metric tons of production capacity being added this year, according to Bloomberg Intelligence analyst Yi Zhu. Even those declining exchange inventories tell only a partial story: Aluminum, like copper, is favored as collateral in China's bonded-warehouse trade, so much of that tonnage may just be heading to shadowier locations.
A better explanation for the behavior of aluminum's futures curve lies not with demand, but supply. For the past few months China has been tightening rules on loading commodities onto trucks so as to prioritize domestic movement of coal, which is in short supply as the country heads into winter and the traditional Lunar New Year lull in industrial activity.
It's not easy to directly test the effect of these trucking restrictions, but again, you can get an idea from looking at those futures curves. If the key factor in tightening metal markets was delivery bottlenecks rather than a fundamental shortage, you'd expect the cheaper, bulkier metals to be suffering most. A ton of aluminum costs about $1,700 and takes up about as much space as three tons of copper, which is worth 10 times as much. That would tend to put it further back in the queue relative to denser, costlier commodities.
Sure enough, aluminum's short-term premium is one of the largest among China's major commodities, while precious metals and nickel -- the costliest major industrial metal after tin -- are trading in contango, with longer-term contracts costing more.
That's probably a better guide to where prices are going. Once China's winter coal shortage starts to ebb, aluminum's temporary sheen could go away real fast.
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