With some base metals smashing record highs, it’s difficult to focus on lackluster aluminum.
Copper, for instance – a hedge fund favorite – hit a new high of $10,000 a metric ton on the London Metals Exchange last week.
Aluminum just can’t compare, despite being second only to steel, in global metal usage. The lightweight material is used in everything from cars and planes to beverage cans.
Yet one of last year’s most popular trades was on copper outperforming aluminum. That seems to be changing though, as hedge funds begin selling the former and buying the latter.
Those actions helped push the benchmark aluminum contract on the London Metals Exchange above $2,500 a metric ton for the first time since September 2008. In fact, the commodity hit a two-year high of $2,575.35 last week.
Now ordinary investors are paying attention, with good reason…
Unlike copper, aluminum remains well off last cycle’s peak of $3,380 in July 2008. Currently, copper costs nearly four times more than aluminum, the highest recorded difference.
That ratio alone gives investors reason to think the cheaper metal could rally further. But that’s not the only factor worth noting…
China’s aluminum production costs
Aluminum production is a very energy-intensive process. So much so that some traders joke that it’s nothing more than “congealed electricity.”
Indeed, electricity does account for about 40% of aluminum production costs. And that fact has led to a very significant change to the market.
The Chinese government’s push to reduce power consumption has curbed production of the metal. It even cut off power to aluminum smelters altogether late last year.
Naturally, China’s production tumbled after that, from about 17.5 million tons in mid-2010 to 14.5 million today on an annualized basis. That sharp fall changed the balance of aluminum’s supply and demand.
Traders say Chinese inventories are very rapidly falling towards critical levels of about one week’s consumption. That’s despite the sale in December of 210,000 tons of aluminum by the State Reserve Bureau, the government-stockpiling agency.
China may even have to buy from the international market, driving prices even higher, despite a global surplus. Alcoa (NYSE: AA) predicts that Chinese demand will outstrip production by 700,000 tons this year.
Global demand increases aluminum’s upside
Adding to that, many in the industry didn’t expect aluminum demand elsewhere to be so strong.
Yet Alcoa forecasts that global consumption will rise 12% this year, on the back of a 13% hike last year. It also points out how the growth in demand comes just as much from the U.S. and Europe as from China or the Middle East and other emerging markets.
A final upside risk to aluminum prices are new launches of ETFs that buy up the actual physical metal. Two are already supposed to launch this quarter.
All of this gives the metal a greater chance of hitting $2,700-$2,800, though the bullishness needs to be tempered by the huge overhang of global aluminum inventories.
The global recession has left 4.6 million tons of aluminum in LME-registered warehouses. And some estimates indicate global inventories could be in excess of 10 million tons.
Aluminum investments to consider
Aluminum has little chance of mimicking copper’s rise anytime soon. But that doesn’t mean investors don’t have an opportunity on their hands all the same.
Increased global demand for the metal and the situation in China still allow the metal to run further. And that’s good news for aluminum producing companies like Alcoa and Norsk Hydro ADR.
Even without the upcoming physically backed aluminum ETFs, investors can look at the Powershares DB Base Metals Fund (NYSE: DBB). It devotes about 37% each to aluminum and copper futures.
The iPath Dow Jones-UBS Aluminum Total Return Sub-Index ETN (NYSE: JJU) also looks good. Maintained by Barclays, it mirrors the performance of an aluminum futures contract.
Investors should just be wary of holding on for too long. The large global stockpiles will keep aluminum price from rising too high.
Disclosure: The author does not own positions in any of the stocks mentioned