Aluminum: Up or down?

The opinions expressed in this report are those of CRU Group and are considered market commentary. They are not intended to act as investment recommendations. Full disclaimers are available at the end of this report.

Since reaching a short term high on January 17, CME Group’s Aluminum futures contract has trended broadly lower. This has been due to:

• A weakening economic outlook in many major economies
• A lack of bounce in China following the ending of their COVID-19 lockdowns
• The cooling of electricity prices in Europe relieving pressure on smelters to curtail
• Most recently the return of Chinese production in Yunnan province

In addition, the generally strong dollar has added to the bearish momentum with short periods of dollar weakness followed by resurgent strength. Since July, however, the metal has traded in a range between $2,130 /t and $2,300 /t. Now the summer holidays are over, and all parties have returned to work, the question is asked: what will the metal do for the rest of the year?

At present, the short-term trend seems to still be down with more down days than up and brief rally attempts being followed by steady periods of retracement. More fundamentally however, are there any bullish factors that the market may be overlooking?

Of course, the demand story for aluminum remains intact overall. This is based on aluminum’s function as a sustainable, lightweight metal, replacing steel in applications such as automotive and aerospace and replacing copper in cables. It is also increasingly used instead of plastic in the beverage market. Geopolitical tensions add a further dimension – aluminum is used in defence applications, which are now restocking after years of drought.

The bear case, however, focuses more on legacy applications such as building and construction, general engineering, machining, and consumer products, including cooking utensils and electrical goods. In these areas demand remains very weak largely for economic reasons – high inflation, rising interest rates, and lower-cost imports are a major factor.

We expect this bifurcation to remain for the foreseeable future. For commodity products prices and volumes are likely to be weaker whereas for premium and more targeted or locally sourced applications margins and demand will be better. This observation is not immediately helpful for investors in the primary metal, which services both markets. Deciding which is likely to win out in the short term is not an easy matter. CRU forecasts continued weakness in primary metal until Q1 next year when prices may recover. However, the uncertainty of the market on this point may explain the current ambivalence of investors in deciding up or down.

However, we can point to two bullish factors, which may be overlooked:

The first is the determination of China not to show economic weakness. In early September the Chinese government announced a stimulus package aimed at the stricken real estate sector. This was unexpected and lowered deposit requirements for mortgages, cut payments on existing mortgages, and lifted household incomes slightly by raising personal income tax allowances for child education and caring for infants. While this is less than the massive package some investors have called for, it shows the government’s willingness to stand behind the real estate sector and potentially to do more over time. Investors are now watching to see the results in terms of additional transactions. If the Chinese economy was to strengthen in the coming months this would of course be a major bullish factor.

The second point relates to energy prices. At the time of writing, crude oil is at its highest this year at $87 / barrel. This follows a surprise move by OPEC+ to extend their supply cuts to the end of 2023. There is a correlation between oil and other industrial commodities, so this is bullish on a statistical basis. Separately, gas prices have also risen in recent months due to concerns around strikes in Australia impacting LNG exports. Europe’s wholesale gas prices have gained around 30%. With winter approaching, we cannot fully discount the possibility of a repeat of last year’s energy stresses. This would be bullish for aluminum since supply would again come into question. On the flipside, however, this might also bring demand destruction. There is a possibility that in the premium sections such as electric vehicles and other lightweight transportation, demand may even improve in this scenario as Western consumers become even more determined to get off petroleum.