Aluminum Prices Will Fade

Aluminum prices have rediscovered their mettle this year, on expectations that China’s vast smelting industry could cut output of the metal used in everything from cars to cans. But, without more evidence that production is decreasing, investors may soon find prices falling instead.

The commodity has risen 12% in 2017, topping gains in copper and nickel, because investors and others believe it will be the next target of reform in Beijing’s campaign to rein in bulky and often polluting industrial operations.

For now, though, China continues to churn out the metal. The Asian commodities powerhouse produced 2.95 million metric tons of aluminum in January, according to the International Aluminium Institute, a trade group. That is a monthly record and follows a hefty 2.89 million tons in December. Both months’ production easily topped January 2016’s 2.48 million.

“Unless the constraints and closures of capacity that happened in sectors such as steel play out in aluminum, it is difficult to see how the market will significantly tighten up,” says Daniel Hynes, senior commodity strategist at Australia and New Zealand Banking, or ANZ.

CHINA DOMINATES PRODUCTION, as it does in many metals markets. It has doubled output since the turn of the decade and now accounts for more than half of global aluminum supplies.

That means it has a large influence on the availability of the metal and, consequently, prices. Early this year, Beijing signaled it might intervene in the industry because of environmental concerns and overcapacity. This week the London Metal Exchange’s three-month aluminum futures hit a 22-month high of more than $1,915 a ton. On Friday, those futures traded at $1,891 a ton.

But brokers forecast the price will fall in the next six months. ANZ predicts an average price of about $1,650 to $1,660 in the second half of 2017, and Citigroup estimates a similar $1,650 to $1,700 a ton. Citigroup says production cuts are “very far from certain,” and that the greater likelihood is that China will pare unused capacity. Last year, primary aluminum-production facilities in China operated at a utilization rate of 77%, Citi notes.

Uncertainty about China’s restructuring plans isn’t the only reason for caution. Cost deflation is possible because of a weaker yuan and easing coal prices.

Conversely, there are reasons to see higher prices. Better general sentiment toward industrial metals has been helping aluminum, aided by President Donald Trump’s pledge to reinvigorate U.S. industry. And a U.S. complaint filed with the World Trade Organization over subsidies it argues Beijing provides aluminum makers could accelerate reforms in China. If the Asian nation cuts more than spare capacity, prices could rise sharply. Last year, when China put restrictions on coal production, prices for some types of coal rocketed threefold.

Still, analysts want more clarity before changing their views. “The catalysts for a further rally in prices will need to come from clearer evidence of the Chinese government’s action on supply cuts,” Goldman Sachs said in a recent note.

Investors who want to bet on the market, but not through futures, can use the iPath Bloomberg Aluminum Subindex Total Return exchange-traded note (ticker: JJU) or the iPath Pure Beta Aluminum ETN (FOIL). But it should be noted that they are thinly traded.