Short-term gain, long-term pain for aluminum prices

（Reuters） - Aluminum will climb to $2,700 a ton next year, as improving demand, exchange traded products （ETPs） and falling output in top producer China, buoy prices.

But excess capacity coupled with the threat of huge inventories flooding back to the market, mean that market bulls may eventually be forced to retreat longer-term, analysts say.

Much-anticipated ETPs are the current focus for investors, with worries prevalent that they could tie up excess material, divert metal away from the normal supply chain, and distort prices.

"From a fundamental point of view, further price rises in aluminum are not justified," said Daniel Briesemann, analyst at Commerzbank. "But we think the imminent launch of base metal ETPs will probably have a huge effect. That should be the major price driver for aluminum.

"The market is still flooded with aluminum," he said, adding that prices could go as high as $2,700 next year as excess metal is sucked into ETPs. "Don't believe anyone who tries to tell you aluminum is in a supply deficit."

At 1056 GMT, aluminum traded at about $2,280 a ton, having touched a two-year peak at $2,500 on November 11. Aluminum prices above $2,700 have not been seen since September 2008. The metal, used in transport and packaging, hit an all-time high at $3,380 in July 2008.

Despite the price recovering from lows at $1,828 in June, London Metal Exchange （LME） warehouse stocks of aluminum are 4.3 million tons -- not far from record highs above 4.6 million tons hit in January

Analysts say as much as 75 percent of those stocks are tied up in finance deals, to release cash for producers and to earn banks higher returns than they would get in money markets.

On top of that, additional off-warrant stocks are estimated at about 4 million tons, analysts say.

Government stimulus packages, quantitative easing and planned ETPs are all partly responsible for rising metal prices.

Providers in recent months to announce plans to launch ETPs, include ETF Securities and JP Morgan.

In October RUSAL O486.HK （RUAL.PA）, the world's top aluminum producer, said it had committed to supply as much as 1.0 million tons of aluminum to a physically backed ETP.

CHINESE POWER

Metals analysts expect global aluminum output to total about 41 million tons this year, with China producing around 16 million tons. Chinese consumption is about 16.5 million tons.

But a drive by Beijing to cut energy use and emissions has caused aluminum firms in China to consider new energy efficient investments, and possible mergers to cope with new policies.

Power-hungry smelters in some Chinese provinces have already cut production on reduced power supplies as local governments rush to meet a current energy intensity reduction target by December.

"We expect that fundamentals may improve over the next 12 months to support higher aluminum prices," Deutsche Bank said in a note. "Support is likely to come in the form of our expectation that aluminum production growth in China could slow more quickly than is generally acknowledged."

Deutsche Bank analysts added they did not believe recent actions by Beijing would be shortlived, and expected the drive for increased energy efficiency to be maintained and enforced for the next 5-year plan.

Deutsche forecasts aluminum prices at $2,650 next year and $2,850 in 2012.

Higher power costs in China should help limit price declines. Marginal costs for Chinese smelters are estimated at between $2,000-$2,200 a ton, analysts say, which may provide a floor for prices going forward.

A consensus on producer surplus for this year does not exist however, with estimates ranging from thousands to millions of tons.

Investors might also need to factor in global economic recovery, in which case interest rates might rise and riskier assets become more favorable, leading to aluminum finance deals being unwound and material flooding onto the market.

Some market participants doubt the success among investors of base metal ETPs, while financial regulators may also step in to block launches.

"A lot of people are scared about all the stock that is out there, financing deals being unwound, and the same camp think the ETP talk is rubbish," said David Thurtell, analyst at Citigroup.

（Additional reporting by Rebekah Curtis, Karen Norton and Marie-Louise Gumuchian）