MI LME WEEK SPECIAL Good times postponed again for aluminium

Once again the metals world gathers in London for the annual LME Dinner Week and once again it seems that the good times have been postponed for the aluminium market. LME 3-month metal closed Friday valued at $2,430/t. One year ago it was valued at $2,590. The 6.2% year-on-year slide is dwarfed by the 13.3% year-to-date slide. Only zinc has under-performed as badly as the light metal in terms of 3-month price so far in 2007. Under-Performer At the start of this year LME aluminium was showing all the "irrational exuberance" that had characterised its early 2006 performance—a surge above $3,000 in May 2006. In January 3-month aluminium was nibbling away at resistance in the $2,800-2,900 area helped by a backwardation across the front part of the market structure. That in turn was a function of the dominant long position holder that bestrode the aluminium market in the first half of 2007. Each month brought with it renewed concern about big upside call option exposure and the resulting potential for an upwards surge. Monthly options dates came and went with no fireworks but the slow-motion squeeze didn't budge. It kept aluminium in a state of suspended animation through the first half of the year, although 3-month metal never convincingly broke up through the bands of producer selling to get even close to that magic $3,000 number. The dominant long sloped off some time in June and since then it's been largely one-way traffic. There was a half-hearted recovery back up towards the $2,850 level in July but the last couple of months have seen a severe price collapse in 3-month metal with bear funds swarming into the downtrend and any lurking bulls left nursing their wounds and a good deal of battered pride. Of course, macro-economic developments have hardly helped. The LME's most liquid contract has a closer correlation with the likes of US equities than the other metals. Inevitably, the light metal got battered and bruised by the consecutive waves of risk-reduction that have broken across the financial markets this year. Inevitably too, it was particularly hard hit by the eruption of the US sub-prime mortgage fiasco into a full-blown global credit and liquidity crunch. But the same macro shocks have hit all the metals and others, copper and lead in particular, have simply absorbed the blows and powered back to the highs and to new all-time highs respectively. Aluminium, by contrast, has been discarded into the under-performer category, along with zinc, which has persistently remained out of favour right through 2007. The reason, in short, is that it does not have the same shiny bull credentials as the likes of copper and zinc. Stocks have been low by historical standards but never close to the critical level. Only once this year, at the end of June, did global reported stocks show a year-to-date decline and that by a marginal 35,707t. Over July and August they rose by almost 189,000t. In September, LME stocks rose by a huge 97,775t, reflecting the wholesale movement of metal from off-market to on-market, possibly to capitalise on the finance-friendly contango that had grown ever since the end of the slow-motion squeeze in June. Nor were any of the other drivers that had so excited the aluminium bulls the previous year performing to expectations in 2007. Rather than rolling over quietly and dying—as expected by many analysts—older, higher-cost smelters in the developed world showed a frustrating ability to rise from the ashes. In Europe, Germany's Trimet restarted the 133,000tpy Hamburg smelter that had closed at the end of 2005. Alcan managed to sell its 85%-owned Vlissingen smelter in the Netherlands—another likely casualty of rising power prices—to a private equity company. And Hydro won a reprieve on 120,000tpy of old-technology capacity at its Karmoy smelter. In the US, the most remarkable turnaround came with the restart of Ormet's 268,000tpy Hannibal smelter. A year or so ago the smelter was idled, there was a bitter long-running strike and the company had just sold its rolling mill. It is currently preparing to activate the last of its six potlines. Alcoa has just restarted 90,000tpy of capacity at its Intalco smelter and is looking at building a power plant to help reactivate its mothballed Eastalco smelter. North American production is running at levels not seen for many years. China, meanwhile, has seen no appreciable slowdown in its metal production growth…or in its alumina production growth for that matter. Both parts of the sector are still expanding at break-neck speed. Nor has there been any real slowdown in the country's exports, even if changes to the tax regime mean that more "product" rather than primary metal is now flowing out of the country. The good times, it seems, have once again been postponed for aluminium. Over-Performer Which is why we have to be cautious in our appraisal that aluminium has under-performed this year. That is certainly true of 3-month metal but it is certainly not true of far-dated metal. Aluminium for delivery in 63 months' time closed last week valued at $2,520. One year ago it was valued at $1,870. That's a handsome year-to-year gain of 34.7%. Aluminium? Under-performer? It all depends which way you look at it… Investor enthusiasm for long-dated aluminium has become a regular feature of this market in recent months as has high-volume lending all along the forward curve. The result has been a complete change in the forward structure of the market, captured in the chart below. This has been a hot topic on the London "street" for some time now but no-one seems quite sure what to make of it or whether this will prove to be a temporary or lasting phenomenon. The consensus thinking right now is that we've seen a massive reassessment of aluminium's prospects beyond the immediate (1-2 year) time-horizon. Globally rising power and other raw materials costs, the potential for actual rather than theoretical capacity closures and a resolution of China's current structural oversupply are all in that curve somewhere. So too is the recent birth of two potentially huge "dominant longs" in the aluminium market. Not the type that featured daily in the LME's compliance reports in the first months of this year, but two new super-size players in the world of physical aluminium. The merger of the two Russian producers—RusAl and SUAL—and the aluminium interests of Swiss trade-house Glencore was sealed earlier this year. At the time we greeted the arrival of the new giant—UC RUSAL—with the headline: "The birth of the ultimate dominant long". We were wrong. A couple of months later Rio Tinto rode as white-knight to the rescue of Alcan, which was fending off the unwanted attentions of its US peer Alcoa. That deal is still going through but once completed another production colossus will stride the world's aluminium sector. Rio's eye-watering $38.1 billion take-over had analysts the world over crunching the numbers to reach a consensus view that the UK-Australian behemoth was evidently in the long-term aluminium bull camp as well. It is there with a good part of the aluminium producer community and a good part of the investor community. The future, it appears, is a bright one for the light metal. It's just the here-and-now that fails to enthuse. Is it just us having a strong sense of déjà vu?