Launch of ETFs may boost aluminium prices

There is dialectics for aluminium makers in the US Federal Reserve's?Fed? two observations about economic outlook. The Fed remark that the short-term interest rates would stay near zero for an extended period, possibly running into 2012 would be supportive of inventory deals in aluminium. Such deals, as long as interest rates remain where they are, translate into LME warehouse stocks remaining frozen.

This is all for the good of white metal. Aluminium supply is rising on account of some capacity shuttered earlier in the wake of demand collapse in 2008 being brought back in production stream and also commissioning of new smelting facility. Estimates are that up to 80 per cent of around 4.5 million tonnes of LME stocks are locked up in finance deals. Even then concerns about global economy have sent aluminium prices down by about 12 per cent since last year end.

In the Fed's other observation that financial conditions have become "less supportive of economic growth on balance, largely reflecting developments abroad," non-farm commodity traders will read signals of caution.

So the benefits are likely to emanate from the continuing low interest rates for aluminium stand to be offset to some extent by economic woes, particularly in Europe. A commodity expert has aptly put it that confidence or the lack of it is the most important mover of the market and the recovery now is so much hobbled by poor confidence.

If one is to take a view or more appropriately crystal gaze about where aluminium prices will be this year end or in 2011, one has to take into account the factor that is China, the world's biggest producer and user of both alumina and the metal. Traders are also curious to know what impact the proposed launch of a physically backed exchange traded fund on aluminium will have on supply. We understand that UC Rusal, the world's leading aluminium producer, is planning to launch an ETF next year.

Market buzz is there that Swiss commodity trader Glencore in a tie-up with Credit Suisse will start another ETF. But how much aluminium will the two ETFs take out of the market? If ETFs pull in 1.5 million tonnes of aluminium or more then that should give a major lift to LME prices. Many are betting on a price jump of over $300 a tonne in the short run in case the ETF potential is realised.

There is more than one issue concerning China that will have significant bearing on aluminium price. The long US campaign for correction of the artificially low yuan exchange rate helping exports has evoked some response from the Chinese establishment. Whatever that is, the market wants to know if yuan revaluation will boost aluminium exports to China thereby making some reduction in global supply spate.

Hindalco in a recent briefing for analysts said that China would use 18 per cent more aluminium at 16.407 million tonnes this year when Indian consumption is forecast to rise 18 per cent to 1.664 million tonnes. And the world excluding China will need 22.592 million tonnes. Observers point out that the $586 billion Chinese stimulus programme launched in 2008 is doing a world of good to aluminium and also other metals. Investments earmarked for house building and railways remain to be spent and this should spell further demand for aluminium.

Data from CRU, a leading metals consultancy, show Chinese aluminium use of 1.512 million tonnes in May translating into annual consumption of 17.8 million tonnes. This is as it should be, for that country's white metal production is rising every month since the beginning of this year with May output at a record 1.53 million tonnes. But CRU's sources in China anticipate "a slowdown in activity" in the building sector in the coming months as "government tightening is starting to bite."

What is not good for metals per se is that May inflation in China rose at its quickest in 19 months. This may lead a concerned Beijing to restrain growth by raising interest rates. If this is going to be the case then the small net Chinese aluminium import of 2,800 tonnes in May could prove to be a flash in the pan and the country will remain a net exporter of the metal through 2010 and beyond.

In the meantime, supply problems and improving demand in the wake of commissioning of more and more smelting capacity – May world aluminium production was a robust 3.641 million tonnes – have kept alumina prices firm. Even while China continues to ramp up alumina production – in the first two quarters of 2010 the country's output was 14.303 million tonnes against 23.417 million tonnes in the whole of last year – it still remains a major importer of the smelter feedstock material. Expensive alumina is giving a cost push to the white metal. On top of that Chinese alumina makers now also have to put up with power surcharge. The latter has cost implication of $100 a tonne and more depending on smelter efficiency.

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