Reuters reported that aluminum has become the in vogue defensive play amid the broader sell off across the LME metals markets. This is partly due to the fact that there was less speculative premium built into the light metal than say copper. It also reflects the unwinding and reversal of previous long copper and short Aluminum trading strategies, a trend that appreciably accelerated last week.
As of close at USD 2,545, three month Aluminum had fallen by only 3.2% from its 2011 high of USD 2,628 recorded on March 3. Most of the other LME base metals peaked earlier in February and have tumbled harder over the last few days of speculative blow off.
There are good reasons why Aluminum is currently out-performing. The market is drawing strength from precisely the same combination of Middle East instability and high oil prices that is pressuring the rest of the complex. The light metal has also been evolving its own fundamental bull narrative although it is one that could easily be derailed by the recent run up in prices.
Political turmoil across the Middle East generally and fighting within Libya specifically have shaken the risk asset universe, including industrial metals. Aluminum however is unusual within the base metals complex in having significant production located in the region.
Indeed, the Gulf is currently registering the fastest Aluminum output growth anywhere in the world. Annualized production rates were 3.18 million tonnes in January up 42% from year earlier levels.
Accelerating regional production is primarily down to the ramp up slightly delayed of the new 585,000 tonne per year Qatalum smelter in Qatar. The JV between Norsk Hydro and Qatar Petroleum is expected to reach full-capacity run-rates in June of this year. More will come. Waiting in the wings for a 2013 debut is Alcoa's Maaden JV in Saudi Arabia The integrated complex will include 740,000 tonnes of annual smelting capacity.
No operating smelter has experienced any production issues from the wave of protests that have swept the Middle East. Nor is there any suggestion that existing projects will not go ahead. But political risk has just risen sharply across the region and there is potential for further escalation specifically in Bahrain which hosts the 860,000 tonne per year Knuff smelter.
As the only base metal with a clear supply-side relationship with the Gulf, Aluminum will continue to be supported by the rapidly-unfolding events across the Middle East and North Africa.
Emerging economies are particularly sensitive to energy price inflation, which is doubly problematic for industrial metals prices leveraged to China and other fast-industrializing countries such as India and Brazil. Aluminum is no exception. But because of the energy intensive nature of the smelting process higher energy prices also feed directly into rising production costs for the light metal.
For this reason Aluminum is a hybrid metal energy play for many market participants. Higher energy prices are therefore medium term neutral for price with negative impact on demand offset by positive impact for production cost.
Even prior to the political whirlwind in the Middle East aluminum's bull narrative was improving on the back of production trends in China the world's largest producer of the light metal.
China's national output slumped by an annualized 2.65 million tonnes to 14.67 million tonnes over the second half of 2010 as capacity was forced off line to meet Beijing's energy usage targets ahead of the December expiry of the old five year plan.
Affected smelters are widely expected to reactivate potlines just as soon as they can. It is simply a question of timing. The longer it takes for Chinese production to normalize the greater the impact on domestic supply demand dynamics and the bigger the hit on domestic stocks.
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