Category Archives: Aluminum

image

Commodities: Stick To The Fundamentals, Beware Of Speculation


  • Oil prices are increasing the number of rigs, putting pressure on prices.
  • Soros sold his gold, should you?
  • Iron ore is hot, but waiting until winter might provide better purchasing opportunities.

Introduction

Yesterday we discussed how Treasury Inflation-Protection Securities (or TIPS) are a great protection during times of inflation. Today we are going to take a deeper look into another great inflationary protection, commodities.

The general feeling is that commodities have surged since January, but there is a high level of divergence. This divergence in commodity price movements is due to speculation in some commodities and fundamental reasons in others.

Situation – Oil

Oil is currently trading at $46 per barrel which is 75% higher than it was at its low six months ago.

figure 1 oil prices
Figure 1: Oil prices. Source: Bloomberg.

The 75% price jump in oil is a clear indication of price speculation in oil markets because the demand is stable and well known. Speculators include the whole chain, from producers to retailers and future traders who can trade high quantities on margin. In such an environment, the only option is to make an educated guess about the long-term fundamental oil price and trade around it. As Russia and Saudi Arabia are in talks to stabilize the oil market, we could see the market push through year highs, but higher prices call for more global production. As oil prices stabilized above $40, the number of U.S. rigs increased for seven consecutive weeks and the global rig count also increased in July. More rigs mean more supply and further pressure on oil prices.

Investors should be careful with oil, production is very flexible and much of it is low cost which disables a higher level price stabilization. Therefore, oil is a pure trading play with fundamentals easily influenced by speculation.

Situation – Metals

As we discussed gold yesterday while discussing traditional safe haven assets, today we are going to focus on iron ore, copper, zinc and aluminum.

An additional warning for those long gold, George Soros, the legendary hedge fund manager that opened a $263 million position in Barrick Gold in Q1 has cashed out in Q2. Be careful not to get burned on gold as smart money is slowly leaving the playing field.

Iron Ore

Iron ore has had a wild ride this year, but its supply is much less flexible than oil and divergence from fundamentals can be easier to grasp.

figure 2 iron ore
Figure 2: Iron ore prices. Source: Bloomberg.

As iron ore is more predictable than oil, Morgan Stanley sees seasonal weakness ahead, increased supply due to the VALE S11D project, and suggests that prices might fall back to $40 again. Those dips are excellent opportunities to open a position in iron ore miners as when iron ore prices are low, their share prices also decline. By looking at the lowest cost producers, share price is the main risk factor as in the long run, big, low cost miners are unavoidable for global development. Companies to look at are Rio Tinto (RIO), BHP Billiton (BHP), Vale (VALE) and Glencore (GLNCY), but for lower risk it might be better to wait for winter.

Aluminum & Copper

Aluminum is only up 8% year-to-date, and copper is only up 3%. Both metals are a clear example of how commodities diverge. This divergence is what creates opportunity because lower prices tend to eliminate high cost production, limiting supply and pushing prices up again. The current price stability for aluminum and copper, and price increases for precious metals and iron, suggests that the 5-year commodity bear market has come to an end and things should slowly turn as we begin to run into supply deficits due to lower investments.

Aluminum and copper are closely related to global economic growth. An good aluminum play is Alcoa Inc. (AA), while with copper it’s good to look at the lowest cost producers.

figure 3 copper costs
Figure 3: Copper production costs. Source: Southern Copper Corporation (SCCO).

The production cost for the stock pick detailed in The Copper Goldmine—a report I wrote earlier this year, along with an update, that was sent to subscribers last Friday—was $0.92 per copper pound in Q2 2016, and is expected to be $0.52 for the company’s future copper project putting it among the lowest quintile in terms of production costs. To download this report, click here.

Zinc

Zinc is the superstar metal of the year. It has increased by more than 50% year-to-date and is expected to increase more due to the inevitable supply gap forming. More about the zinc supply gap here.

In addition to our above mentioned stock pick—which is transitioning from a mostly copper producer to a mostly zinc producer in 2017,—another good option to be exposed to zinc, copper and aluminum is the PowerShares DB Base Metals Fund (DBB) with equal weights for zinc, copper and aluminum.

Conclusion

Commodities seem to have reached a bottom, but global economic turmoil or China slowing down might ignite speculators to short metals on margin and put severe downward pressure on prices. Therefore, any commodity related investment has to be done with the notion in mind that 50% of it can quickly be lost.

On the other hand, the world cannot live without commodities and therefore it’s a good idea to be exposed to such an investment, especially to miners as their prices increase exponentially if commodity prices increase due to their fixed costs. Production costs are always the main factor in assessing how much can be lost when investing in commodities.

A good strategy with commodities at this point in the commodity cycle is to average down if commodities experience further declines and then ride in full the eventual upside. The upside is certain as global demand for commodities is expected to grow as a result of increasing demand from developing countries.

To sum things up, commodities are at or near their bottom. The upside impetuses to be aware of are growing global demand, limited supply and potential inflation, while downside risks come from an eventual slowdown in China or a global recession.

image

Aluminum: A Leveraged Investment Into the Global Economy


  • If the economy continues on its growth path, aluminum will enter into a supply gap.
  • After 5 years of losses, investors should be in for a treat.
  • The risks and potential rewards of investing in aluminum will be explained in this article.

Introduction

Aluminum is the third most abundant metal in the Earth’s crust and accounts for 8% of its mass. The mineral it is most commonly mined from is bauxite. The most widely known uses of aluminum are aircraft bodies and aluminum foil, but it has a multitude of other uses like window frames, beer cans etc.

Aluminum is a great element to watch in order to better understand the global economy as the supply is unlimited and its price depends purely on demand and production costs. Like any other metal, aluminum is cyclical and this article is going to shed some light on where we are in the cycle now, what the risks are, and introduce you to a few investing opportunities.

figure 1 consumption1
Figure 1: Aluminum consumption by industry (kt). Source: All About Aluminum.

Aluminum Price

The current aluminum price is below its historical average as prices fell along with all other commodities. The current price is $1,591 per metric ton.

figure 2 aluminum
Figure 2: Historical aluminum prices. Source: InfoMine.

From a price perspective, the above figure shows that aluminum is close to the bottom of its cycle. Prices are at the same level where they were in 1990 which is strange because inflation has lowered the value of the dollar by 83% since then and aluminum is a commodity and should therefore protect investors from inflation.

Supply and Demand

Supply and demand has been pretty balanced in the last decade with a slight tendency toward higher consumption which creates a market deficit.

figure 3 supply and demand
Figure 3: Aluminum supply and demand. Source: All About Aluminum.

Aluminum is expected to remain in a market deficit as global consumption is expected to grow by a rate of 4% per year. In total, aluminum consumption is expected to increase by almost 50% by 2025 due to rising utilization intensity and more diverse end-use applications. For example, car manufacturers are expected to use more aluminum because of it lightness.

figure 4 car usage
Figure 4: Use of aluminum per car. Source: Alcoa.

Ford (NYSE: F) uses an all-aluminum body for its F-150 pickup and we can only imagine where aluminum will be if all car manufacturers switch to aluminum. With more electric cars and their range issues, weight becomes more important and aluminum fits perfectly into that scenario.

In addition to cars, another example of why aluminum will be a wanted metal is that consumption in India is at 2kg per person while the global average is 20kg per person.

figure 5 consumption per person
Figure 5: Aluminum consumption per person. Source: Aluminium Association of India.

As for supply, the availability is not the issue as there is plenty of aluminum, but production costs are an issue. In such a competitive environment, scalability is important as high investments are necessary to develop feasible mining projects.

figure 6 aluminum prouducers
Figure 6: Major global aluminum producers. Source: Rusal.

In an environment where a few players dominate, production costs are essential for profitably producing aluminum. The current aluminum price is below the 4th quartile producers which means that 25% of global aluminum producers produce at a loss.

figure 7 cost curve
Figure 7: Aluminum production cost curve. Source: Rusal.

Currently, the reason for the low aluminum price is high inventory levels. As a quarter of producers are not profitable, this should bring a longer term market deficit.

figure 8 aluminum supply and demand forecast
Figure 8: Aluminum global supply and demand balance forecast. Source: Rusal.

If the above presented forecast realizes itself, aluminum investors will be in for a bullish ride.

The main risks are that aluminum demand will not grow as fast as expected and that the new developing projects will create a market oversupply. As transportation is the main demand growth factor for aluminum, any recession that would impact cyclical car sales would also have a negative impact on aluminum demand and consequently, prices.

figure 9 transportation
Figure 9: Aluminum demand in transportation in million metric tons. Source: Rusal.

Due to the high necessary investments to set up aluminum production it is difficult to be flexible and avoid huge losses if the price of aluminum falls.

Investment Opportunities

For those who are convinced that aluminum is the metal of the 21st century, there a lot of investment options. There are several different ETFs which have the word aluminum in their names, but that does not mean much as they consist of various assets. Only two ETFs are pure aluminum plays but they are very small and are at risk of being liquidated due to their low trading volume.

For aluminum exposure, a good ETF is the PowerShares DB Base Metals Fund which has equal exposure (33%) to aluminum, copper and zinc, and is based on the metals’ future contract prices. But as all of the three metals are expected to go into a supply deficit in the next few years, this ETF might be the best exposure to basic metals that an investor can get. You can read more about zinc here, and about copper here. The performance of the ETF has been terrible in the last 5 years which gives a great opportunity for a rebound.

figure 10 performance
Figure 10: PowerShares DB Base Metals Fund performance. Source: Yahoo Finance.

Another method for aluminum exposure would be to invest directly into pure aluminum producers like Rusal, Aluminum Corporation of China (NYSE: ACH) or Alcoa (NYSE: AA) but those investments necessitate a thorough analysis, not only of the systemic risks for aluminum, but also the specific company risks. A more diversified metal play that gets 31% of its revenues from aluminum is Rio Tinto (NYSE: RIO).

Conclusion

In short, it can be said that aluminum is a bet on transportation. This is not such a bad bet given that everything needs to be lighter to lower CO2 emissions or to save on energy consumption, and the developed world car number per capita still has plenty of room to grow.

The current car of the future, Tesla (Nasdaq: TSLA), is made mostly of aluminum, but the metal is still expensive in relation to steel for mass car production. On the flip side, it gives downside protection for aluminum as at lower prices, car manufacturers would make the switch to aluminum much faster.

As aluminum is such a base metal, the risks are related to the global economy. Lower demand for cars would really affect global demand and quickly erode the future expected supply gap. Therefore, aluminum is a metal that should be watched as it is essential for the world as we know it and portfolio exposure can be increased when the metal is cheaper and decreased when more expensive.