The opinions expressed in this report are those of CRU Group and are considered market commentary. They are not intended to act as investment recommendations. Full disclaimers are available at the end of this report.

Since late September the bulls trading CME’s ALI contract have had the upper hand. To recap on last year’s activity, aluminium prices hit a peak early in 2022 of over $4,000 /mt but fell back to about $2,100 /mt by September on demand concerns. Since then, however, the bulls regained control and by the end of the year aluminium had recovered to about $2,400 /mt, 15% above the lows. This was driven by increasing optimism around the global economy.

Now in the first week of 2023 that recovery is being tested. As of the first week in 2023 the aluminium price has fallen back to $2,300 /mt and even touched $2,250 /mt.

We believe that this a major test. To confirm the theories of the bulls, global stocks of aluminium products (billets, slabs and semi-finished products) must start to fall appreciably from the high level that they reached in 2023. That normalisation of stocks must be seen in Q1 2023. At the same time, inventories of primary ingot must also remain close to their current low levels and not show effects of spill-over from the high product inventories. If either of these conditions do not hold, the recent price recovery will come into question.

CRU’s central view is that the market will return to deficit by Q2 2023 and aluminium prices will progressively recover throughout the rest of 2023 and 2024.

Why did the market rally?

The main driver was the expectation that the US Federal Reserve will moderate its pace of its interest rate increases. This supported the view that inflation is moderating and a recovery in demand can be expected by H2 2023. The actions of China around its zero-Covid policy were also important. The rally in ALI prices picked up steam especially in November after China announced a relaxation in this policy and started steps to reopen.

Other industrial metals also gained with copper rising 14% from its mid-2022 lows and iron ore 36%. Equity markets also jumped with the DJIA increasing 14%, recouping more than half its losses in 2022. The FTSE 100 also rose by 9%, putting it essentially flat for 2022.

Specifically for aluminium, power prices have been a major issue both in Europe and the US since mid-2021. 1.7 Mtpa of primary smelter capacity has been taken out since 2021, or 45% of Europe’s total. This has helped to balance the market as demand has fallen. In addition, we believe, production cost pressures are providing support. These have increased for smelters in recent years and made them less willing to accept a return to the historical prices pre-2022 when aluminium traded below $2,000 /mt.

Overall, CRU is forecasting just a small surplus in the market in Q1 2023 of 429 kt and a return to deficit by Q2 2023 of 52 kt, with rising deficits thereafter. We believe demand will improve from H2 2023 onwards and will outpace supply growth. In particular, we see strong demand growth in the automotive and packaging sectors and this will more than offset weakness in construction, certain industrial sectors and a soft economy in Europe.

One further factor supporting prices has been the risk of sanctions being applied to Rusal by the US government. Bloomberg reported they were considering this in October. If this were to happen it could cause a sudden price spike. Although this may appear increasingly unlikely as time passes, it does increase in probability if the ALI price falls, and hence deters shorting.

Why is the rally now being challenged?

Below we consider several questions which we believe investors may be considering as they ask themselves whether the rally since September is start of a longer-term recovery or a bear market rally in the larger decline which began in March.

  • The scale of the construction slowdown
    Construction demand for aluminium in Europe was down by about 25% y/y at the end of 2022. This sector is about 20% of aluminium demand. How quickly it recovers and whether it may deteriorate further are important questions
  • Lower growth in packaging
    World ex. China packaging growth was exceptionally strong in 2021 but in H2 2022 it began to slow due to inflation concerns. We continue to expect strong growth but construction weakness in puts an extra burden on packaging to take up the slack.
  • Some uncertainty over the transport potential
    Supply chain issues have suppressed demand in recent years and these are now clearing. However demand may now be a challenge due to inflation, higher financing costs and falling prices of used vehicles in 2023.
  • Energy shocks later in 2023
    Assuming the Ukraine war continues in 2023 there remains the possibility of a significant escalation in energy prices in Europe later in the year which could compound consumer inflation and lead to disruption in economic activity in Europe.
  • Risks around China’s reopening
    China’s relaxation of its zero-Covid policy has led to an increase in Covid infections in the country. Coinciding with the Chinese New Year this has led to a sharp drop in demand. The speed of resumption of economic activity and how this may affect both China’s primary production and its semis demand is an important factor.

Stock levels are key

One of the key indicators of global supply and demand balance are stock levels. In September last year publicly reported stocks of primary aluminium rose for the first time in many months after reaching their lowest level in almost 20 years. By October they had doubled. Since then, they have fallen slightly and still remain low by historical standards.

On the other hand, stocks of semi-finished aluminium products such as slabs, billets, rolled products and extrusions have shown clear increases. These are not reported but we believe they stand at about four times historical averages. The reason for this is falling demand and customers requesting that deliveries be delayed. This is also reflected in the falling German billet premium which dropped from $1,600 /mt at the start of 2022 to $675 /mt today.

We believe that for the aluminium rally to be sustained it is important that 1) product stocks come down and 2) there are no signs of spill-over from product stocks into primary inventories. This would happen for example if more smelters switched from products to ingot due to the falls in product premiums. CRU’s expectation is that product stocks in Europe and elsewhere should fall during Q1 as demand recovers. The year has just begun and there is no evidence of this yet. We will be reporting on both these trends as the year progresses.

Also, there is a question mark over how China’s reopening will impact their inventories. Reported stocks there have also been low for many months but this may have begun to change. On the first week of 2023 the stock data showed an unexpected build, triggering a fall in the Chinese aluminium price back to the lows of October. Stocks increased by 11%, the first meaningful gain since early 2022. Billet stocks in Guangdong also rose by 45%.

We believe this is due to sudden sharp falls in demand due caused by the surge in Covid cases and approaching Chinese New Year. These are temporary factors and should not last much longer than a few months. However, until there is more data concerns may linger that stocks may rise higher as demand stays weak.

It is also important to note that Chinese domestic logistics have been significantly impacted during their lockdown period. This may have led some producers to avoid using third party warehouses and hold stock at their own premises. Once Covid cases decline and logistics normalise, a more accurate picture of Chinese stock levels should become available. We will also be reporting on this in the coming weeks.

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