Aluminum subdued as tin trends upward

The following was culled from Barclays Capital’s monthly report The Commodity Refiner:

Aluminum

Three-month aluminum prices managed to trade 4.2% higher during October and another 3% firmer by mid-November (near the US$1,400-per-tonne level), supported by forward tightness and inventory movements. However, the near-term outlook for demand remains subdued, and rising production will help maintain large supply surpluses. The recent price rise has primarily been driven by technical fund activity.

We continue to expect a large supply overhang during the next three years. China remains the wild card, and changes to production plans could significantly affect exports to the Western World. We continue to expect 2003-04 to represent peak years for former east bloc net exports to the West.

For the nearer term, the outlook is fragile, and we think renewed pressure could emerge, depending on economic developments. U.S. aluminum order data remain weak, though at least recent declines have not accelerated. However, we’re concerned about the state of the auto industry in light of falling sales and rising inventory levels. Poor demand is evidenced by Pechiney’s recent decision to downsize its Ravenswood rolled products operation in the U.S.

On a positive note, the Japan Aluminum Association reported that shipments of aluminum mill products rose 7.7%, year over year, in September to 192,000 tonnes. As we are still cautious in our outlook for Japanese demand, we think recent strength is related primarily to strong Chinese demand. Over the medium term, aluminum’s relatively greater exposure to the U.S. economy and the less cyclical packaging industry should be supportive factors.

While Chinese output and exports continue to rise, operating rates in the Western World are also rising, to 58,500 tonnes per day according to the latest statistics from the International Aluminum Institute (IAI) for October. This represents the highest level we have on record (since 1996). Restarts of power-related curtailed production in Brazil and the U.S. Pacific Northwest are partly behind the rise. Chinese official statistics show net exports amounted to 303,000 tonnes in the first 10 months of this year, with exports 109% higher than in the comparable period last year. However, in October alone, exports were slightly lower at 56,900 tonnes, compared with 60,000 tonnes in the previous month.

r Prices — The average price for Australian spot alumina declined by about another US$4 per tonne in October, leaving prices in a range of US$139-144 per tonne. Overall spot activity remains weak, notably with the absence of Chinese buyers from the spot market. This reflects good availability of alumina in an environment of rapidly rising primary output.

Sharply rising open interest in a falling price environment suggests short selling was aggressive on the London Metal Exchange (LME) during the second and third quarters. In October, total futures open interest for aluminum rose to 374,000 lots, up by 10.3%, month over month, and 22.9%, year over year. Lately, higher prices have been supported by short-covering activity, with open interest for all futures reduced to about 348,000 lots at mid-November.

Trading volumes of LME aluminum futures have remained in an overall downward trend since 2000 (prices have also trended lower), though they picked up during September and October after a quiet August. In October, volumes rose to 2.1 million lots, up by 21%, month over month, and by 11.7% from the corresponding month a year earlier. Aluminum remains the most-traded LME metal, with trading volumes about 25-30% above those of copper in October.

r Inventories — The aluminum forward curve has flattened out notably over the past month, whereas trading in previous months was marked by temporary backwardation. Such sharp tightening of spreads at times of good metal availability and weak demand is almost unprecedented.

We believe the borrowing activity could be related to a producer with idled capacity or a merchant with an inventory shortfall striving to meet customer obligations. Contracts for 27-63 months forward started trading in early October.

Physical spot prices have continued to increase over the past month, especially in Europe, where there has been some tightening in the market. Continued strength appears to be related to a significant amount of inventories tied up in financing deals and hence not readily available to the market. Premiums are higher in Japan, too, and to a lesser degree in the U.S. (but only since September).

Consumption of primary aluminum in the U.S. has been steady over the past month, despite further weakness in the flat-rolled and extrusion markets, whereas in Japan, the volume of trade has been pretty thin following the settlement of fourth-quarter term premia. However, scrap tightness has been a major supportive factor.

The latest statistics from the U.S. Aluminum Association show the total net new order index for domestic aluminum mill products was flat in October at 83.91, compared with 83.63 in the previous month and 82.48 in October 2001. The total index, less can stock, rose to 83.45 in October, representing a rise of 6.9%, month over month, and 4.1%, year over year. The order index leads shipments by about three months.

While the data series tend to be volatile, the 3-month moving averages for both indices still point downward. We think it is too early to say that improvements in the index, excluding can stock, represent a turning point, especially given overall economic weakness.

Total LME aluminum stocks have been largely unchanged since the beginning of October until mid-November (at 1.3 million tonnes), and the recent firm uptrend has flattened out. Net outflows have been most notable at Swedish warehouses, but also at warehouses in Singapore. However, stockpiles at United Kingdom locations have continued to rise and now exceed those in Sweden. Stockpiles in Rotterdam remain firm after a more extensive buildup earlier this autumn. These are convenient locations for Russian material, in light of that country’s reduced exports to China.

Cancelled aluminum warrants have continued to rise in recent times, amounting to 110,000 tonnes in mid-November (or 8.5% of the total remaining). While this represents metal due for outward delivery, still, net outflows have been modest. Large amounts of metal on cancelled warrants suggest net inflows should remain constrained, preventing the LME aluminum stockpile from growing further. Meanwhile, inventories at other exchanges remain modest, with the Shanghai Futures Exchange’s stockpile at around 8,000 tonnes, and Nymex stocks at 105,000 tonnes.

The IAI reported a sharp fall in aluminum producer inventories at Western World smelters for September. Unwrought inventories (representing the largest share of total reported stocks) declined to 1.5 million tonnes at the end of September, compared with 1.6 million tonnes in August (-3.4%) and 1.7 million tonnes in the corresponding month a year earlier (-13.4%). While this was the 14th consecutive year-over-year decline in unwrought stocks, the September reading represented the lowest level since November 1990. As a result, the total reported stockpile (also including inventories held at exchanges and Japanese ports) declined for the first time since April, to 3.1 million tonnes.

However, the stock-consumption ratio rose to 8.2 weeks in the third quarter (the highest levels since early 1999), compared with 8.1 weeks in the previous quarter and 6.4 weeks in September 2001.

Tin

Not unusually, tin prices have traded in opposite directions to the rest of the LME complex in recent months. A firm upward trend was evident during September, when the other base metals traded sideways or downwards; then the upward trend eased during the latter part of October, when the others rallied. We regard this market’s fundamentals as attractive in relation to the rest of the base metals complex.

Although demand is showing some signs of recovering, especially in the Asian markets, the positive market factors are related primarily to the supply side. In late September, Malaysian Smelting Company (MSC) announced it was closing two of the four operating furnaces at its Butterworth smelter, owing to the ban and subsequent termination of tin concentrate exports from Indonesia. As a result, MSC will halve its output to 15,000 tonnes next year.

Meanwhile, PT Timah reported a 20% drop in mine production (to 20,800 tonnes) in the first half of 2002 and may cut its offshore production further. The company suffered its first first-half financial loss in 10 years, during which time it saw its refined tin output fall 7% to 17,000 tonnes.

Another supportive factor for the tin market is the reduction in Chinese tin exports. During the first 10 months of this year, exports fell by 31.3%, year over year, and net exports for the period were only 22,700 tonnes. This is partly a reflection of lower domestic production, thought it’s also an effect of domestic prices trading at a substantial premium to LME prices.

In China, Yunnan Tin closed its Ausmelt plant during September and October. It is likely, however, that production disruptions are being offset by increased output at its new Henan operation and by the greater use of old furnaces at its Gejui plant. The company recently announced an increase in its production target to 28,000 from 24,000 tonnes.

On the demand side, U.S. tinplate imports fell sharply at the beginning of this year after the tariff deadline. As a result, domestic tinplate production has started to rise, though the amount of tin consumed in tinplate seems to have declined, according to estimates by London-based CRU International. Meanwhile, China has imposed a 25% tariff on imported tinplate — a move which might reduce annual import levels, which amounted to 300,000 tonnes last year. We expect the market to move into deficit next year.

r Prices — Western Europe remains the key consumer of tin, for it is a major producer of tinplate (which is one of the key end-uses of tin, apart from solders and chemicals).

We estimate that European consumption will reach approximately 61,000 tonnes by 2003. Meanwhile, Chinese consumption is rising at the fastest rate — to an estimated 57,000 tonnes by 2003.

Open interest and prices for tin have moved in irregular patterns in recent times, making it more difficult to read trading activity. What does seem clear is that the sharp price fall last year was driven by aggressive short selling, with open interest moving in the opposite direction of prices. More recently, we believe rising prices have been a combination of short-covering and the establishment of fresh long positions.

In October, total tin futures open interest amounted to 23,000 lots, compared with 22,000 lots in the previous month and 25,000 lots in October 2001.

Data since 1998 show that trading volumes of LME tin futures have been relative volatile. However, in more recent times, monthly trading volumes have amounted to around 120,000-140,000 lots, apart from July, when prices spiked and volumes rose towards 200,000 lots. In October, volumes rose to 133,000 lots, up by 10.6%, month over month, but were 8.5% lower in comparison with the comparable period of 2001

Tin remains, by far, the lightest-traded base metal on the LME. The tin forward curve remains in a full contango, suggesting market perception of good metal availability over the coming 15 months. However, in light of production declines and stockpile reductions, combined with a potential pick-up in demand, forward spreads might tighten in the near future. The cash-to-3-month spread remains steady at around US$25 per tonne.

In October, when the price spiked at US$4,400 per tonne, the nearby spread tightened temporarily to a small backwardation.

Physical tin premiums in the U.S. are in a rising trend, trading at around their highest levels since late 1995, when LME prices were trading well above US$6,000 per tonne.

Strength in premiums is due to robust domestic consumption and reduced availability.

r Inventories — LME tin inventories have declined in most major warehouse locations in recent months. While drawdowns have been consistent throughout the year at Barcelona and Rotterdam, stockpiles at Singapore have also started to decline.

Inventories in Europe have been depleted at an accelerated pace as producer shipments were reduced or diverted elsewhere. Declines in the Singapore stockpile since August coincide with declines in Asian production and improved demand in the region. At mid-November, total LME stocks stood at 27,700 tonnes. This is down sharply since the recent peak at the end of July at 39,000 tonnes, yet higher than a year earlier (22,000 tonnes).

We believe declines in LME stocks since August reflect a combination of real consumption and the fact that merchants are relocating inventory to more convenient locations.

During the same period, cancelled LME tin warrants fell sharply, though they have started to rise. Cancelled warrants now represent 7% of the total remaining, suggesting another 1,800 tonnes are awaiting outward shipment at present.

On a total reported basis, tin inventories are still near historically high levels. In contrast to most other base metals (bar copper and zinc), inventories held at the LME represent the largest share of the total. According to the latest available statistics, total tin stocks stood at 52,900 tonnes at the end of September, compared with 63,000 tonnes at the end of July.

Consumer and producer inventories were estimated at 15,000 tonnes and 9,000 tonnes, respectively, at the end of September.

The stock-to-consumption ratio remained firm at an estimated 11.6 weeks for the recent third quarter, compared with 12.8 weeks in the previous quarter and 8.6 weeks in third quarter of last year.

— The opinions presented are the author’s and do not necessarily represent those of the Barclays group. For access to all of Barclays’ economic, foreign-exchange and fixed-income research, go to the web site at barclayscapital.com. Queries may be submitted to the author at kevin.norrish@barcap.com