Aluminum: A Leveraged Investment Into the Global Economy

June 30, 2016

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 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.

 

By Sven Carlin Aluminum Commodities Investiv Daily Share: