Xu Maili: China’s aluminum prices may collapse after surges in H2

Asian Metal: Hello, Mr. Xu. Thank you for taking the time to talk with Asian Metal. Although Chinese aluminum prices recovered strongly in the first half of July, domestic consumption of raw aluminum was not healthy. What do you think are the major reasons for the appreciation? Is the upward trend likely to persist?

Xu: Three forces led to the appreciation. Firstly, LME aluminum prices had already seen great increases. As to the reasons, firstly, global liquidity was loose, so nickel prices led the appreciation on the metal markets followed by price increases for copper, zinc and aluminum. Therefore, a succession of price increases were witnessed for these materials, caused by large amounts of capital around the globe flooding into the metal market on the back of worldwide loose liquidity. Turning to the fundamentals, overseas markets saw balanced supply and demand, but then witnessed tighter supply amid declining production outside of China; furthermore, the favorable economic growth in overseas countries ensured a steady increase in consumption. The LME warehousing reforms were given up halfway, with the queuing problem still not solved. With stronger stock locks, traders held more power when it came to controlling inventories, so LME aluminum prices were readily dragged down. Therefore, the soaring LME aluminum prices were the strongest impetus for aluminum ingot price increases in China.

Favorable macro expectations across China were the second factor for the recent price increase. The government rolled out a succession of micro stimulus measures and released liquidity, leading to stronger confidence in the domestic market with the ongoing PMI recovery also registering a new record high. The macro conditions across China were good and any unfavorable factors for basic metals became weaker.

The third factor was that metal prices across China had recently skyrocketed with rates for zinc and copper rebounding after bottoming out at the end of Q2. Copper prices went up earlier than those for zinc, with aluminum a little later. Aluminum prices were driven up by the current obvious uptrend and stocks of the material have also increased significantly recently, although prices had been consolidating at low levels for a long time and no improvements have been seen on the stock market. The increase in aluminum stock prices was related to the aluminum price appreciation to some extent and these two aspects influenced one another. As for the fundamentals, oversupply was still common across China, but its influences on the market in the short term have not been exacerbated.

Personally speaking, I do think that prices will not rise incrementally but will instead peak in one go. We can see this from the aluminum pricing trends, with many peaks being witnessed historically, including those in March 2008, December 2009, July and August 2011 and May 2006. Prices for materials like aluminum usually go up quickly thanks to capital incentives, as a slower pace is unfavorable for buying in stocks. Materials are requested when participants remove stocks, while no materials are available to those buying in stocks. As a result, prices are set to reach their peak or even go up further, but the latter is more likely judging from current conditions.

Asian Metal: Consumption expectations for the aluminum market outside China have been favorable with LME prices continuously hitting new record highs recently, so do you think we are already seeing a “bull market” on the overseas aluminum markets?

Xu: I would be relatively conservative. Though aluminum prices on the LME have increased substantially, the actual consumption which is needed on the “bull market” can not last long by simply relying on speculation. I think that the “bull market” will last at least two or three years instead of just being around for a short while or even a quarter, and it will be based on actual consumption levels. Aluminum consumption across the world remains stable at present and the so-called strong demand only applies to China. The slowdown in demand growth across China definitely plays an important role in the market as no substitute markets have been established.

As for the confidence in overseas consumption and predictions of a "shortage", I think there are two ways to understand this. One is a straight comparison between overall supply and demand. The other is to compare supply and consumption., Because supply will not be sufficiently released to the market a shortage will potentially occur this year according to the second of these approaches.

Asian Metal: Currently, the international political situation is complicated and geopolitics has had a great influence on the pricing of many bulk products, including international aluminum prices. What do you think about this influence?

Xu: The most complicated regions are the former CIS countries and those in the Middle East at present. If the current situation becomes any worse, aluminum consumption will definitely stagnate. However, after a period of time, once the key issues have been solved, there will come the reconstruction, which will provide a positive stimulus for aluminum consumption. So it is a question of time, as well as how the situation develops.

Speaking of aluminum consumption, there has been little confidence in the market in the Middle East, so any positive sign in consumption will be an improvement. However, even without this, the market will not be significantly impacted as it is not a major influencing factor in the market.

Asian Metal: What’s your opinion on the development direction in domestic aluminum consumption?

Xu: The traditional industries are still the largest aluminum consumers, and this will continue to be the case for some time, so when it comes to the expansion of aluminum applications, we’re focusing on a marginal increase. As far as I know, aluminum is becoming more popular as a replacement for copper in China, as is aluminum alloy cable. Nevertheless, the domestic cable industry is still somewhat conservative and consumers in this field are struggling to accept aluminum as they have been so used to using copper to make cables. Therefore, the application of aluminum in this field still needs a bit of time. Some achievements have been made in terms of the aluminum-body car, but this is still not mature enough to be mass-produced, let alone talk of developing an aluminum-body train. One reason for this is the performance of aluminum and the other is people’s habits.

Although it is widely believed that domestic aluminum consumption per capita is very low, the unit consumption level is not so bad. As for copper, domestic consumption of copper per unit of GDP is far higher than in the United States, which ties in with the fact that domestic economic development relies on investment, consumption and net exports.

Asian Metal: The Chinese economy survived despite being under pressure in H1, 2014. The government will maintain certain levels of economic growth through targeted stimulus measures in H2. Do you think this will actually improve domestic aluminum consumption?

Xu: Firstly, consumption as reflected in the market did not decline and was a bit better than the published data in H1. However, the figures showed a marked decline in real estate, home appliance and automobile consumption growth, which registered less than 10% , whereas the figure had always been higher than 20% previously with the lowest level no lower than 15%. The domestic policies are reasonable in terms of consumption and on their long-term focus on railways, industry and infrastructure, given the rather limited actual consumption of aluminum. We think that overall consumption in H2 will be fairly stable with no significant increase, as few policies will directly push up consumption of aluminum, especially in the real estate market. Some policies are likely to be issued in the automobile industry, but growth in consumption over the past few years far exceeded last year’s increase. Automobile holdings are rather sizeable domestically, and with growth slowing down, large inventories are inevitable in the absence of any growth. Moreover, enterprises will need to start cooperating. Two factors should be considered besides sales orders. The first is mobility. Enterprises will not purchase in large quantities without funds. Although bonds have increased noticeably of late with sufficient funds in banks due to the current favorable domestic mobility as a whole, funds will not flow into the ferrous metal, nonferrous metal or real estate markets, so capital is unlikely to be injected into aluminum enterprises, in spite of the loose policies witnessed overall. The second is enterprises’ profits. Many aluminum enterprises are not experiencing a significant lack of profits, hence banks have no reason to provide capital to them. In this situation, we think that domestic aluminum consumption will be unremarkable, despite the rather massive volumes in H2.

Asian Metal: Central Government continues to stress easing overcapacity, but local governments insist on production at electrolytic aluminum enterprises to maintain growth in the local economy. Meanwhile, domestic capacity is still expanding, what do you think about this?

Xu: Oversupply highlights the inconsistency between local and central policies, which has existed over several years instead of being a short-term situation. From the point of view of the industry alone, it is difficult to solve, and this has been proven by past experience as local governments do not execute the policy. In addition, we should solve the problem from the environmental protection perspective, and both parties would be able to phase out some capacity. With their focus on ensuring economic gain and employment, local governments can hardly be expected to solve such a situation. Central governments adjust industrial structure step by step and will not do so at the expense of employment, so structural change will not happen overnight but as part of quite a long process.

Asian Metal: The nationwide average production costs for electrolytic aluminum have slipped with the capacity proportion in Northwest China increasing. How will this impact aluminum prices?

Xu: Cost reductions will have a negative effect on aluminum prices in the long term. Looking at the historic trends, prices were up and down around the cost line. Price reductions will result in a price decline, the extent of which will not be very clear in the short term. With higher margins, plants will increase operating rates, and supply will increase accordingly, which also has a negative impact on prices. In fact, taking Xinjiang in Northwest China as an example, the speed of capacity expansion is not as rapid as expected, and it has been difficult to release the capacity completely. Furthermore, the stability of workers in a region will influence its operating rates with higher costs in maintaining stability, while the cost advantages are not as high as expected.

Asian Metal: What do you think about the price trend for aluminum in China in H2?

Xu: Aluminum prices will rise and then decline, and after that, they will fluctuate. We will see the most rapid rise in prices for aluminum in July and this will peak in August, before prices slide back rapidly, and later on they will fluctuate. From a funds perspective, the round of increases in prices is mostly caused by fund hype, and the situation has already lasted for half a month, so it is unlikely to continue into September. Now prices are at RMB14,000/t, and it is difficult to see them rising to RMB14,500-14,800/t. Due to the domestic market conditions, investors will take profits quickly after funds are pushed up. Then the market will decline.

Asian Metal: Thank you once again for accepting our interview.