The aluminium price

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By Michael Knox

Job title:

Chief Economist and Director of Strategy

Date posted:

04 August 2014, 11:02 AM

Early in the year there was concern about possible weakness in the Chinese economy. Data now shows that the Chinese economy bottomed out in the first quarter. 

Chinese industrial production bottomed out at 8.6% in January, then improved to 8.8% in February, moved sideways to 8.7% in April, recovered again to 8.8% in May, before moving up to 9.2% for the year to June.

The GDP numbers for China show a similar pattern. The year-on-year growth rate bottomed out in the first quarter of 2015 with a quarterly increase of 1.5%. The quarterly increase of GDP then increased in the second quarter to 2%. This led year-on-year growth rate to rise to 7.5% for the year to June. 

This improvement in the outlook for China seems to have taken place at the same time as an improved outlook for the aluminium price. In Chart 1 (see below), we see our stocks to consumption ratio for aluminium back to the beginning of this century:

We see how the stocks position deteriorated dramatically during the global financial crisis. The stocks to consumption ratio based on LME plus Comes plus Commercial World Total Stocks increased from less than four weeks of supply in 2007 to over ten weeks of supply in early 2009.

Since that time, we have seen a gradual improvement down to the current level of 7.1 weeks of supply. This steady decline in stocks has happened at the time where the behaviour of the aluminium price has been anything but steady. We can see the aluminium price per tonne together with our model based on the stocks to consumption ratio in Chart 2 (see below):

Our model of aluminium based on our stocks to consumption ratio explains 66% of monthly variation in the $US aluminium price. Our model is a lot better from 2000 to 2008. During that time, the price seemed to follow a path that was fairly close to fundamentals. This has not been the case since 2008. The price first rose between 2008 and 2010 at a rate far faster than the improvement in fundamentals in our model.

Having got to an unsustainably high level in early 2011, aluminium then lurched into a three year bear market. Starting from a point where the price was much higher than justified by fundamentals, it slumped down to a final low in January 2014, where the price seemed much lower than anything justified by fundamentals. Since January, the aluminium price has been drifting up. Still, it is a level far lower than seems justified by physical supplies.

In Chart 3 (see below), we see our overbought/oversold indicator for our aluminium model:

We can see that in 2011 the actual traded price was almost three standard errors higher than our model estimate. It then began an extended bear market. By the time the bear market had come to an end in January 2014, the price had slumped to a level which was almost two standard errors lower than our model estimate. Since that time, it has been gradually drifting up. Recently, the pace of the rally has increased. 

Our model currently tells us that based on the physical availability of aluminium relative to consumption, the current fair value suggested by our model is $US2,296 per tonne. This is $US322 higher than the actual traded value of $US1,974 on 29 July.

In spite of the recent rally, the current level of the aluminium price is still one standard error below our model estimate. This means that the aluminium price still has an 84.24% chance of going up further from here. 

The rally in the aluminium price has only really just begun.