LONDON (Reuters) - The price of aluminium in Shanghai traded at nine-month highs this week on the back of Chinese smelter outages.
The Shanghai Futures Exchange (ShFE) contract has seen volumes accelerate and open interest surge on the higher prices, suggesting local speculators may be getting in on the action.
In London the price is unmoved. London Metal Exchange (LME) three-month aluminium has been treading water around the $1,800-per tonne level after hitting a two-and-a-half year low of $1,745 earlier this month.
The London market is apparently more concerned with the deteriorating macro picture and betting that smelter hits in China won’t make much difference to the country’s flow of exports.
The disconnect between the two markets is instructive but international players ignore “local” problems in China at their peril.
The ShFE’s most active contract hit a nine-month high of 14,455 yuan per tonne this week amid a sharp pick-up in trading activity.
Last week’s volumes of 1.2 million contracts were the highest in a year, while open interest has mushroomed to 877,524 contracts from 666,706 in the space of two weeks.
The last time the contract was this active was in the first quarter of 2018, when aluminium was retreating from a price spike above 18,000 yuan.
Aluminium tends not to attract the same level of speculative interest as other Shanghai metals such as steel rebar and nickel but it’s clear it’s just moved on to the investment radar.
Reports of at least two significant smelter outages have triggered the new-found interest in aluminium. The exact status of both plants is uncertain, meaning there is plenty of speculation wrapped up in this speculative activity.
Hongqiao Group, the world’s largest aluminium producer, has denied flooding in the province of Shandong earlier this month caused any of its smelters to close.
However, in a seemingly contradictory statement, Weiqiao Pioneering, part of the Hongqiao Group, said a wall of one of the group’s aluminium plants was “immediately overwhelmed” by water from the Xiaofu river.
The market is left scratching its collective head as to what is really going on in terms of output and transport connections in the flood area.
There is a similar lack of clarity about Xinfa Group’s operations in the northwest province of Xinjiang.
The company has made no official comment on reports that it has closed 500,000-tonnes per year of capacity after an explosion at a plant north of the provincial capital of Urumqi.
But the consensus among industry watchers in China is that something serious has happened at the smelter, leaving it out of action for at least a couple of months if not longer.
Inevitably, the lack of official comment on either incident merely serves to fan the speculative fires.
The smelter hits come against a backdrop of flat-lining aluminium production in China.
The country was the driver of rising global output through much of this decade but the growth engine has stalled.
National production increased by just 1.6% last year, a very low pace by China’s standards, and it has fallen by 0.6% in the first seven months of this year, according to the International Aluminium Institute.
Annualised production of 35.9 million tonnes in July was a million tonnes lower than in December 2018.
Poor margins, environmental inspections and broader structural reform of the aluminium smelter are all in the mix.
Visible stocks in China, meanwhile, have been falling for many months. Inventory registered with the ShFE closed at 387,663 tonnes last week, down by 284,522 tonnes on the start of the year and a long way off last year’s peak of 993,207 tonnes.
This may in part be a structural phenomenon as ever more Chinese smelters produce more valuable semi-manufactured products rather than commodity metal.
It’s worth noting that the ShFE contract is backwardated across the front part of the forward curve, with nearby months trading at higher levels than further forward months.
The LME market, by contrast, is in comfortable contango and has been so for much of the year.
In other words, the Shanghai market currently seems to be much more sensitive to disruption in the primary metal segment of the supply chain.
The focus outside China, by contrast, remains on the robust flow of China’s semi-manufactured (“semis”) exports.
Semis exports rose by 4% in 2017 and by 24% in 2018 and were up another 8% at 2.65 million tonnes in the first half of 2019.
This export tide serves to depress demand for primary aluminium everywhere else and its continued strength is one of the reasons why Western investors don’t much like the aluminium market.
However, analysts at CRU have consistently argued that Chinese semis exports also serve to mask a growing deficit of primary aluminium in the West, even if it’s not visible from LME stock movements, which are as much to do with storage as aluminium mechanics.
A general awareness that there is much more aluminium sitting in off-market storage has left the market inured to the sort of smelter hits currently being experienced in China.
However, there is a risk of complacency, particularly if, as CRU claims, non-visible shadow inventory has been steadily declining.
This leaves the global aluminium supply chain ever more dependent on China, which accounts for around 55% of global production.
And unlike in the West, where smelter outages are few and far between, China’s sprawling aluminium sector seems a more volatile mix of short-term and structural disruption.
The LME aluminium market isn’t pricing in this sectoral instability because of the comfort cushion of China’s exports.
But if refined metal stocks are declining in both China and the rest of the world, it may not be long before smelter outages in China impact the London price just as much as they rattle the Shanghai market.
The opinions expressed here are those of the author, a columnist for Reuters.
($1 = 7.0834 Chinese yuan renminbi)
Editing by Kirsten Donovan