Alcoa (NYSE:AA), United Company Rusal Plc HKG:0486


For the better part of the last 2 yrs, aluminum was the metal everyone loved to hate. While, Copper, the darling of hedge funds, raced to 1 record high after another, hitting US$10,000 a tonne last week for the 1st time, Aluminum, the most widely used metal after Steel, lagged.

The lightweight metal, used in consumer, and industrial products from cars, and aircraft to drinks cans, has been winning favor in the metals community.

Strategists at RBS (NYSE:RBS) have made it their Top pick for Y 2011, while Macquarie (NYSE:MIC), Barclays Capital and Deutsche Bank (NYSE:DB) have also turned bullish.

Players are beginning to take note. Hedge funds have begun to unwind one of last year's most popular trades, that Copper would outperform Aluminum, by buying Aluminum and selling Copper.

That helped push the benchmark Aluminum contract above US$2,500 a tonne for the 1st time since September 2008, and Wednesday it hit a 2 yr high of US$2,575.25.

Unlike Copper, Aluminum remains a long way from its high of the last cycle, US$3,380 in July 2008, but, Copper is now nearly 4 times as expensive as Aluminum, the highest such ratio on record.

That alone is 1 reason some believe Aluminum could rally. Aluminum is set to play catch up and redress the imbalance, says Nick Moore, head of commodity strategy at RBS.

More important is a change in perceptions about the balance of Aluminum supply and demand.
The most significant change is in China, where Aluminum production, a notoriously energy-intensive process, has been curbed by the government's push to reduce power consumption, culminating in power being cut off to smelters late last year.

The sharp fall in Chinese Aluminum production, from about 17.5m to 14.5m tonnes on an annualized basis, has changed the balance of supply and demand in the country.

Traders say that Aluminum stocks in China are very rapidly being drawn down towards critical levels of about 1 week's consumption, despite sales of 213,000 tonnes in December from the State Reserve Bureau, the government stockpiling agency.

That means inventories on the Shanghai Futures Exchange, the visible part of China's Aluminum stock, could fall sharply. The country could even be forced to turn to the international market for supplies, driving prices higher.

Alcoa (NYSE:AA) has predicted that Chinese demand will outstrip production by 700,000 tonnes this year even as the rest of the World has a surplus aluminum output.

Add to that, traders and analysts have been surprised by the strength of Aluminum demand, Global consumption of the metal will rise 12% this year, according to Alcoa forecasts, after a 13% rise last year, with the growth coming as much from the USA, and EU as China or the Middle East.

A final upside risk to the Aluminum price is the potential for the launch of new exchange-traded funds (EFs) that buy up physical metal.

The 1st 2 such investment products are slated to launch this quarter, hey are, ETF Securities, which in December launched ETFs in three LME-traded metals, has said it hopes to bring an Aluminum ETF to market, while Credit Suisse (NYSE:CS) has filed an application at the London Stock Exchange (LSE) to launch its own Aluminum ETF after earlier trying to launch the product in Switzerland.

All this makes a quick run to about US$2,700 or more a tonne likely in here, some analysts and players believe.

But their Bullishness is tempered by the massive overhang of Aluminum inventories, which were built up when manufacturers slashed production during the financial crisis.

There are 4.6M tonnes of Aluminum in LME-registered warehouses and by some estimates total Global stocks could be in excess of 10M tonnes.

The existence of huge stockpiles has not led to a price crash because they are mostly locked up in long-term financing deals held by banks such as Deutsche Bank and Goldman Sachs (NYSE:GS) or traders such as Glencore, keeping them off the market.

However, the deals rely on a combination of low interest rates, financial incentives provided by warehouses and the fact that aluminum for delivery soon has traded at a large discount to longer-dated futures. Already that discount, called the contango, has narrowed significantly, while premiums paid in some locations above the LME price have reached record levels, both indications of tightening physical markets.

If things turn out as the Aluminum Bulls predict, the rise in prices could have the effect of squeezing the international market until metal starts to come out of financing deals.

Already, traders and bankers say, profitability has been significantly reduced on financing deals, making them shorter-term in nature and only available to those able to secure bargain warehousing rates.

Thus the Bullish call comes with a caveat. Be wary of holding on for too long, says Max Layton of Macquarie. There is a cap to prices.-Paul A. Ebeling, Jnr.

Metals analysts are very bullish on aluminium, iron ore and palladium as the best commodities to invest in for 2011.

While the base metals index has risen 145 per cent since its December 2008 low, the rise in 2009 was 91 per cent, and last year there was only 21 per cent growth.

Of HCM's winners for 2011, the top pick is aluminium, 'providing the most attractive risk-reward play of the base metals.

We expect the substantial rise in the price of palladium, used in jewellery and fuel cells, to continue this year. Palladium has already risen 400 per cent since December 2008.

The launch of copper ETFs in 2011 could provide more price excitement in 2011, HCM says, but zinc, the only base metal to finish 2010 lower, remains out of favour, with surplus inventories eliminating the need to top up stocks.

Among the bulk commodities, iron ore and coal, which are no longer priced annually, are expected to perform well this year.

Shayne Heffernan