Aluminum's Short Squeeze Can Turn on a Political Whim

(Bloomberg Gadfly) -- By rights, the surge in aluminum prices on the London Metal Exchange this month should be great news for Chinese producers.

With U.S. sanctions on United Co. Rusal taking about 6 percent of the world's supply off the market and throwing the global aluminum supply chain into disarray, a Chinese industry that produces about half the world's metal seems well placed to step in.

For the first time in almost seven years, metal in London is trading at a premium to its Shanghai equivalent, and available stockpiles in Chinese warehouses are just a sliver away from overtaking the amount in LME sheds not already marked for delivery.

The problem is government policy. China's smelting industry has long been quarantined from the rest of the world by Beijing's 15 percent tariffs on primary aluminum exports -- one reason that its gross overcapacity has caused fewer ructions than the similar glut of Chinese steel.

Aluminum's Short Squeeze Can Turn on a Political Whim

That means the Shanghai metal that's available to the global market is still priced at a premium to equivalents elsewhere. CRU Group, a metals consultancy, reckons that LME prices would need to rise to as high as $3,000 a metric ton -- a further 18 percent gain on top of the 24 percent jump over the past nine days -- to tempt that product offshore.

Anything feels possible after the past two weeks, but it's hard to believe that aluminum is headed that high. Speculative positioning by investment funds in LME aluminum was net long to the tune of 81,717 contracts on the eve of the U.S. Treasury's April 6 sanctions announcement, but there were still 377,050 non-commercial, non-hedging contracts betting on lower prices that traders will have been struggling to unwind ever since. That suggests a short squeeze has contributed to the vertical movement in prices.

Aluminum's Short Squeeze Can Turn on a Political Whim

Metal's ability to wriggle past government regulations could mollify many of these factors. That stranded Chinese primary aluminum has long evaded the 15 percent tax by being wrought into basic forms that can be exported at lower tariffs; similarly, Rusal's metal may find itself back on the market after being re-melted in third countries.

Still, in the battle between free trade and government policy, the state seems to have the upper hand right now. The market is being driven by the supply-side effects of sanctions announcements in Washington, policy measures in Beijing, and the outcome of court processes in Brazil far more than by the shaky demand-side picture. 

Economic trends can be quite predictable, but political processes are inherently far more unstable -- both to the upside, and the downside. Those wanting to bet on the outcome should take heed.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

David Fickling is a Bloomberg Gadfly columnist covering commodities, as well as industrial and consumer companies. He has been a reporter for Bloomberg News, Dow Jones, the Wall Street Journal, the Financial Times and the Guardian.

To contact the author of this story: David Fickling in Sydney at dfickling@bloomberg.net.

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