Spot aluminum prices have been trading at the biggest discount to futures on the London Metal Exchange since the global financial crisis, as weak demand for one of the most widely used industrial commodities reignites fears of a glut of unwanted Russian metal.
The aluminum market is coming under pressure from a sharp downturn in demand, combined with a rebound in supply in top producer China and high interest rates that make it more expensive for traders to hold inventories.
The mounting weakness means that traders and executives are bracing for excess stocks to hit the market – a situation made more complicated because much of the metal that’s piling up in warehouses is Russian, largely a result of “self-sanctioning” by consumers and banks in the U.S. and Europe.
Cash aluminum contracts this week traded at a $54.50 discount to benchmark three-month futures on the LME, the most since 2008, in a condition known as contango that signals supply is overshooting demand in the spot market.
European aluminum producer Norsk Hydro ASA said last month it expects a consumption to drop in the second half of the year, heavily driven by a downturn in global construction markets.
Its sales of aluminum extrusions – used by the auto and construction sectors – were down 13% in the second quarter from a year earlier.
The dramatic unraveling of the closely watched spread – the discount has only been this wide on a handful of previous occasions in data stretching back to 1995 – points to the continued weakness in construction and manufacturing demand for one of the world’s most commonly used industrial commodities. For the LME itself, it also shines a fresh spotlight on the question of how the market is dealing with Russian metal, after the exchange last year decided against banning its supplies.
Typically in the aluminum market, banks and trading houses respond to large contangos by buying up spot metal to sell for a profit at a later date against higher priced futures contracts.
These warehouse financing deals became particularly attractive when demand weakened and borrowing costs plunged after the financial crisis, but the surge in interest rates over the past two years has meant that today’s traders need much bigger contangos to cover their costs.
But while the latest unraveling of the spreads mean the trading strategy is just starting to become lucrative again, the large volumes of Russian metal in the system are making things more complicated.
“Normally when you have a contango of this size, you’d see metal going into financing deals and we really haven’t had that yet, so there is a bit of a breakdown there,” Michael Widmer, head of metals research at Bank of America Merrill Lynch, said from London. “It all comes down to having a lot of metal of Russian origin that people want to handle carefully, and that’s what driving this volatility.”
There are no sanctions on buying Russian metal, but some consumers and banks have been shunning it since the invasion of Ukraine. Over the past year, large volumes of Russian stock have been moved into LME warehouses.
By the end of July, about 80% of the LME stock was of Russian origin, data showed on Thursday.And there may be more to come – over the past month, there have been seven new listings of LME warehouses in South Korea, a key delivery point for metal from Russia’s far east.
Two warehouse executives, who asked not to be named as they weren’t authorized to talk to the media, said that traders with supply contracts from United.
Rusal International PJSC had been delivering new Russian aluminum into South Korean warehouses for several months.
The trend is expected to continue, although not all of the material will necessarily be registered for delivery on the LME, they said.
The speed and extent of potential deliveries is also likely to be heavily influenced by developments in China, which has been buying growing volumes of Russian aluminum since the war.
However, rebounding output from the country’s own aluminum smelters is raising expectations that demand for additional metal could soon start to wane.
For now, inventories on the Shanghai Futures Exchange remain near historically low levels, and time spreads haven’t unraveled in the way they have on the LME.
However, a rare jump in Chinese exports of aluminum offers a sign that spot supply is starting to loosen up.
In western markets, some producers including Norsk Hydro and Alcoa continue to lobby the LME to reconsider its decision not to place restrictions on Russian inflows.
However, a group of European aluminum consumers argued against any potential ban.
The LME closely monitors the levels and flow of Russian metal through its physical network, a spokesperson said in response to questions.
“We note that all metals of Russian origin continue to be consumed by a broad section of the market, and we will remain vigilant in respect of this matter.”