Aluminum: The metal of choice for investors
Normally, base metals like steel, iron, and aluminum are dependent on end-consumer demand. This means that their prices are guided by the demand-and-supply scenario in the market. Aluminum became a favorite for investors looking at diversifying their portfolios. It emerged as a hard asset after the global recession. Last year, aluminum was the most actively traded metal on the London Metal Exchange (or LME). This was due to financing deals in aluminum. According to estimates, half of the demand in aluminum is due to these financing deals.
Key facts about aluminum financing deals
Aluminum financing deals basically involve buying the near delivery while making a forward sale. This generates an arbitrage profit equaling the difference in the prices of the two contracts. The higher the difference between the two contracts, the higher the profit potential in the transaction. A low interest-rate scenario globally pushed a lot of investors and arbitrageurs to this market.
Aluminum financing deals generate high profits
The previous chart shows the spread between spot and one-year forward price on aluminum. As you can see, the spreads were as high as 9% at certain times. This means investors in these financing deals were making a decent return on their investments.
Please be aware that investors in these financing deals gain when forward aluminum prices are higher than current spot prices. Apparently, that has been the trend in aluminum prices for the past few years.
Move to the next part to learn how this trend has recently shown a reversal. It’s important for investors in primary aluminum producers such as Alcoa (AA), BHP Billiton (BHP), Rio Tinto (RIO), and Century Aluminum (CENX) to understand this trend. Some of these companies form part of the Standard and Poors depositary receipt (or SPDR) S&P Metals and Mining exchange-traded fund (or ETF) (XME).