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Positive contango argues well for aluminum prices

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Aluminum prices

We’ve already seen that aluminum spot prices have corrected in 2015. However, investors should also watch the movement in aluminum’s forward prices.

Normally, base metals such as steel, iron, and aluminum are dependent on end consumer demand. This means their prices are guided by the demand-and-supply scenario in the market.

However, aluminum emerged as a hard asset after the global recession. It’s among the most actively traded metals on the London Metal Exchange (or LME). This is due to financing deals in aluminum.

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Financing deals in aluminum

Financing deals in aluminum basically involve buying the near delivery while making a forward sale. Future aluminum prices have to be higher than the prevailing spot prices in order for these deals to be profitable.

The above chart shows the difference between three-month aluminum forward and spot aluminum prices. As you can see, the forward prices have been higher than spot prices for most of 2015.

Aluminum in contango

When forward prices are higher than spot markets, it’s called contango. On the other hand, when future prices are lower than current spot prices, it’s called backwardation.

Aluminum prices in contango are positive for aluminum producers such Alcoa (AA), Century Aluminum (CENX), and Rio Tinto (RIO). CENX and AA each form ~4% of the SPDR S&P Metals and Mining ETF (XME).

BHP Billiton (BHP) is also a major aluminum producer. It’s in the process of demerging its aluminum business into a new company.

Along with aluminum prices, investors should also closely watch physical aluminum premiums. In the next part, we’ll look at how aluminum premiums have moved so far in 2015.

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