In the previous part, we saw that aluminum inventory on the London Metal Exchange (or LME) has come down in 2015. However, there are piles of aluminum lying in non-LME registered warehouses. According to estimates, more than 10 million tonnes of aluminum metal is stuck in financing deals.
Drivers of financing deals
The above chart shows the key drivers of the aluminum financing trade. The difference between spot and forward aluminum prices is a key necessity for these financing deals. Record low interest rates are also driving these deals.
However, interest rates in the United States might increase this year. Any increase in the interest rate will negatively impact the dynamics of aluminum financing deals. The movement in the US interest rate should be tracked closely by investors of Alcoa (AA), Century Aluminum (CENX), BHP Billiton (BHP), and Vale S.A. (VALE).
Fall in premiums
We’ve already seen that aluminum premiums have come down in Europe as well as the United States. This negatively impacts aluminum traders. Traders are looking to exit financing trades before premiums come down further.
As more traders exit their long positions, aluminum supply is expected to go up in the market. This will put further pressure on aluminum premiums. One of the reasons behind the increase in aluminum premiums last year was that aluminum’s supply has been less than its demand. Major aluminum producers have cut supply over the last couple of years.
With aluminum supply increasing from China and Russia, aluminum traders face an uncertain future. China’s aluminum output has reached record levels. The iShares China Large-Cap (FXI) gives you exposure to Chinese equity markets.
Meanwhile, Alcoa has been working to diversify its business from a pure play aluminum producer. In the next part, we’ll discuss the latest developments in this space.