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Aluminum Premiums Stay Weak as Production ex-China Ramps Up

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Aluminum premiums

The all-in aluminum price consists of aluminum’s price plus regional aluminum premiums. Physical premiums are decided between aluminum buyers and sellers. This is unlike aluminum prices, which are decided on the exchange, which is generally dominated by financial market participants.

Alcoa (AA) sees physical aluminum premiums as a better reflection of the aluminum industry’s dynamics than aluminum prices.

Aluminum premiums reached record highs in early 2015, enabling primary aluminum producers including Rio Tinto (RIO), Century Aluminum (CENX), and Norsk Hydro (NHYDY) to post higher earnings.

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Physical markets weak

While aluminum prices also reflect traders’ sentiments, premiums generally display the mood in physical aluminum prices. Being an industrial metal, aluminum’s medium- to long-term price movements should be guided by the physical market rather than the financial market.

The graph above shows the US Midwest aluminum premium plotted against the average duty-unpaid premium in Rotterdam as estimated by Metal Bulletin. As you can see, though premiums recovered modestly last week, they are still lower compared to January.

Resilient supply?

Aluminum prices rose sharply after hitting multiyear lows in January 2016. As prices fell, smelters reduced production in a bid to reduce losses. However, as aluminum prices started to gain traction, aluminum production also rose.

According to a Reuters report citing International Aluminum Institute data, aluminum production excluding China climbed to a four-year high in February. While China seems to have cut down its production, which the official data suggests, producers elsewhere have capitalized on higher aluminum prices.

Higher production ex-China seems to have negatively impacted aluminum market dynamics, leading to lower premiums. Aluminum has also moved from backwardation to contango as new supply has come in.

Meanwhile, there are some key events that Alcoa investors should track in April. We’ll discuss these in the next part of the series.

You can consider the Materials Select Sector SPDR ETF (XLB) to get diversified exposure to the materials sector. Metal producers currently form ~12% of XLB’s portfolio.

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