Aluminum stronger in first quarter; tin demand buoyant

Aluminum rose above US$2,000 per tonne for the first time in 10 years in the first quarter but failed to gain further as Chinese primary aluminum exports remained at high levels despite tax changes, and as fund length became excessive.

As our price target of US$2,000 per tonne has already been reached, we’ve dropped aluminum as one of our preferred base metals. Nonetheless, we expect underlying price support (around US$1,800 per tonne) to hold as a result of high production costs (for alumina and power, for example).

Demand conditions remain sound overall, especially in China, but notwithstanding an expected upturn in seasonal demand in the second quarter, there are signs of softer demand conditions ahead, with the U.S. Aluminum Association’s order indices falling during the first quarter. This is in line with a weak U.S. auto industry, though reasonable growth is still registered in some segments of that country’s transport sector, such as trucks and trailers, where aluminum intensity is greater. U.S. truck sales were up 2.2% in March, while car sales fell by 1.3%.

We expect the aluminum market to register a sizable deficit this year, and solid fundamentals support the upward revision of our 2005 average cash price forecasts from US$1,850 to US$1,950 per tonne. The supply shortfall means inventories are likely to continue to fall, and this should keep spot prices supported. Longer dated aluminum contracts have also been trending higher, with constraining supply-side factors, such as high energy prices and tight power supply, key drivers of this trend.

As a result, previously strong growth in China’s primary aluminum supply is now slowing. The changes to the Chinese export tax scheme at the beginning of this year (removal of an 8% rebate and the addition of a 5% tariff) have had a negative impact on production, but we still expect domestic output to grow by 18% this year and add about 1 million tonnes to the market. While Chinese aluminum demand has so far shown little sign of slowing, we expect easing in growth from 17% last year to 13% this year, which would mean annual consumption of 6.8 million tonnes.

The Chinese aluminum market remains in surplus, and high London Metal Exchange prices continue to encourage (larger-than-expected) exports. Given tightness, particularly in the U.S. market, where physical spot premiums remain firm, Chinese deliveries have been welcomed by the market. However, some deliveries have been stockpiled in other parts of Asia (for example, into LME warehouses in Singapore). The Chinese government now plans to increase export tariffs further, possibly to 20-30%, while the ban of tolling is also being discussed. Tax changes normally take place at the beginning of the year, so an imminent change seems unlikely.

Elsewhere there are reports of smelter restarts. Alcan (AL-T) has restarted three of its smelters, which is now supporting higher growth rates in the Western World. The restarts, together with continued strong demand from China, have helped keep the alumina market tight. Spot alumina prices have risen to around US$430 per tonne f.o.b. as a result.

After having doubled in price over the past couple of years, tin now seems to be performing sideways, as it were, with producers quick to respond to strong demand. However, demand conditions have remained buoyant, keeping prices supported above US$8,000 per tonne, and we expect another supply shortfall this year. Coupled with low inventories, this should keep prices pressured to the upside.

Demand conditions are positive in all major tin-consuming regions, in particular China, Europe and the U.S. In Asia, it’s the electronics sector that has boosted tin demand, enhanced by the relocation of manufacturing to China from the Western World. In Europe and the U.S., tin demand is being supported by the switch away from lead-free solders, which has offset the negative effects of a slowing economy.

Because of extremely low reported inventory levels (the LME now holds 5,000 tonnes, which is only about a third of total stocks a year ago), consumption has also been boosted by re-stocking, as consumers are afraid of being caught short again.

China became the world’s largest tin-consuming region in 2003, and consumption last year grew by almost 25% to 95,000 tonnes. Chinese refined tin exports have fallen steadily over the past couple of years, and strong internal demand is likely to reduce refined tin exports further. Indeed, including trade of semis and concentrates, China has already become a net importer this year. In light of this, Indonesia, which is the world’s second-largest refined tin producer after China, has reportedly moved its sales away from other parts of Asia to China in recent months.

Considering the strong demand, we estimate global refined tin supply will rise at least 6% this year. However, this would still only be about half the growth rate of 2004. Higher Chinese tin production is being consumed domestically, and while Indonesia is increasing supplies to China, some suggest total output from small Indonesian smelters has peaked. In addition, adverse weather conditions affected output during the first part of this year, causing a reduction in profitability and some idled capacity.

In the current marketplace, much effort is being made to expand production. For example, the largest tin producer in China, Yunnan Tin Group, plans to invest up to US$60 million over the rest of this decade (both domestically and overseas) to become the world’s largest supplier. Yunnan Tin cranked out 36,300 tonnes of tin in 2004, second only to Minsur of Peru.

— The opinions presented are the authors’ and do not necessarily represent those of the Barclays group. For access to all of Barclays’ economic, foreign-exchange and fixed-income research, go to the web site at barclayscapital.com. Queries may be submitted to the authors at kevin.norrish@barcap.com and ingrid.sternby@barcap.com