Gradual Recovery For Aluminium Prices Appears Best Case Scenario

This story features ALUMINA LIMITED. For more info SHARE ANALYSIS: AWC

By Chris Shaw

Since peaking last July aluminium prices have declined by around 60% to just over US64c per pound. The fall has largely mirrored the 168% increase in inventories the market has experienced over the same period of time as the aluminium market has struggled from the simple combination of too much supply and not enough demand.

Commodity analysts at Standard Chartered note the news is not all bad as while inventories at LME warehouses now total around 2.9 million tonnes, which is a record (in absolute numbers) since such data began to be recorded in 1978, it only represents 7% of annual global demand. This is well down from the 13% of annual global demand indicated by the previous LME inventory level record of 2.65 million tonnes in 1994.

As well, the analysts point out the rate of increase in inventories has slowed in recent weeks, which suggests a turning point in the market is approaching. The slowing pace of inventory build represents the supply response, with analysts at UBS noting production cuts continue to be announced and now account for as much as 20% of 2007 production

These cuts have been necessary as UBS suggests some data indicate demand has fallen by as much as 50% in the past year, thanks to large falls in demand in key markets of the US and Japan in particular. On Standard Chartered’s numbers, demand in the US had fallen by 24% in year-on-year terms in December, with industry heavyweight Alcoa suggesting there is scope for demand in that market to decline by another 10% in the current year.

In Japan for the same month and on the same basis demand fell by 22%. As these two markets account for 22% of global demand, the price impact has been significant. So significant in the view of Standard Chartered that the group estimates 75% of global smelters were loss making at the time prices hit their low last month, an outcome it suggests all but ensures additional cuts to output in the weeks and months ahead.

As this weaker output flows through, Standard Chartered sees scope for the aluminium market to improve, though it suggests any recovery will be a relatively gradual one. Other factors are also supportive for higher prices going forward in its view, as Standard Chartered’s forecasts call for the US dollar to weaken over the course of 2009 and for oil prices to slowly strengthen. As well, with global economic growth expected to begin to show signs of recovering later this year, there should be some pick-up in aluminium demand.

On this basis Standard Chartered expects aluminum prices will gradually recovery, its forecasts calling for an average price in the December quarter of this year of US$1,600 per tonne as against an average for January of US$1,330 per tonne. In 2010 the group expects prices will average US$1,750 per tonne. UBS agrees prices can move higher eventually, especially as on its numbers the normalised price for the metal should be something around US130c per pound, or around double current levels.

To play the aluminium market in Australia the primary exposure remains Alumina Ltd ((AWC)), UBS liking the stock given its leverage to metal prices and the fact the shares are currently trading at a significant discount to its estimated DCF (discounted cash flow) valuation.

The broker continues to rate the stock as a Buy but is out on its own in doing so as the FNArena database shows a total of four Holds and Five Sells along with the sole UBS Buy rating. The average price target on the stock is $1.40, while again UBS is among the most optimistic with its $1.90 target. GSJB Were has a $2.00 price target on the stock, while JP Morgan is the leader of the bears with its $0.55 target.

Shares in Alumina Ltd today are little changed and as at 1.00pm the stock was up 0.5c at $1.315.

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