China aluminium prices - the gloss is coming off

China’s aluminium prices have hit a wall recently. After accelerating through the second half of May, prices have slipped back a little. The gloss is coming off.

At close of trading today, ShFE’s active contract was RMB12,455. That compares with RMB12,855 just 10 days ago.

There are a couple of interesting points to note about the aluminium price.

The Changjiang spot price closed today at RMB12,610, while the ShFE spot price closed at RMB12,555. That means the market is currently in backwardation - where the spot price is higher than the future price.

There are two likely reasons for this situation developing in the aluminium market in China. One is that traders see the idled smelters bringing additional metal into the market starting in June. Add to that the capacity that is being added from new construction. Shandong’s Xinfa and Hongqiao are both quietly ramping up their plants. There are other plants that completed construction previously but waited on firing up until the price improved.

The other reason why the front price is holding a little firmer than the forward price is that some of the demand underlying the price spurt is genuine demand growth. But there’s a caveat to that.

We are hearing reports of improved sales in several sectors. We spoke to several window frame manufacturers today, and they reported increased orders. So too in sectors such as high voltage power lines and other cable manufacturers, and some can makers. But what we are not yet seeing is the sustained growth that comes when all those factories sell their finished goods. We know that many enterprises were coaxed back into operations following Chinese New Year in February, and in the run up to the Lianghui week in March. The carrot that got those enterprises working was cheap credit. That easy money is in some cases being used to finance finished goods inventories. Indeed, some of the money has kept flowing and has ended up in commodities markets.

It’s only natural for purchasing managers to place orders for raw materials in March, and we saw a good PMI at the end of that month. But if the finished goods don’t sell through, then the purchasing people will delay placing second and third orders for top-up supplies. Hence I am waiting to see if the demand growth is going to be sustained or not.

The other thing to note about the gap between the spot price and the forward price is that as the future price shot up in April, the physical price managed to keep up somewhat. That’s another hallmark of real demand growth, not to mention that the speculators who drove cotton, rebar, and even egg prices up largely steered clear of aluminium.

So there is real demand growth, but is it sustainable, or has the market been duped by the Chinese government’s push to ensure the GDP target was met? The aluminium market is in backwardation now, thanks to a combination of genuine demand and an outlook for increased metal supply, but it is beginning to look like demand will back off just as supply increases - a case of exquisite bad timing.