The aluminium market has suffered from months of low demand through the Covid-19 pandemic, but the impact on premiums in Europe has been small and even a moderate demand recovery is likely to lead to sharp premium increases, similar to what happened after the global financial crisis.
In 2011, manufacturing activity and aluminium demand sank amid the worldwide recession that followed the 2008-09 financial crisis. Shorn of consumers but unable to cease output affordably, producers naturally turned to the London Metal Exchange (LME) warehouse system, which led to a huge build-up of inventories and to massive delivery queues that locked metal away from the market. Warehouse companies incentivised the activity as they were able to collect rent on every tonne in their sheds up until its delivery.
The metal was largely held by cash-and-carry investors. Aluminium offers an attractive haven for investment in times of economic strife owing to its abundance. A dependable forward curve allows traders to carry metal for long periods, and periods of weak demand support this activity because they depress nearby prices relative to values further along the forward curve, pushing the market into contango and supporting storage economics. Unlike other metals, extended periods of weak demand seldom affect aluminium production.
"There are investors that come in every time when demand is low but the contangoes are wide," a trader said. "From hedge funds to family offices to people who used to work in the industry, they realise there are safe returns because there is always metal."
When consumers did return to the market following the financial crisis, as economies improved throughout the first half of the 2010s, they were faced with paying huge premiums to prise metal out of lucrative warehouse deals. Premiums over the LME price rose to become almost one quarter of the total buying price of aluminium, from more normal levels of around 5-8pc.
The impact of the warehouse companies' strategy on the aluminium market prompted the LME to legislate against such queue-building and introduce other measures to combat the withholding of metal from the physical market.
But the motivation for investors to hold metal in warehouses during times of low demand has not gone away. So although any post-lockdown recovery of the European economy that sparks a return of physical consumers to the market will not result in the kind of premium spike that the market experienced almost 10 years ago owing to the LME's rule changes, there is still a lot of metal tied up in long-term carry deals that will not be made available to the market cheaply. Stronger demand is still likely to cause European aluminium premiums to rise swiftly.
"The carry is there, and traders have got a lot of metal," a second trader said. "At some point the tide is going to turn and people will need metal, and I don't see a downside to the premiums in the near future."
European duty-paid premiums fell at the start of the coronavirus lockdowns but recovered swiftly. Premiums declined to a low of $90-100/t in April from $150-155/t in early March, but now stand at $120-140/t after weeks of steady cash-and-carry demand.
Should physical market demand return in force for September and the fourth quarter — as many hope — few of those holding metal in warehouse deals will be willing to sell at current market levels.
"The majority will just carry, and will not sell at these levels," a third trader said. "Maybe for some small deals, but not for 5,000 or 10,000t. There is no shortage of warehouse space."
