Reports from Harbor Intelligence's aluminum outlook conference in Chicago this week suggest that Credit Suisse and Glencore are close to the launch of an exchange-trade fund (ETF) back by physical aluminum. Speculation is that Goldman Sachs may also look to launch an aluminum ETF, following its recent purchase of London Metal Exchange warehousing company Metro International Trade Services. And Russian aluminum player Rusal has previously indicated its interest in supplying metal for an ETF.
As Greg Wittbecker, director of material management with aluminum giant Alcoa, put it, "There is still plenty of risk capital around to finance metal ... It's one of the reasons why the ETFs are becoming more attractive."
The ETF talk comes as a number of analysts have suddenly turned very bullish on aluminum prices. Citigroup, Morgan Stanley and Societe Generale have all recently raised price targets on aluminum, predicting gains of anywhere from 10 to 25%.
One of the cited reasons for the banks' enthusiasm is the relative underperformance of aluminum compared to other metals. Al is up about 55% from its bottom late in 2008. In the same period copper is up 140%, gold and nickel have gained 70%, and zinc 60%.
Although many analysts back this up with talk about excellent fundamentals for aluminum, the "Al frenzy" is starting to look like a classic sector rotation.
Prior to the financial crisis in 2008, investment banks made a lot of money playing the rotation game. It's a simple concept. Get on board with a particular metal. Create excitement and structure investment products (like ETFs) to bring money into the physical commodity and the companies that produce and explore for it. Watch prices for all these investments appreciate.
Eventually the chosen sector starts to top out. Investors grow tired of the story and money stops flowing in. Time to rotate. Find a new commodity, preferably one that hasn't got much press recently and will seem new and exciting to investors. Begin talking it up and creating new investment products.
The rotation becomes self-reinforcing the longer it goes on. Investors remember the spectacular run the previous hot metal enjoyed. So when a new and upcoming metal is presented to them, they want to be first in. It thus becomes easier and easier to sell people "the latest thing".
Usually these "mini-manias" are based on some truth and fundamentals (most good scams are). But at the heart they are Ponzi schemes, relying on incoming investors to make money for the people who previously bought in. Fundamental valuation is a distant consideration.
This cycle has happened in the past with commodities such as uranium, molybdenum (twice), rare earth elements, lithium, potash and nickel. Notice how these are all somewhat obscure, giving investors the impression they are getting in on something secret and exciting.
Aluminum also fits this bill. It's not a commodity we generally hear much about, aside from recycling pop cans. And conveniently, the metal hasn't had any kind of investor boom during the current commodities bull market. In short, it's ripe for an introduction to center stage.
Maybe I'm wrong and the investment bankers really are seeing bright things in the fundamental future for aluminum. But many of the pro-Al arguments are inane.
Morgan Stanley recently noted that large aluminum inventories on the London Metal Exchange are not cause for concern. The reason? As much as 80% of this metal is tied up by investors in long-term financing deals. Meaning the metal can't hit the market tomorrow, crushing prices.
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This is true. But investors will (by definition) sell at some point. They are not end users, who buy aluminum and never send it back to market. The fact that such huge volumes of aluminum are held for investment purposes mean that all of this metal will return to market at some point. Yes, it's tied up for the moment. But how many weeks or months do we have until financing deals mature and metal starts dribbling out, putting a damper on prices?
The sudden and concerted bullish consensus on aluminum smacks of financial games, rather than a fundamental rally. Undoubtedly some will make money on this. But it's critical to get in on the upswing and get out before the inevitable downslide.
By. Dave Forest of Notela Resources
