September/October 1989
Victorious aluminum conquered the market hill last year, then took a rapid descent down a slippery slope. Here’s the story of this metal’s ups and downs.
By Si Wakesberg
Si Wakesberg is a New York City-based consultant for the Institute of Scrap Recycling Industries, Washington, D.C.
The summer of 1989 may be remembered for blockbusters like Batman, Ghostbusters II, Indiana Jones and the Last Crusade, and Honey, I Shrunk the Kids; but it won't be remembered for the aluminum market's performance--hardly a sellout at the box office. For aluminum industry members this was a season of expected but nevertheless surprising downturn after more than two years of remarkable business--a time for reflection on the state of the economy and some sober thinking on where aluminum was heading.
Aluminum's blockbuster season was a year ago, in June 1988, when London Metal Exchange (LME) spot metal made a meteoric rise to $1.80 a pound. One year later, that explosive LME price had sputtered to 75 cents a pound--less than half the June '88 peak. Last year, the aluminum market soared into a never-never land of constant demand, tight supplies, falling inventories, and unbelievable prices. This year is different: demand has ebbed, supplies are accumulating, prices are sliding, and the market is undergoing shock treatment.
Looking back for a moment at June '88, when the LME prices hovered around $1.70-$1.80, a backwardation of around 45 cents a pound existed between cash and forward prices. At the close of June '89, the LME had plunged to 84 cents a pound and the price differential between cash and forward had virtually disappeared. By mid-July, LME cash had fallen to 75 cents a pound and, instead of a backwardation, a slight contango existed--a state in which forward prices are higher than cash prices. (The three-month price was fractionally higher than cash.)
There had been a subtle change in the aluminum market during the second quarter of '89 and by mid-July these subtleties gave way to an out-and-out downturn as LME prices skidded below 80 cents. Merchant prices were reported at around 81-82 cents a pound. Not only was there a change in the direction of the economy but there was a marked change in metalmen's perceptions of where the economy was heading. Some fundamental economic factors influenced the aluminum market.
The sudden unexpected strength of the U.S. dollar mystified the financial experts and affected domestic and international trade. It had particular impact on scrap metal exports. Reports within the trade indicated that Japanese scrap consumers were reluctant to purchase aluminum scrap because of the change in the dollar-yen relationship. Similar reports were heard about European consumers, who limited their buying as the dollar grew stronger. On the other hand, one might anticipate a larger influx of foreign-made goods into the U.S. to take advantage of the dollar situation.
Government reports indicated that the operating rate of U.S. factories fell in June and that industrial output dropped 0.2 percent. A stream of similar economic data led some analysts to surmise that we were entering either a period of recession or one of slowing industrial activity.
More germane to the aluminum industry were announcements of skidding auto sales. There was a 23-percent decline in General Motors sales in the last 10 days of June and a drop of 22 percent in Ford sales. In addition, housing starts were down three months in a row. For aluminum, these were ominous signs.
More Production on the Way
As the aluminum market overheated during 1988 and 1989, plans were on producers' drawing boards to increase the flow of metal. But that takes time. It is ironic that by the time the effort begins to show results, market conditions themselves change and the oncoming stream of additional productive capacity further aggravates the market situation. But the producers hardly had a choice. Reeling from the debacle that jolted the industry in the early 1980s, producers had streamlined and cut back operations and were hardly prepared for the surge of worldwide demand that hit them later in the decade. They had to work beyond full capacity--and that meant literally at over 100 percent--while planning for future increases of production and new capacity.
By mid-1989, production had begun to increase. A look at the Aluminum Association's production figures for the first five months of 1989 reveals each month at a higher productive level than the year before. Output for the first five months of 1989 reached 1.7 million metric tons, against 1.6 million metric tons in the same 1988 period, a rise of 4.5 percent. It bore out an estimate made by Leanne M. Baker, analyst for Philipp Brothers, Inc., New York City, who stated in an aluminum outlook earlier in the year: "1989 production will likely increase by 4.6 percent ... and would require that demand increase by 3.5 to 4 percent to keep pace." Other sources have estimated that Western World demand rose by less than 2 percent in 1988, and believe the figure may be lower for 1989.
With higher production levels already appearing, expansion projects and new productive capacity also must be considered. A week hardly goes by without a news item to that effect. Inventories are also on the rise: U.S. producer inventories in the first four months of 1989 climbed 95 million pounds, according to the Aluminum Association. World stocks, which had been expected to rise in May, instead slipped slightly. However, the five-month figure was still about 4 percent above that of last year, according to the International Primary Aluminum Institute.
Can demand keep pace with this buildup? Some signs on the market horizon seem to indicate that it cannot. Estimated new orders of aluminum mill products in the first five months of 1989, totaling 5.7 million pounds, were down 2.7 percent from the same 1988 period. Aluminum can stock--aluminum's largest single product, accounting for more than 22 percent of total aluminum shipments--declined in 1988. Consumers are wary about making commitments at a time of failing prices.
The sharp price drop tells its own story. In mid-July, Alcan Aluminum sliced 5 cents from its ingot and billet prices to 87 cents a pound for ingot and 95 cents a pound for billet for August delivery. That price was still about 10-12 cents a pound over the LME aluminum price. Concurrently, prices for used-beverage-can scrap were slashed to 60 cents a pound.
Scrap Purchases Tapering Off
The prime producers over the years have become major purchasers of scrap in the open market. They, together with the secondary smelters, are today the principal purchasers of aluminum scrap. A Bureau of Mines breakdown of scrap Purchasing in June 1988, a typical month, shows that the primary producers consumed 46 percent of the total monthly intake of aluminum scrap, the secondary smelters took 38 percent, and the fabricators, foundries, and other consumers took the rest.
"If primary producers have to cut back, they can always reduce their intake of open-market scrap," said a secondary aluminum official. He was indicating that the prime producers have the option of buying less scrap rather than reducing their primary operations. The secondary smelters, however, cannot as readily turn off the tap since their principal source of raw material is scrap. While they can adjust their scrap buying prices when business falls off (and they have been doing that), "we can't permit our source of raw material to dry up," is the way one smelting executive put it. The smelters are thus often caught in a classic squeeze between their declining sales and their inability to stop buying scrap, even at prices they can't afford.
Said one industry official: "Secondary ingot prices began failing several weeks ago, but we couldn't drop the scrap price because LME was still holding and the Japanese were in the market for scrap." Another executive pointed out that the fall in automotive sales was having an impact: "We haven't shut down a plant in the summer for five years; this summer we're closing five plants for vacation periods."
Scrap processors, too, are caught in a squeeze when prices begin to fall as rapidly as they have in aluminum. Their suppliers, the industrial generators, have not yet caught up with the market's downtrend, and continue to ask for prices that scrapmen find difficult to meet in view of the lower secondary-smelter buying levels. It then becomes a question of whether processors can afford to pay the asking price, or simply shouldn't accumulate scrap metal--which they may need later. It is reported that in the period of May and June, processors moved large tonnages of metal and by mid-July, they were left with slimmer inventories.
Even the scrap aluminum export business, which flourished earlier in '89, seemed to trickle off by midyear. While statistics show first-five-months figures at 213,435 metric tons (against 136,248 metric tons in the same 1988 period), by July, overseas buyers were said to be picking and choosing and trying to wangle the lowest possible price. The unfavorable dollar exchange rate appears to have put Japanese and European scrap consumers out of the market for the time being.
What Lies Ahead for Aluminum?
All signs had been pointing to a downturn in aluminum but the price drop in late June and early July was steeper than most analysts anticipated. There is some feeling that the price drop was exacerbated by the summer lull and that a period of upward adjustment will follow. Some observers contend that the price decline has been overdone and the market will steady itself as it approaches September.
Most aluminum executives are hopeful but realistic. "Fundamentally, we are moving into another phase of the cycle," said one industry official. Will the economy maintain strength? Will the dollar back down? Will auto sales pick up in the fall? Will aluminum supply and demand achieve a balance? Will overseas consumers be in the market for scrap? A lot of questions...but soon, we may know the answers.•
Victorious aluminum conquered the market hill last year, then took a rapid descent down a slippery slope. Here’s the story of this metal’s ups and downs.