Research Commodities Four key factors to drive the aluminium market

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1 Investment Research 22 May 2014 Research Commodities Four key factors to drive the aluminium market Aluminium price to edge higher in the second half of the year The aluminium price seems to have landed relatively safely after a long period of steep decline since the peak in early During the first half of 2014, the aluminium market has settled around a price range of USD1,700-1,900/MT. With the aluminium price back on the ground, we take a look at the outlook for the aluminium market for the second half of the year. Overall, we see four critical themes driving the market in the near term: 1. The recent signs that the Chinese economy is stabilising following a period of slowdown and now is moving into a phase of moderate recovery will limit an important downside risk to the aluminium price and will provide support over the coming months. 2. The Indonesian mineral ore export ban, which came into effect in January and has tightened global supplies of bauxite, has not had a major effect on the market for aluminium compared to the spike seen in the nickel price this year. However, upside risks prevail as Chinese stocks are gradually run down. Contents Aluminium price to edge higher in the second half of the year... 1 Chinese economy is finally stabilising... 2 Indonesian export ban taking its toll on the aluminium market... 2 Energy costs headed lower the dollar is headed higher... 3 Normalisation of aluminium stocks... 4 Contango in the aluminium market 3. A lower oil price and a higher US dollar will weigh on the aluminium price and limit the upside from the above mentioned factors by reducing producers energy costs and lowering demand from non-dollar based consumers. 4. The large aluminium stocks will gradually normalise as the global economic recovery gains further ground and raises demand for the grey metal. It will add further support to prices and narrow the present contango. In the following sections, we go into detail on each of the above factors. While these factors will weigh differently on the aluminium market, we expect the net effect on the aluminium price to be positive and push the aluminium price well above USD1,900/MT by the end of the year from the current level around USD1,775/MT. and Danske Bank Markets Contango has narrowed a bit lately The combination of further strengthening of the global recovery driven by, among other things, a rise in investment demand and supply uncertainties will keep upward pressure on the back end of the forward curve, while a decline in stocks may relieve some downwards pressure on the front end of the curve and narrow the present contango. Aluminium price has landed safely Aluminium and copper have moved close together, Danske Bank Markets, Danske Bank Markets Analyst Jens Nærvig Pedersen Important disclosures and certifications are contained from page 5 of this report.

2 Chinese economy is finally stabilising One of the key factors behind the past year s decline in the aluminium price has been the slowdown in the Chinese economy. Since early 2013, monetary and financial conditions have been tightened in China, which has taken its toll on economic growth. Growth will probably end slightly below the government s 7.5% target this year, which should be somewhat satisfactory for the market. China is the world s largest aluminium consumer Given China s position as the world s largest consumer of aluminium, the past year s slowdown in China has led the market to worry that China would suffer a hard landing following years of double-digit growth. Such a scenario has likely been factored into the aluminium price with some probability. The latest key figures released in China suggest that the economy is now getting back on its feet. The central bank has loosened its grip on the economy a bit and the government has announced a stimulus plan both will make important contributions to the growth recovery which lies ahead though we have yet to see clear signals of a turnaround in the Chinese economy. Source: WBMS, Danske Bank Markets However, one noteworthy bright spot has been the recent pick-up in Chinese commodity import growth, which indicates that demand for commodities in China is improving. With growth now looking more stable a key downside risk has been reduced, which could further pave the way for a higher aluminium price. China to grow close to 7.5% target China is increasing commodity imports rapidly again, Danske Bank Markets Indonesian export ban taking its toll on the aluminium market The big theme in base metal markets this year has been the implications of the Indonesian ban on mineral ore exports, which came into effect in January. Indonesia is an important supplier of nickel ore and bauxite to the world market and as the ban now requires miners in Indonesia to invest in smelters to process the minerals domestically before exporting them, global supplies of these minerals, the chief ingredients in the production of nickel and aluminium respectively, have tightened this year. While this has led to a big rally in the nickel market with the price up 40% since the beginning of the year, the market for aluminium has been fairly untouched by the ban so far, even though Indonesia has completely shut down exports to its largest market for bauxite, China around 40% of China s bauxite supplies came from imports from Indonesia before the ban was implemented. Indonesia an important supplier of bauxite in the global market Source: WBMS, Danske Bank Markets The lack of a similar rally in the aluminium market may be due to China having made preparations ahead of the implementation of the ban. Since late 2012, the increase in China s bauxite supplies has vastly outpaced the increase in China s bauxite demand for alumina production, indicating that China has stockpiled bauxite to limit the immediate 2 22 May

3 effect of the ban. This means that China may have enough bauxite in stock to keep going for another year, depending on the development in demand. As the ban looks set to survive both legislative and presidential elections in Indonesia this year, China may need to look elsewhere for future supplies with Australia, Brazil and Guinea as obvious targets given their large bauxite reserves and large mine production. Another solution may be to invest in smelters in Indonesia to get a hand on processed minerals. That may further serve to bring down domestic pollution from the energy intensive aluminium production. Note that China has already announced planned investments in nickel smelters in Indonesia. In any case, the Indonesian mineral export ban will continue to be a dominant theme in the base metal market for the foreseeable future. The tighter supply situation will certainly put upward pressure on prices. However, the big upside risk to aluminium is if we see a marked reaction later this year as China s bauxite stocks are gradually run down the ban has probably already created a deficit on the Chinese bauxite market. China has stockpiled bauxite ahead of Indonesian ban China needs to look elsewhere for bauxite supply, WBMS, Danske Bank Markets Energy costs headed lower the dollar is headed higher While an improving economic situation in China and the halt of supplies from Indonesia have created a clear upside potential for the aluminium price heading into the second half of the year, two external factors may limit this effect. One is the global supply shock on the oil market led by the US shale boom. It has taken over the dominant market moving role in the oil market, which is doing everything it can to ignore the messy situation in the Middle East and Eastern Europe. The oil boom will push global oil production higher over the coming years and continue to put downward pressure on prices. We expect the oil price to dip USD10/bbl from the current level of around USD110/bbl towards the end of the year. That will probably result in lower energy costs for aluminium producers and subsequently lower prices on aluminium. Note that energy costs currently account for around 25-30% of the total cost of producing aluminium. Another factor to keep in mind is the effect of a stronger dollar exchange rate. The divergent path of monetary policy in Europe and the US, with the Federal Reserve on the one side tapering its asset purchases and the European Central Bank on the other getting ready to lower interest rates will, in our view, send EUR/USD markedly lower over the coming year. We now forecast EUR/USD at 1.28 in 12 months a 6.5% drop which will make aluminium more expensive to all non-dollar based consumers. Although it is unlikely there will be a full pass through from dollar strengthening, it will weigh on the demand from non-dollar based consumers and thus limit the upside for the aluminium price. Oil price headed lower, Danske Bank Markets The US dollar to strengthen further 3 22 May

4 Normalisation of aluminium stocks Almost six years beyond the 2008-shock to the global economy plenty of aluminium remains piled up in inventories. While financial demand for aluminium and warehouse inefficiencies has played an important role, the lack of a strong global investment driven economic recovery has also slowed the recovery in aluminium demand. The latter looks bound to change over the coming years. The recovery of the US economy is well under way, despite the temporary winter setback, and the euro area has reported four consecutive quarters of growth since stepping out of a record long recession in the spring last year. The stabilisation of growth in China mentioned above may add further fuel to global growth. We forecast global growth to come close to 4% this year and edge slightly above this level next year. The global economic recovery will gain further strength in the second half of the year. One feature of the improving growth outlook is an expected pickup in investment demand. During the years of economic slump businesses have increased their savings, which we suspect they are now ready to spend on new investment as the economic outlook has finally brightened. Global growth to improve Source: IMF WEO Investment in construction and transportation and other capital goods is relatively metal intensive and world demand for aluminium will therefore benefit from the supposed rise in investment activity. That should gradually erase the present large surplus in the aluminium market and bring along a gradual normalisation of inventory levels. Finally, it will add support to the aluminium price and probably relieve some of the downwards pressure on the front end of the forward curve, thereby narrowing the present contango. Plenty of aluminium in stocks Large surplus to narrow and Danske Bank Markets 4 22 May

5 Disclosures This research report has been prepared by Danske Bank Markets, a division of Danske Bank A/S ( Danske Bank ). The author of this research report is Jens Nærvig Pedersen, Analyst. Analyst certification Each research analyst responsible for the content of this research report certifies that the views expressed in this research report accurately reflect the research analyst s personal view about the financial instruments and issuers covered by the research report. Each responsible research analyst further certifies that no part of the compensation of the research analyst was, is or will be, directly or indirectly, related to the specific recommendations expressed in the research report. Regulation Danske Bank is authorised and subject to regulation by the Danish Financial Supervisory Authority and is subject to the rules and regulation of the relevant regulators in all other jurisdictions where it conducts business. Danske Bank is subject to limited regulation by the Financial Conduct Authority and the Prudential Regulation Authority (UK). Details on the extent of the regulation by the Financial Conduct Authority and the Prudential Regulation Authority are available from Danske Bank on request. The research reports of Danske Bank are prepared in accordance with the Danish Society of Financial Analysts rules of ethics and the recommendations of the Danish Securities Dealers Association. Conflicts of interest Danske Bank has established procedures to prevent conflicts of interest and to ensure the provision of highquality research based on research objectivity and independence. These procedures are documented in Danske Bank s research policies. Employees within Danske Bank s Research Departments have been instructed that any request that might impair the objectivity and independence of research shall be referred to Research Management and the Compliance Department. Danske Bank s Research Departments are organised independently from and do not report to other business areas within Danske Bank. Research analysts are remunerated in part based on the overall profitability of Danske Bank, which includes investment banking revenues, but do not receive bonuses or other remuneration linked to specific corporate finance or debt capital transactions. Financial models and/or methodology used in this research report Calculations and presentations in this research report are based on standard econometric tools and methodology as well as publicly available statistics for each individual security, issuer and/or country. Documentation can be obtained from the authors on request. Risk warning Major risks connected with recommendations or opinions in this research report, including a sensitivity analysis of relevant assumptions, are stated throughout the text. Date of first publication See the front page of this research report for the date of first publication. General disclaimer This research has been prepared by Danske Bank Markets (a division of Danske Bank A/S). It is provided for informational purposes only. It does not constitute or form part of, and shall under no circumstances be considered as, an offer to sell or a solicitation of an offer to purchase or sell any relevant financial instruments (i.e. financial instruments mentioned herein or other financial instruments of any issuer mentioned herein and/or options, warrants, rights or other interests with respect to any such financial instruments) ( Relevant Financial Instruments ). The research report has been prepared independently and solely on the basis of publicly available information that Danske Bank considers to be reliable. While reasonable care has been taken to ensure that its contents are not untrue or misleading, no representation is made as to its accuracy or completeness and Danske Bank, its affiliates and subsidiaries accept no liability whatsoever for any direct or consequential loss, including without limitation any loss of profits, arising from reliance on this research report. The opinions expressed herein are the opinions of the research analysts responsible for the research report and reflect their judgement as of the date hereof. These opinions are subject to change and Danske Bank does not undertake to notify any recipient of this research report of any such change nor of any other changes related to the information provided in this research report May

6 This research report is not intended for retail customers in the United Kingdom or the United States. This research report is protected by copyright and is intended solely for the designated addressee. It may not be reproduced or distributed, in whole or in part, by any recipient for any purpose without Danske Bank s prior written consent. Disclaimer related to distribution in the United States This research report is distributed in the United States by Danske Markets Inc., a U.S. registered broker-dealer and subsidiary of Danske Bank, pursuant to SEC Rule 15a-6 and related interpretations issued by the U.S. Securities and Exchange Commission. The research report is intended for distribution in the United States solely to U.S. institutional investors as defined in SEC Rule 15a-6. Danske Markets Inc. accepts responsibility for this research report in connection with distribution in the United States solely to U.S. institutional investors. Danske Bank is not subject to U.S. rules with regard to the preparation of research reports and the independence of research analysts. In addition, the research analysts of Danske Bank who have prepared this research report are not registered or qualified as research analysts with the NYSE or FINRA but satisfy the applicable requirements of a non-u.s. jurisdiction. Any U.S. investor recipient of this research report who wishes to purchase or sell any Relevant Financial Instrument may do so only by contacting Danske Markets Inc. directly and should be aware that investing in non- U.S. financial instruments may entail certain risks. Financial instruments of non-u.s. issuers may not be registered with the U.S. Securities and Exchange Commission and may not be subject to the reporting and auditing standards of the U.S. Securities and Exchange Commission May

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