Fears that the ongoing sovereign debt crisis in Europe could materially derail global economic growth has prompted a commodity sell-off over the last couple of months. Leading prices lower have been the key industrial metals - copper, nickel, lead, zinc and aluminum - all of which have retreated materially from their recent April highs.
But could the recent plunge in metals prices, and the shares of companies mining and producing these commodities, be a bit overdone? In the case of aluminum and the shares of aluminum producers, the answer could be yes.
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China Moves To Curb Aluminum Production
After falling roughly 17 percent from their April highs, aluminum prices have now fallen to below the cost of production in China, a leading aluminum producer. That, plus the fact that the Chinese government recently boosted electricity prices for marginal aluminum producers in a bid to curtail excess production, will likely have the desired effect of closing down a lot of excess capacity - thus raising prices.
Aluminum Producers Could See Profits Soar When Metals Demand Rebounds
That's good news for major world-scale aluminum producers like Alcoa (NYSE: AA) and Rio Tinto (NYSE: RTP), which acquired its exposure to the aluminum business when it bought Alcan in 2007. Unlike Chinese producer Aluminum Corp of China (NYSE: ACH), both Alcoa and Rio are recognized as low-cost producers and are well-positioned to realize major profit gains when aluminum prices recover. According to a recent report published by the Royal Bank of Scotland, by 2012 Alcoa's profits could double, and Rio's aluminum unit could generate a profit of $1.86 billion - a huge increase over the $111 million it has made in its most recent six-month period. Another broker, Macquarie Research, recently made Alcoa its top pick in the mining sector.
Another interesting situation is Noranda Aluminum (NYSE: NOR). The company recently came to the market at an issue price that was 70 percent below the value that it had initially sought from investors.
Consumer Electronics: A Growing Factor In Overall Aluminum Demand
This bullish call mirrors other similar positive views on the metal that appear to be grounded in the belief that aluminum demand, particularly from emerging markets, is set to grow sharply over the coming years. Meanwhile, traditional demand from the auto and airline makers is augmented by fast-rising demand from the manufacture of consumer electronics that are mostly in Asia. That could be a huge new source of demand as an expanding middle class in China has the potential to become a key driver of consumer product demand. As a result, by 2015, aluminum prices could be 30 percent higher then they are today.
The Bottom Line
China's recent move to curtail excess aluminum capacity could be the catalyst that halts the downtrend in aluminum prices - and sets the stage for a recovery. (For more, see A Beginner's Guide To Precious Metals.)
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