FxWirePro: Anomalies surrounding Aluminum and strategizing to keep price risk on check

As wintertime pollution surged in Beijing, news reports began circulating that winter production restrictions could spread from the cement and steel industries into aluminum.

30% of aluminum smelting and 50% of alumina refining capacity in Henan, Shandong and Shanxi provinces could be potentially affected. The Ministry of Environment Protection is driving the effort.

The risk to supply is significant, as the three provinces combined account for about 36% of the total current Chinese aluminum capacity.

We understand that if capacity cuts were to be approved, they may be rolled for the next winter season, i.e. from November 2017 through March 2018.

The impact on both the aluminum and alumina price should be significant.

On January 12, the Office of the United States Trade Representative (USTR) filed a complaint with the World Trade Organization (WTO) regarding China’s subsidies to its domestic aluminum producers.

If the complaint by the US is successful in bringing about more concrete steps at addressing overcapacity in China either through settlement (removal of export rebates on aluminum products and capacity cuts) or adjudication, it would lead to more permanent meaningful changes to both the aluminum cost structure and production level in China.

One of the focal points of the incoming Trump administration is to revamp the US corporate tax system.

Apart from the obvious incongruities between the two proposed tax plans, in the case of commodities, there remains uncertainty whether the border adjustments/border tax would even apply to commodities and more specifically to those commodities of which the US is a net importer, such as aluminum. If the answer is that it does apply to commodities, then we do not see any other way but up for the MW aluminum premium.

Recommendations: Go long Dec’17 LME Aluminum and the Dec’17 CME Aluminum MW US Transaction Premium Swap.