Goldman’s Safe Bet
Until recently, aluminium hasn’t received a lot of press coverage, although it is in fact the second most commonly used metal after iron. However, late in June investment bankers put aluminium in the spotlight when word got out about the bankers’ sudden interest in the metal.
Unlike gold or copper, which have been used for thousands of years, aluminium is a relatively new metal: people learned how to purify it only 100 years ago. However, the “youngest” of the metals is also the most plentiful metal in Earth’s crust. Its properties (light weight, rust resistant, malleability and ductility, to name a few) make it very versatile. It is used in manufacturing cars, trucks, ships, airplanes, washing machines and so forth. None of the above would necessarily indicate that aluminium should be a great source of income for investment bankers. Nevertheless, it has been.
In a dilapidated neighbourhood in Detroit, Michigan, Goldman Sachs - the largest investment bank in the world - has stockpiled about a quarter of the global aluminium inventories. Why would the savviest investment bankers hoard it? The answer is simple: Goldman receives more than 150 million of dollars a year in storage fees. The aluminium does not belong to the bankers; they are just storing it in warehouses under their control, which effectively guarantees rental income without exposing the bankers to price risk, while the owners of the metal actually participate directly in price fluctuations.
This beneficial storage scenario was created by the LME’s (London Metal Exchange) regulations: there is a limit per warehouse operator per city as far as how much metal it can release daily. Goldman got around this regulation by claiming that it is just a landlord, which happens to be in the right business, at the right time. This effectively makes hoarding legal and enables Goldman to collect rental income indefinitely. Given the location of the warehouses the most affected are the buyers in the US, althoughthere is a ripple effect that has been felt by buyers as far as Japan and Australia. This lucrative business model has been replicated for zinc - Goldman and Glencore own warehouses in New Orleans that store about 60% of the world’s zinc supply.
Big Business in Australia
Another beneficiary of higher aluminium prices is Australia, which plays a major role in the aluminium market as the world’s largest producer and exporter. It mines 40% of the world’s bauxite, the ore from which aluminum is obtained. The major mining areas are Weipa in North Queensland, Gove in the Northern Territory and the Darling Range in Western Australia. Australia's demonstrated bauxite resources are second in the world after the Republic of Guinea. Other important deposits are located in Vietnam, Jamaica, Brazil and China. Australia's aluminium industry consists of mining, refining, smelting and semi-fabrication processes and Australia exports 80% of its aluminium production. China accounts for about 27% of the total exported volume, followed by South Africa, the United Arab Emirates, Bahrain and other countries.
Troubles Ahead
However, the picture is not that rosy for aluminium, and the key word is uncertainty. Since it is being used in construction and machineries, it is very sensitive to economic cycles. The rollercoaster that we have experienced in the last few weeks in the financial markets is an indication that there are some turbulent times ahead, and businesses are likely to be more cautious regarding significant investments. Since China is a major importer of Australian aluminium, it remains to be seen what consequence the US debt downgrade will have on the country that finances it. If the Chinese economy is affected, the demand for aluminium will most certainly decline.
Another dark cloud on the aluminium industry is the carbon-pricing plan of the Australian government. Industry representatives, such as the Executive Director of the Australian Aluminium Council, Miles Prosser, believes that the new tax will make the Australian aluminium less competitive and will leave workers jobless: “This imposes a carbon cost on Australian aluminium producers of at least $60 per ton of aluminium compared to only $8 per ton in China. Australia’s carbon cost will rise every year of the scheme and over the next decade to more than $200 per ton of aluminium while in China it is not expected to get any higher than $60.” This issue is in line with the troubles faced by coal mining companies. They are required to comply with stricter environmental laws, while their competitors in developing countries can mine and pollute at their leisure. The end result of the new legislation is good for the environment; however, it is detrimental to Australian miners. Some of the major producers include BHP and Bauxite Resource Limited (BRL).
As with nickel, I would stay away from investing in companies that mine only aluminium. Goldman’s warehouse hoarding may come to an end because of buyer’s outrage and the carbon pricing effects remain to be seen. Nevertheless, a large conglomerate such as BHP - which is exposed to a variety of materials - may be a safer bet if you're keen to invest in aluminium. As always, do your homework and look at the technical and fundamental aspects of each stock.
>>Back to the newsletter to view other articles - August 13th 2011
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