Slide1 :
Robin Bhar, Base Metals Strategist
robin.bhar@ubs.com +44 20 7567 7850
April 2006 Aluminium market outlook: Going from strength to strength
ISRI 2006 Annual Convention & Exposition: Spotlight on Aluminium, 4 April 2006
Commodities traded at UBS : Commodities traded at UBS
Growing interest in commodity indices : Growing interest in commodity indices
Fundamentals continue to improve : Fundamentals continue to improve Underlying consumption growth strong on
back of robust global economy
Impact of power and alumina shortages
on aluminium production – the re-rating of
energy values is supportive in the longer-
term and prices should reflect this
China not exporting as much metal
following abolishment of toll smelting and
strong domestic consumption growth
Late-cycle credentials intact
Market to remain roughly balanced but
risks are to the upside given higher energy
prices
Inventories are not excessive
Investment funds active in commodities -
aluminium has good risk:reward
Price forecast:
2005 (actual): 86c/lb
2006: 110c/lb
2007: 95c/lb
LME 3m Aluminium Prices Stocks:Consumption Ratio
Aluminium: market details - forecasts : Aluminium: market details - forecasts Source: LME, AME, Brook Hunt, CRU, UBS estimates
Zinc and aluminium are the laggards : Zinc and aluminium are the laggards Base Metals Prices: Relative Performance
Key themes : Key themes ‘Stronger for longer’ on energy, China and asset class momentum
Energy prices lead the commodity price rises
The most significant change in global commodities in the past six months has been the sustained rise in energy values and the strong correlation that has developed between oil and other commodities. The common drivers of commodity prices have been supply tightness induced by underinvestment, continuing growth in China’s demand, cost inflation, and speculator involvement.
Demand: China and the world
China remains critical to our case for a secular uplift in materials-friendly demand growth rates. Nevertheless, we point out the potential improvement in Indian, Japanese and European economic activity..
Commodities still an under-invested asset class
It is our view that the emerging 'commodity asset class' could be significantly under-invested by a factor of 4-5x. We believe that the total exposure of many institutional investors to commodities is well below 5%, compared with the 10-15% weighting recommended by portfolio consultants.
`Stronger for longer` - key drivers in 2006 : `Stronger for longer` - key drivers in 2006
European and Japanese indicators suggest synchronous growth : European and Japanese indicators suggest synchronous growth Source: Datastream US ISM manufacturing and German IFO business conditions US ISM at 56.7 in Feb
German IFO at recent record highs 105.4
Japan Tankan remains positive US ISM and Japan Tankan manufacturing
Secular theme #1: Costs are rising rapidly : Secular theme #1: Costs are rising rapidly Source: Brook Hunt Most extreme for aluminium: re-rating of energy values expected to impact aluminium prices – floor
Labour, equipment, feedstock, royalty costs rising as well
C$, A$, Real, Rand
Operations, across sub-sectors experiencing costs increases between 20% to 50%
Aluminium: illustrating cost pressures : Aluminium: illustrating cost pressures Relationship between oil price, power and smelter costs (Europe) Source: AME, Datastream, Brook Hunt, UBS estimates Energy increasing marginal capacity
750kt capacity in Europe threatened
High power – CO2 costs Aluminium cost split (2004) Aluminium smelter cost curve
Aluminium: ‘power hungry’, prices revised up on power costs : Aluminium: ‘power hungry’, prices revised up on power costs Source: China Custom Statistics, Datastream, UBS estimates Impact of emissions trading on coal plant op cost €/MWh Aluminium price revisions China net import/exports from 2001 in mt Energy driving aluminium prices
Alumina: market details - forecasts : Alumina: market details - forecasts Source: LME, AME, Brook Hunt, CRU, UBS estimates
Secular theme #2: China : Secular theme #2: China China’s share of global demand Source: AFPA, AME, BP, Brook Hunt, CEMBureau, CMAI, CRU, GFMS, IISI, RISI, SRI, WBMS, WGC, UBS estimates China’s share of global supply Copper
Zinc
Nickel
Iron ore
Platinum
Gold
Power – Aluminium (?)
Power – Thermal Coal (?) China influences commodity preferences
Aluminium and China - long of the metal : Aluminium and China - long of the metal Alumina realised prices Source: Chinese Customs Statistics, Datastream, Brook Hunt, UBS estimates Toll abolishment to decelerate aluminium exports
Alumina imports to be impacted, but quality and growth rates important
High power and alumina costs continue to pressure China
Future rationalisation? Aluminium net imports & production Alumina net imports & production
China to impact global intensity of use trends : China to impact global intensity of use trends Source: AME, Brook Hunt, USGS, World Bank, UBS estimates Note: Intensity of use defined as materials consumption per unit of GDP Aluminium consumption/capita growth in major economic takeoffs, year 1-25 Aluminium Intensity
of Use
China’s growth to offset any US slowdown : China’s growth to offset any US slowdown Growth rates for regional metal demand, 2002-05 Source: AME, BP, Brook Hunt, CRU, UBS estimates Weaker Chinese demand offset by stronger US Re-accelerating China enough to offset US slowdown? Probably China’s growth enough to offset weak US materials demand growth in 2003
US demand has actually been weak over most of 2005 with no noticeable downward impact on prices
Would China’s re-acceleration in 2006E be enough to offset a weaker US? We believe so % of world materials demand, 2005E
China could average 8% pa materials dmd growth for 15-20 yrs : China could average 8% pa materials dmd growth for 15-20 yrs Steel consumption per capita Copper consumption per capita Source: IISI, AME, Brook Hunt, United Nations, USGS, US Census Bureau, UBS estimates Modelling China’s consumption/capita vs US, Japan Implied Chinese steel consumption growth
Urbanisation a key secular driver of materials demand : Urbanisation a key secular driver of materials demand Steel and urbanisation in US Source: Japanese Iron & Steel Institute, United Nations, US Census Bureau, UBS Urbanisation rates % of total Steel and urbanisation in Japan Urbanisation rates, people
Using Japan, Korea and the US to forecast China’s demand : Using Japan, Korea and the US to forecast China’s demand US, Japanese, Korean and Chinese steel consumption per capita, 1900-2005 Source: AME, Brook Hunt, IISI, Japanese I&S Fed’n, UN, USGS, World Bank, UBS estimates Per capita consumption for countries with lower populations peak at higher levels
All countries follow a similar growth trend
NOTE: this is not a straight line trend – there are cycles Aluminium consumption/capita growth in major economic takeoffs, year 1-25
Secular theme #3: Capital flows to hard assets : Secular theme #3: Capital flows to hard assets
Oil vs. other commodities… drivers converging : Oil vs. other commodities… drivers converging Source: Thomson Financial Datastream, UBS estimates Oil price & LME copper Apparent convergence of price performance between oil and many other commodities, including copper and aluminium
Share similar drivers particularly for copper; Chinese demand, supply constraints, rising production costs, speculator involvement and downstream bottleneck
Firms are consolidating, management focus on returns; cyclical mentality resulting in slow response to an arguably secular environment Increased harmony in performance may be a function of convergence
of global drivers
Fund flows into commodities – asset diversification, etc. : Fund flows into commodities – asset diversification, etc. Source: Goldman Sachs, Dow Jones, UBS estimates Fund flows are fundamentally supported
Asset diversification benefits
Momentum to reach a maximum this year (?) Combined dollar value and metal equivalent of GSCI and DJ indices
Fund flows into commodities – asset diversification, etc. : Fund flows into commodities – asset diversification, etc. Source: BME, UBS estimates Fund flows through indices could grow by 50% this year
Decelerate in 2007E, but fundamental underpin should remain in place Potential impact of additional future funds flows in terms of volume
Supercycle?… yes and no : Supercycle?… yes and no Yes. We expect an extended period of commodity price strength based on two fundamental secular factors 1. Higher global consumption growth and 2. High cost inflation
No. This is not new, extended commodity cycles have been witnessed historically Copper price trend (real) Source: Brook Hunt, USGS, UBS estimates
Forward curves: expectations of stronger for longer : Forward curves: expectations of stronger for longer Source: Reuters, UBS estimates
What could go wrong? – Downside risks : What could go wrong? – Downside risks
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