Why We're Bearish on Aluminum Prices

Andrew Lane: Amid a substantial rally, aluminum spot prices have held above $2,000 per metric ton since early August. Elevated prices have been driven by better than expected aluminum demand as well as the perceived benefits of capacity reductions in China. However, we believe investors have become overly enthusiastic on both counts. We forecast a significant deceleration in aluminum demand growth after 2017 and anticipate that the impact of capacity cuts will prove far overstated. Accordingly, we forecast a long-term aluminum price of roughly $1,500 per metric ton (in real terms). Our forecast sits roughly 25% below both current prices and consensus expectations.

The primary driver behind our admittedly bearish outlook for aluminum prices is our below-consensus forecast for Chinese fixed-asset investment. As China's economic growth model becomes more consumption-driven at the expense of the heavy investment contributions witnessed over the past two decades, we anticipate that growth in gross capital formation will be effectively zero over the next five years. This forecast compares with consensus forecasts of 3%-5%. Accordingly, we also maintain below-consensus price forecasts for steel, iron ore, metallurgical coal, and copper.

On the supply side, many analysts cite Chinese aluminum capacity cuts as the key driver of higher price expectations. However, these cuts will be more than offset by the continued addition of new, low-cost supply and we expect global overcapacity to persist.

Our outlook for sharply lower aluminum prices would have a substantial impact on share prices for Alcoa, Norsk Hydro, Chalco, and Alumina Limited, each of which has a no-moat rating and trades well above our fair value estimate.