The health of the global economy can be measured by looking at its manufacturing base – what is being produced and what is in demand. The demise of China’s longstanding heavy importation of commodities has left many investors wondering where global industry is headed next. If China is not demanding goods for manufacturing purposes, does it mean the economy is headed south, or does it just mean demand has shifted elsewhere?
Aluminum is one of the most widely used metals in the industrial sector. It has applications in the packaging, construction, aerospace, automotive, transportation, energy and consumer durables industries. Because it is in demand for so many facets of industry, aluminum is considered a good proxy for the health of the global economy.
The Aluminum Market Today
Over the past several years, aluminum has been on a downtrend. The fall primarily can be traced back to the weakness in the Chinese economy, which has seen slowing GDP growth for years. In 2014, its GDP growth was 7.4%, while 2015 is on track for just 7% growth. As the country with the world’s largest aluminum demand, a reduction in growth expectations directly translates to lower prices.
Interestingly, China isn’t just the country with the largest aluminum demand, it’s also the country with the largest aluminum production. Thanks to the Chinese government, aluminum production stayed robust even as demand fell, through reduced taxation and increased subsidies for suppliers.
Now that the Chinese stock market has crashed, all that stockpiled aluminum has created a supply glut. They’ve reduced costs for exporting aluminum and cut prices to stay competitive, which has only served to flood the market and bring worldwide aluminum prices down even further.
The Chinese Contagion: How Far Will It Spread?
The most pressure is put on aluminum producers right now, with companies such as Alcoa (AA) and Noranda Aluminum (NOR) overseeing huge stock losses this year alone. Alcoa has even gone so far as to split up the company to create a second “value-add” segment that’s focusing on new technologies, such as 3-D printing. The company has cut back on high-cost endeavors such as smelting, and made great strides to diversify its business practices to include more elements to reduce the impact of aluminum prices on its bottom line.
However, the decision to realign Alcoa’s business model seems to contradict its projections for growth in the aluminum market. In the company’s last earnings statement, Alcoa estimated global demand growth for aluminum to be at 6.5% for 2015 and on track to double from 2010 to 2020.
The main problem with this estimate is that it relies on the assumption the Chinese economy will meet certain expectations. If the slowdown overseas is worse than anticipated or the government interferes in an unforeseen way, those growth estimates could prove false.
Given that China is both producer and supplier, the aluminum market could be faced with further volatility. As the fallout from the Chinese slowdown continues to impact the global marketplace, aluminum producers such as Alcoa will almost certainly attempt to diversify away from aluminum as their sole means of earnings.
The Bottom Line
The aluminum market as a proxy for global economic health is telling us the marketplace is feeling under the weather. The vacuum in the commodities space left by the absence of Chinese demand has created a supply glut, while producers begin to distance themselves from what could be a volatile industry over the next 12 months. It remains to be seen, however, if another player might step in as a new manufacturing powerhouse and begin to lift aluminum demand again.
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