| LME Makes a Major Correction | June 15, 2006 |
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| LONDON (Dow Jones)--The London Metal Exchange aluminum market is in a "serious correction mode" with a further 5% of the price accounted for by funds yet to exit the market, according to James Southwood, President of U.S. metals consultancy Commodity Metals Management Company. Around 10% of the price related to fund investors has already exited the market, Southwood told Dow Jones Newswires. These funds players are termed "for profit" players by Southwood, who says there's been "a huge financial transformation in that the mainstream financial institutions have made a long-term investment in commodities." "We're in the phase of this investment now where the smart money - the early investors like the commodity trade advisory players or the macro hedge funds - is getting out and handing the market to the general public, such as the pension funds," he said. "I'm not saying there's not money to be made, but we're in a cyclical correction and these corrections will become increasingly volatile as the smart money gets in and out of the market," he added. Southwood said that the 'not for profit', pension fund type investors, who have adopted an "alternative investment class concept towards commodities, stay in the markets for years regardless of the near-term result." LME three-month aluminum prices fell to a low of $2,425 a metric ton Wednesday, down 26% from the May 11 high of $3,300/ton. The sell off came as part of a broader corrective move lower in the financial markets, particularly the commodity, equity and emerging markets. But the fundamentals for aluminum are still relatively strong, Southwood said. "Alumina prices are admittedly softening but that's all part of the changes in Chinese production that are affecting the supply-demand balance. Lower alumina prices are a reality," he said. "Right now, with aluminum at its first point of support, around $2,450 a metric ton, we'll likely see a bounce as we're still in a very strong part of the business cycle. As the summer months progress in the western hemisphere, seasonal factors will slow demand and as this occurs, we can expect aluminum prices to come down again," he noted. "But again, this will likely be short-lived and it wouldn't be unreasonable for the market to return to close to its former levels, around $3,000/ton, once more," Southwood added. This bounce will come because the LME aluminum market isn't short, Southwood said; "if it were, aluminum prices would be a lot lower than they are now." "Because there are obviously still long positions out there, we believe that there's more upside to aluminum prices. When the market does go short we'll see another leg down in prices," he added. The recent sell off has come as investors downgrade their expectations of global growth in response to interest rate hikes in Europe and the U.S. and tough inflation talk by the U.S. Federal Reserve. But Southwood said changes in the macroeconomic environment will take some time to filter through to the attitude of the funds. "It takes a few years for the impact of macroeconomic changes to affect the funds. We'll see much lower aluminum prices in a year or so from now, when economic conditions are a lot softer," he added. While Southwood doesn't object to the presence of the funds in the commodity markets - "they have the same objective as commercial customers: to make a profit," - he does object to their size. "What we do object to is the size the funds represent relative to the industry at large," he said. "The speed at which the commodity markets react is so much faster than previously. You have to forecast three or four quarters in advance in order to be able to make good price predictions," he said. "The ability to reinterpret this into the present causes some of the current volatility. It's a reflection of how aluminum has become less of an industrialized commodity and more like a financial market," he added. |
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