Base Metals - How to effectively trade aluminium futures - Motilal Oswal
Base Metals - How to effectively trade aluminium futures - Motilal Oswal

Base Metals - How to effectively trade aluminium futures

Globally, aluminium is the second most consumed metal after steel and has a variety of industrial applications. From aluminium foil to keep your food warm to electrical appliances like refrigerators to cars and aircraft, aluminium has applications in a wide variety of industries. In case of aluminium, the major issue is not of supply as the crude form of aluminium is available to the extent of 8% of the earth’s crust. The big challenge in aluminium is that the manufacturing process is extremely power intensive. In fact, the power cost accounts for over 10% of the cost structure of an aluminium manufacturer. Like in case of most metals, China accounts for over 50% of the global demand for aluminium and therefore any alpha in terms of incremental demand for aluminium has to necessarily come from China.
 
The big story on aluminium is about the shifts in per-capita consumption of aluminium. The global average per-capita consumption of aluminium is 80 KG. However, the distribution is quite skewed. While countries like the US and Western Europe have per capita consumption of nearly 350 KG, in case of countries like India, the per capita consumption of aluminium is as low as 25-30 KG. That is why there is a huge opportunity for aluminium demand to pick up in countries like India. One of the major qualities of aluminium is that it is very light and also has anti-corrosive properties. Hence, aluminium has a big role to play in critical engine parts where corrosion needs to be avoided.
 
How have aluminium prices moved in the past
 


Source: Bloomberg / LME
 
The above chart measures the price of aluminium in the global markets. On the LME, the price of aluminium is expressed in terms of $/MT, where one metric ton represents the equivalent of 1000 KG. Like in case of copper we have seen aluminium also peak out around 2012 and then move sharply down. This fall in aluminium prices were largely driven by weak demand from China and a global economic slowdown across the board. Even in case of aluminium, the Trump trade is clearly visible from the middle of 2016 when aluminium prices went up sharply on expectations that the $1 trillion infrastructure investment proposed by Trump would be a game-changer for aluminium demand. The LME is also betting on greater demand for aluminium from China as the Chinese economy is seeing a pick-up in GDP and in global trade. Additionally, the Chinese Railways is also planning a multi-billion dollar capital expansion.
 
How does the local price of aluminium price get benchmarked?
Like in case of most industrial and precious metals, the international price on the LME serves as the benchmark. The aluminium futures prices are quoted exclusive of all levies and charges. These charges will have to be borne by the buyer at the time of taking the physical delivery of the commodity. As a result, the local price almost matches closely with the international price. Let us consider the above example.
 
The Bloomberg LME prices is quoting aluminium at the price of $1910.50/MT. If you were to convert this into INR terms at the current exchange rate of Rs.64, then the INR price will be INR 121,317 per MT. Since the aluminium futures on the MCX are quoted on a per KG basis, the above calculation will translate into Rs.121.32/KG. This is approximately the price at which 1 KG of aluminium is quoting on the MCX. Thus it is clear that due to the price of aluminium futures being quoted exclusive of charges and taxes, the global prices and the local prices are normally at par. Therefore, if you are long on aluminium futures on the MCX, then you will not only benefit from the LME prices of aluminium going up but also from the INR weakening against the US dollar.
 
Trading aluminium futures on the MCX Exchange
In terms of volumes, the daily volumes on aluminium futures are nowhere close to what we get to see in gold and crude oil. In fact, it is also much lower than the volumes on copper. But considering India’s low per capita consumption of aluminium, there is scope for a massive expansion of trading volumes in aluminium. The aluminium also trades in two versions. The Big Aluminium contract comprises of 5MT (5000 KG) lot size and is substantially more liquid. There is also the Mini Aluminium contract which has a lot size of 1 MT (1000 KG) but that is not a very popular contract.
 
Considering the current market price of Rs.121/KG of aluminium, the Big Aluminium contract will have notional lot value of Rs.605,000 (121 x 5000). As in case of most other commodities, the margin will be levied as 4% SPAN margins and 1% extreme loss margin. Thus the 5% margin will entail a payment of Rs.30,250/- per lot of aluminium futures. The aluminium contract will commence on the 01st of the month and will expire on the last day of the calendar month. At any point of time there will be 5 monthly contracts on aluminium futures, although the volumes will still be concentrated in the near month contracts.
 
One can trade aluminium futures on the MCX either for squaring up trades or for taking actual delivery. Currently, volumes on aluminium futures are yet to develop in a big way. But the potential continues to be huge. It could be a contract to watch out for!
 

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