Market and product

(Reuters) - Aluminium has staged animpressive price rally since the start of the month.

On the London Metal Exchange (LME) three-month metal has powered up to $1,900 per tonne, a level last seen in October2013.

That makes aluminium the third-best performer among the coreLME-traded base metals, behind nickel and tin, both of which aretrading off a bullish supply story in the form of Indonesia'sban on nickel ore and the same country's tightening grip on tinexports.

Aluminium is chasing its own bull narrative, one ofaccumulating production cutbacks pulling the global market intosupply deficit after years of cumulative surplus.

That narrative has recently received some powerful boosts inthe form of more cutback announcements by Western producers suchas Alcoa and BHP Billiton and by Chinesealuminium giant Chalco <.

The problem, though, is one of timing.

At an individual smelter level, it takes time to wind downproduction prior to mothballing or closure, meaning a lagbetween statement of intent, price reaction and actual cutback.

At a global level, this is an industry still struggling toturn itself around due to the historic momentum of capacitygrowth in the Middle East Gulf and in parts of China.

It is a problem all too evident in the latest globalproduction figures from the International Aluminium Institute(IAI).

Despite some 1.6 million tonnes of announced capacityclosures since the start of 2013, global reported output stillrose by 3.3 percent to 11.75 million tonnes in the first quarterof this year. That represents a slowdown from last year's growthof 4.3 percent, but only a marginal one.

Run-rates dropped in March itself but at an annualised 47.9million tonnes they have increased by just over a million tonnessince December.

CHINESE SUPERTANKER WILL TAKE TIME TO TURN

The growth momentum is still largely coming from China,where aluminium output rose by 10.2 percent in the firstquarter.

There was a drop in run-rates in March itself, according tofigures from the China Nonferrous Metals Industry Association.

But this conforms to an established statistical pattern atthe start of any year, production apparently surging in Februaryonly to fall back in March.

Even allowing for that "normal" statistical quirk,annualised output in March of 23.4 million tonnes representedyear-on-year growth of over 14 percent.

Which is not to say that Chinese smelters are faring anybetter than their Western counterparts. Indeed, Shanghaialuminium prices <0#SAF:> have lagged LME prices since the startof the year and many smelters are still struggling to stayafloat.

However, too few are giving up the fight, thanks in part tocontinued support from local governments, to compensate for thenew generation of smelters ramping up in northwestern provincessuch as Xinjiang.

The result is a chronically over-supplied Chinese marketwith stocks, both visible and off-market, rising and the pricecontinuing to trade below the producer pain threshold.

Does Chalco's announcement it is suspending some 600,000tonnes of annual smelter capacity change things?

Well, obviously, much depends on whether the promisetranslates into reality. It's fair to say the announcement hasbeen greeted with a degree of scepticism, both in China andelsewhere. That's because it's still not clear whether a similarstatement of intent last June, when it said it was cutting380,000 tonnes of capacity, ever made much difference on theground.

However, even if the cuts do materialise, and that may be abig "if", they will not in themselves turn the Chinese aluminiumsupertanker around.

The country's annualised production grew by just over610,000 tonnes in the first three months of this year and morecapacity is still being constructed. Analysts at AZ Chinaconsultancy assess the amount of capacity under constructionwith a 2014 completion date is around 3.7 million tonnes.

The dynamics of China's huge aluminium smelter sector arenow widely understood and the LME price (but not the Shanghaiprice) is disregarding continued evidence of surplus in China onthe basis that prohibitive export taxes prevent that surplusfrom impacting the rest of the world.

It's an assumption, mind you, that requires a collectiveblind eye to be turned to the flow of aluminium manufacturedproducts out of the country.

MORE CUTBACKS BUT GULF SMELTERS POWER UP

Perhaps more surprising than the continued growth in Chinais the fact that aluminium production everywhere else iscreeping higher again.

Annualised production grew by 438,000 tonnes over the firstquarter of 2014 and March's ex-China run-rate of 24.5 milliontonnes was the highest since August last year.

The impact of production cuts is clear to see inyear-on-year comparisons in areas such as Eastern Europe, LatinAmerica and North America (as shown in the chart above).

But the effect has been more than offset by a renewed growthspurt in the Gulf region, where EMAL is firing up a new pot lineat its Abu Dhabi smelter and the new Ma'aden smelter in Saudi Arabia is ramping up.

Gulf production rose by almost 14 percent in the firstquarter, while annualised production of 4.5 million tonnes inMarch represented year-on-year growth of almost 18 percent.

True, some of the announced cuts are yet to take place, suchas Alcoa's closure of the Point Henry smelter in Australia (dueto be completed in August) and of 147,000 tonnes of capacity in Brazil (due in the second quarter).

There is also the increasing probability of BHP Billitonclosing permanently its Bayside plant in South Africa. What thecompany calls "a formal stakeholder consultation" is takingplace with a view to closure in the second half of this year.But the 180,000-tonne per year plant has been operating at onlyhalf that capacity anyway for several years.

As in China, it is clear that turning the smeltingsupertanker around is going to take time.

GREAT EXPECTATIONS

None of which is obvious from the $200-per tonne rallystaged by LME aluminium over the last month or so.

It is in the very nature of commodity markets that theytrade on expectations about the future.

It's just possible that the world outside of China isapproaching a state of aluminium supply deficit, although thelack of independent statistical analysis in this market makes itvery hard to say with any conviction.

LME stocks are not going to provide any clues, clouded asthey are by the mass movement of metal to off-market storage forfinancing.

Which leaves production rates as the firmest statisticalyardstick by which to measure any shift of fundamental dynamic.

And right now, production is growing.

In China it never stopped. It's the renewed rise in outputin the rest of the world that should give aluminium bulls pausefor thought.

This is a market with great expectations. Reality maystruggle to meet those expectations.