Makers have to focus on fundamentals

IN FOCUS/ ALUMINIUM

The recent movement in prices of aluminium has only highlighted the need for producers to be globally competitive in terms of cost. Only these producers would be able to stand up to the downturn in the industry which appears to be inevitable after 6-8 months.

Credit rating agency ICRA Ltd has highllighted the importance of this factor in a recent report on National Aluminium Ltd (Nalco).

ICRA has pointd out the cost leadership status enjoyed by Nalco in both alumina and aluminium operations which have led to healthy profitability and strong cash accruals even during industry downturns.

The successful completion of large capacity expansion projects giving it additional volumes at a time when product prices were favourable have also set standards in the industry.

Nalco's cost advantage arises out of the vertically integrated nature of its operations, adoption of efficient smelter technology and a captive power plant for supplying quality and cost efficient power, a critical requirement for smelting.

As a result of these factors, which serve as benchmarks in the industry, Nalco has been able to ride out the cyclicality inherent in the commodity prices of alumina and aluminium, which results in some degree of variability in the turnover and profitability of individual players.

Nalco was the largest producer of alumina and second largest producer of aluminium in the country. The company was self sufficient in the entire value chain encompassing mining of bauxite, refining of bauxite into alumina and smelting of alumina into aluminium.

It produced calcined alumina at its refinery and aluminium ingots, billets, strips and wire rods at its smelter. While a small portion of the calcined alumina was consumed internally at the aluminium smelter and the balance almost entirely exported, wire rods, billets and strips were sold in the domestic market. Ingots were sold in both domestic and international markets.

However, the fears expressed on the possibility of inflation caused by high commodity and crude oil prices is not unfounded, if recent surveys by neutral agencies are to be beleived. The apprehension was articulated by the Reserve Bank of India (RBI) in its credit policy announcement on May 18.

International studies released in the recent past have warned that global commodity prices were likely to be firm for the rest of 2004 as a result of a fundamental supply shortage of everything from wheat to base metals.

A report attributed to Goldman Sachs had gone on to warn that the negative impact on global commodity prices of credit tightening measures introduced by China in late April would be limited.

As far as base metal were concerned, the recent news out of China was dampener but fundamentals had not substantially changed, said the brokerage.

China had driven commodity prices to multi-year highs earlier in 2004. Prices softened after Beijing introduced credit curbs in April to cool its economy, which grew at 9.7 per cent in the year through the January-March quarter.

Prices of commodities declined in immediate response but thiw was primarily due to fund liquidation, felt Goldman Sachs. It did not think China would have significant impact on prices for at least another 6-12 months.

If anything, backwardation, or the amount by which the spot price was higher than the forward delivery price, offered investors a good chance to secure high returns by selling in the nearby month and buying at a later date. Most commodity markets would stay in backwardation due to supply constraints.

Base metals prices have been rising despite concerns about a possible slowdown in China's economic growth rate. Trading sentiment had been cautious after recent heavy sales to China. In fact this was a squeeze in spot supply and this trend was expected to persist in the short run.

The economic data from the US on inflation, industrial production and consumer confidence were other factors that would govern base metal prices worldwide.

Base metal would react inversely to moves in the dollar. The dollar would lead to price slides in both the medium term and the long-term, as the dollar had been on the ascent against most other currencies.

If inflation data in the US showed an unexpected upsurge, sharp rises in the dollar and rate expectations will be accompanied by heavy selling pressure against the complex, agencies recently quoted market experts as saying.

Economists expected US industrial production to rise from April 2004 after a drop in March 2004.