CRU: The Risks of Demand Destruction to Aluminum

Conversations with many of our clients’ center on concerns about demand destruction. The logic is simple: With gasoline, food and interest rates climbing, will consumer spending start to suffer?

Consumers Are in Good Shape Financially to Weather Some Inflation

The covid pandemic produced one remarkable change in consumer behavior – higher personal savings rates. Before 2020, the US personal savings rate held around 7-7.5%. The rate soared to nearly 34% in April 2020 because of the pandemic. It’s been coming down since, but consumers did accumulate substantial cash reserves.

In the same timeframe, the Dow Jones Industrial Average rose from 28,000 to 34,000. That creates a “wealth effect” for those Americans with investments. The Pew Research Center estimates about 52% of Americans have some stake in the stock markets, and they clearly feel better about their balance sheets. That translates into a willingness to maintain spending patterns.

Housing prices have already boosted the “wealth effect.” The S&P/Case-Shiller Home Price Index rose 33% from 212 in January 2020 to 281 at the end of January 2022. That means homeowners have increased equity in their homes and greater ability to borrow for purchases. Homeowners represent about 65% of the consumer pool.

Unemployment is also low, and wages are rising quickly for skilled labor. People feel good about their employment stability and future earnings. On balance, a good share of consumers are well positioned to maintain or even grow purchases.

Who Gets Hit by Prices, and Where Does This Manifest?

Notwithstanding the good financial condition of many American consumers, it would be naïve to think that high prices for aluminum, gas, and food as well as interest rate hikes won’t impact consumer spending. We can’t ignore the 35% of the population that does not own a house, the 48% that don’t invest in the market, and those who can’t afford to save.

This segment of the population will see its discretionary income hit hardest by higher prices at the pump, at the grocery store and by serving credit card debt.

So, what sectors of aluminum demand suffer from this segment having reduced discretionary income? We offer the following:

• Leisure goods such as recreational vehicles, motorcycles, boats, ATVs, and jet skis. These are products that have been financeable at very low interest rates and appealed to people during the pandemic. If people could service the debt, they would keep buying them. But with sharp increases in non-discretionary expenses like gas and food, these items may no longer be affordable for new purchases. Higher interest rates on adjustable-rate consumer loans could also strain consumers’ ability to service debt on existing purchases. Watch out for resale prices of these products to start dropping and pay attention to re-possessions.

• Discretionary household purchases such as new windows and doors, appliances, and furniture. Unless the units are failing, consumers may delay remodelling or replacement of serviceable units, especially with long lead-times and higher prices. Watch for industry associations reporting lower order intakes.

• In general, durable goods are where the risks are. Autos and light trucks are an obvious target due to high gasoline prices. But there seems to be such pent-up demand for vehicles that it may defy logic. New vehicle sales during the 2nd quarter will be important to watch.

The Greater Importance of New Orders Versus Shipments

Shipment data tells us about the past, not the future. It confirms orders that are being fulfilled but really is not useful in telling us about what’s coming next.

Orders are much more important, and even order data must be qualified. The Aluminum Association does a good job of tracking new orders. They do not report orders on an absolute basis in millions of pounds but as an index using 2013 as its base line of 100.

Timing is everything in order reporting. Order data does NOT account for front ending loading of large block orders. Here’s a simple example. If a major beverage company decides to place its order for its 2023 and 2024 aluminum can stock requirements in March 2022, it gets reported as a “March 2022” order and will show up as a large order. Provided that they do this each year at the same time, one could say that the pattern of ordering is consistent and is safe to use as a predictor of new business. However, if the orders are unusually compressed, this could be dangerous.

This danger is higher now than in recent years because we operate in an environment of lead times as long as 30-52 weeks. It may be tempting for some buyers to put in big orders now to “get into line” to avoid further price increases or even longer lead-times. This is classic inflation behavior: Buy now before it goes up!

Long lead times force OEM buyers to forecast further into the future, where forecast accuracy becomes more problematic. Discomfort with longer dated forecasting may cause buyers to hit the “pause button” and either reduce or stop new orders.

I hope all these disclaimers about the risks of order rate interpretation have not scared you off. New orders are still our best barometer of new demand. Here’s what they tell through March.

In March 2023, the index was 126.65 versus 105.7 in February and 129.3 in March 2021.

Month on month, a rise of 20% off a shortened booking period. Year on year, orders fell 1.9%.

One month does not make a trend. The March decline year on year may be an aberration, or it could be an early warning sign that demand is starting to suffer. We need to watch this carefully over the next three months to see whether there is a real pattern developing.

In terms of more discrete data, we need to watch new vehicle sales and housing completions for real clues. We say housing “completions” (not starts) because in aluminum, it’s the “back end” of the construction cycle where aluminum demand is met. This comes in the form of windows, doors, gutters, furniture, and appliances.

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