Friday, December 12, 2014
You won't hear it mentioned on the mainstream news... but it's one of the biggest commodity bull markets this year...
While many commodities have fallen recently, aluminum prices are up 27% since February. Many aluminum stocks are now up double digits.
And it's not too late to profit...
Regular readers are familiar with the aluminum story.
Aluminum is widely used in aircraft, construction, household items, and food packaging because it has an excellent "strength to weight" ratio and it is resistant to corrosion.
And like most commodities, the metal is sensitive to economic cycles.
In times of strong economic growth, the demand for consumer goods and building materials that include aluminum increases – and aluminum prices rise. In times of slowing economic growth, the demand for these things decreases and aluminum prices fall. This is what we've seen over the past few years.
Aluminum prices were in "bust" mode from 2011 to early 2014. Prices fell around 30%. And demand forecasts for aluminum looked bleak. So investors fled aluminum stocks. Giant aluminum producer Alcoa (AA) fell 30% during that time.
But this year, the economy started to recover. Global aluminum demand grew 7%. And the price of aluminum rallied 27% from its February bottom. Meanwhile, shares of Alcoa have soared more than 40% since February.
And there's plenty more upside ahead...
You see, the surge in demand in aluminum is in part thanks to demand for a new aluminum-lithium alloy.
This alloy is stronger and less dense than conventional aluminum. It also resists up to two times as much corrosion as aluminum.
Because of this, one of the main markets using this alloy is the aerospace sector.
The alloy reduces aircraft repair costs by 30%. And because the alloy is so strong, it's replacing titanium in jet engine fan blades. The aluminum-lithium alloy improves efficiency in jet engines by 16% and produces less noise than titanium.
In the third quarter, Alcoa – which has developed more than 90% of all aluminum aerospace alloys – signed two multiyear aerospace contracts worth more than $2 billion.
Surging demand for this alloy has been – and will continue to be – a boon for Alcoa.
But there's another reason Alcoa shares are headed higher next year.
You see, the bulk of the company's revenue (more than 45%) still comes from refining and smelting aluminum. And energy is critical in that process. So Alcoa is sensitive to the cost of oil, natural gas, and other oil and gas byproducts – like coke and pitch (which are petroleum products).
The table below shows how much Alcoa's operating income is affected by changes in the cost of certain energy sources.
The price of fuel oil – a liquid petroleum product used to generate heat or power – has fallen around 42% since January. Based on the table above, that means Alcoa's operating income will see a $170 million boost from the change in the fuel oil price alone.
But the fall in oil has caused the prices of coke and pitch to fall as well. This will also benefit Alcoa's earnings.
In short, Alcoa is benefiting from increased aluminum demand and higher aluminum prices. But it's also benefiting from decreased operating costs. I expect these trends to continue well into 2015.
So shares of Alcoa still have big upside potential from here. If you don't already own the aluminum producer, I recommend looking into it today.
Find more of Matt's recent research here:
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