By Tom Daly and Melanie Burton
BEIJING/MELBOURNE (Reuters) - Chinese aluminum prices have skyrocketed amid a crackdown on overcapacity, but traders say final demand is weak and cuts may not be as big as expected. Trading data shows some are bracing for a correction.
China, the world's largest producer of the metal, is forcing illegally built plants to close and pursuing others that have not met environmental targets as it pushes to clear its skies and shore up loss-making industries.
Analysts see 3-4 million tonnes of smelting capacity closures this year, equal to about a tenth of China's production. Just last month, China's top aluminum region Shandong ordered 3.2 mln tonnes offline.
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Expectations of a supply shortfall have seen aluminum prices on the Shanghai Futures Exchange (SHFE) skyrocket 16 percent since Aug. 1. Open interest has ballooned by 50 percent to a record high above 910,000 lots.
But traders and analysts warn that the market has climbed too far, too fast, which has scared off physical consumers.
"Considering the current situation of the physical market ... I think [the speculators] are crazy," said one trader in Shanghai, noting weak downstream demand.
"China's supply side reform is more than expected [but] the reality is inventories are higher, consumption is not good and aluminum rod processing fees are sharply lower," said a manager at a Chinese futures brokerage.
Bears are betting that booming prices will encourage some plants to restart, while new capacity that has been closed by regulators will be allowed to reopen after winter.
"There's a lot of hype to it. This is all expectations of massive cuts coming through," said analyst Ed Meir of INTL FC Stone in New York.
The world's largest aluminum maker, China Hongqiao Group Ltd said last week it would cut more than 2 million tonnes per year of "outdated capacity", but that new capacity would keep its total at 6.5 million-7 million tonnes.
"They are keeping their overall production target intact. If you're not going to see any cutbacks overall, how is that bullish?" said Meir.
At the same time, producers are ramping up output.
China's aluminum production hit its second highest on record in June while SHFE stocks are at four-year highs. One trader at a global merchant in Asia said she expected China's stockpiles to grow from 1.2 million tonnes now to 2 million tonnes by year end.
Bears are boosting positions in the options market, with a surge in put interest at strike prices well below London Metal Exchange aluminum, which was at $2,024 a tonne on Friday. Open interest at strikes of $1,700, $1,800 and $1,900 has jumped by 50-100 percent in the past month.
Meanwhile, premiums for delivery of aluminum held in China's bonded zones sank to one-year lows this week, indicating weak demand for the metal, although premiums have since partially recovered.
To be sure the market is expected to tighten and prices could have further to run. More closures may come from November as China begins its winter heating season, when aluminum producers in 28 cities have been ordered to slash output to curb pollution.
"The LME price is still hitting new highs since 2014 and I feel the Chinese supply side reform is not at the end yet," said one investor in Shenzhen.
But one producer source noted that previously closed capacity can count to the total.
Shares in Aluminium Corp of China (Chalco),, a gauge of investor interest in the sector, have fallen 13 percent in the past two days after touching a two-year high.
"I still hold Chalco shares and options, but have reduced my positions," the Shenzhen investor added.
(Reporting by Tom Daly in Beijing and Melanie Burton in Melbourne; Editing by Richard Pullin)