By the end of Monday’s trading, investors began to question whether China will really follow through with plans to boost its currency. Earlier in the day, we opined that change is coming, albeit more slowly than many would like.

Even after the dust settled and many China-related stocks gave back their gains, shares of metals makers – especially aluminum producers – held onto sharp advances. Both Alcoa (NYSE: AA) and Century Aluminum (Nasdaq: CENX) rose more than +10% on intra-day basis on Monday, and were holding most of those gains in Tuesday trading. For both of these firms, investors need to brace for some short-term pain but real long-term gains.

A Tough Start to Earnings Season

Alcoa, which always kicks off earnings season, will likely set a somber tone. Analysts have been lowering their second-quarter profit forecast from $0.28 to $0.16 during the past few weeks, and that still looks too high. Spot pricing for aluminum has been steadily dropping, and that could push Alcoa’s per-share profits closer to the $0.10 mark. In a similar vein, Century Aluminum may also be on track to miss analysts’ second-quarter forecasts when they are released later in July. That’s why share prices have been in freefall for these aluminum producers prior to Monday’s China-related spike.

The weakening outlook is due to a global aluminum glut. The London Metals Exchange (LME) has been carrying about 4.5 million tons in its inventory. But Chinese inventories have doubled in the last six months to around 500,000 tons. Taken together, those two locales carried more than five million tons on hand, an industry record. (Inventories have since fallen four straight weeks and now stand at about 4.97 million tons). Prior to the economic slowdown, there were typically about one million tons of aluminum in inventory.

And with so much inventory on hand, spot pricing for aluminum has been falling sharply, from $1.11 a pound in late April to a recent $0.88.

As that analysis shows, it is the increase in Chinese inventories that has made all the difference. And that factor is likely to reverse as the yuan slowly builds strength. Even before any move in the yuan, a number of Chinese producers are said to be operating at negative cash costs (which means that their operating expenses are higher than the sales prices they can get for smelted aluminum). While firms such as Alcoa and Century Aluminum operate much more inexpensively (thanks to better vertical integration and smelters in regions where power is cheap), they had to give up profits as their Chinese rivals ramped up output.

Energy is expensive in China. And Chinese officials have repeatedly stressed that the nation’s energy resources shouldn’t be frittered away on money-losing industries. So even though a stronger yuan will lower the cost of imported oil and gas, it won’t be enough to turn these money losers into money makers. Which is why many analysts think China will start to curtail aluminum production.

Action to Take –> As noted earlier, aluminum now fetches less than $0.90 a pound. Some of these money-losing Chinese smelters are likely going off-line as we speak. Aluminum would have to move back up above $1.05 a pound before production re-starts. Yet right now, analysts are tweaking their models to account for $0.90 aluminum. Goldman Sachs, for example, just cut its 2011 EPS forecast for Alcoa from $1.20 to $1.05. (As a point of context, Alcoa earned an average of $2.50 a share from 2005 through 2007).

On the upcoming earnings reports, look for estimates to fall to reflect a sobering pricing outlook. Ironically, that lowered view will be arriving just as the changing industry dynamics should enable pricing to rise back up. So wait for these stocks to digest the bad news, and then pounce. Alco is scheduled to report quarterly results on July 12.