Metals supported by weaker dollar, stronger oil

by: Casper Burgering

• Prices of steel and iron ore are slowly reviving, but will remain threatened by overcapacity
• Base metals prices dragged down by Chinese macro data, but soft dollar and higher oil add support
• Market balance for copper, nickel and zinc tightens, while aluminium remains oversupplied

 

China weighs on long term metals markets developments

The trend in leading macro-economic indicators for the US and Europe are pointing up and our outlook for 2015-2016 is positive. Disappointing economic developments in the US and a further firming of economic growth in Europe have not managed to shift confidence in the metals markets. This is somewhat surprising given that, on average, these two regions together represent 29% of global base metals production and 25% of base metals consumption. Normally, this would have more of an impact, but the effect is overridden by China’s share of 43% of global supply and 49% of global demand in base metals markets. Therefore, developments in China still take the upper hand and continue to dictate markets’ direction. China’s slowdown continued in Q1 2015, prompting base metals prices to lose ground. Mean-while, further targeted economic stimulus by Chinese authorities to prevent a hard landing, such as the recent rate cut, could boost metals demand.

Falling Chinese macro confidence drags metals prices down

The macro-economic climate index in China reached a post-crisis peak in early 2010 and then started its downtrend, alongside the softening of the Chinese economy. Given China’s impact on metals markets, demand (and thus prices) for base metals reacted parallel. Although the weighted average base metals price peaked one year later, the series soon followed the same path as the macro-economic climate indicator. The parallel direction of both series indicates that fluctuations in macro-economic conditions in China ultimately have a major impact on base metals market conditions. In light of this, it is very likely that the economic slowdown in China will have negative implications for demand in base metals markets going forward. Nevertheless, we think growth in base metals demand from China is still on the table, although the pace of growth will soften. We are projecting that in 2015 and 2016, per capita demand for Chinese base metals will grow by 7% and 8%, respectively. From an historic perspective, this growth outlook is clearly disappointing, but given the ‘new normal’ the level is still good.

‘April showers bring May flowers’

Conditions worsened in the ferrous sector (steel, iron ore, coking coal) in particular, while copper and nickel prices are also still below their 1 January level. The strengthening of the US dollar, the weakening of the oil price, persistent overcapacity in China and demand worries in Q1 were the main reasons for the price deterioration. Dark clouds continued to loom at the beginning of April, with disappointing GDP and trade data from China. But later in the month, prices for most industrial metals started to show a stronger recovery, with the exception of coking coal prices. The lift was caused by the weakening of the US dollar (due to the poor US GDP data for Q1 and the Fed’s postponement of a rate hike) as well as higher oil prices. But hopes were also heightened by the prospect of more Chinese economic stimulus measures (and thus higher metals demand).

Ferrous prices remain under threat of oversupply

Steel prices lost ground during Q1 due to relatively weak demand, lower raw material prices (iron ore, coking coal) and overcapacity. In response to worsening steel market conditions, the Chinese government announced restructuring measures and aims to cut and close domestic capacity. The plans are certainly a welcome initiative for the global steel market, but similar plans from two years ago have yet to be fully executed. This year’s main goals are to cut capacity (by 10% to 2018), gain more control over emissions and encourage M&A activity. This seems ambitious, and we have our doubts that it will restore balance. In the meantime, excess steel from China is finding its way to international markets, depressing prices along the way. Unless and until the Chinese initiatives show some real results, we think oversupply in the ferrous market will continue to dominate market direction.

China’s export tax cut will increase aluminium outflow

During Q1, volatility in the aluminium price was relatively limited and prices drifted in a narrow range (between USD 1,733/t and USD 1,877/t). At the end of April, however, prices jumped, reaching reached a four-month high of USD 1,959/t on 5 May. But the jump in no way reflected improvements in underlying fundamentals. Although the stock volume at LME warehouses continued its downtrend (dropping by almost 10% since the start of 2015), the level is still high. In addition, global production is expected to increase further this year and next, while consumption growth will be unable to keep pace. To make matters worse, China has announced it will discontinue the export tax on aluminium from 1 May. This means that even more aluminium material from China – whose aluminium sector is already burdened by oversupply – will be pushed into international markets. In our view, the fundamentals do not justify any strong price gain going forward.

Copper price driven by non-fundamentals

Since February copper price is in an upward trend and have been dictated by non-fundamental developments, such as the volatility of the US dollar and oil prices. Oil prices started to climb again in early 2015 on hopes of a future decrease in oil production and increasing global economic growth. Rising oil prices implies an uptick in costs for miners, which resulted in stronger copper prices. And the recent softening of the USD (on cyclical factors such as US GDP weakness) also played a role. Because copper is traded in USD on the world markets, a lower dollar improves demand as this translates into lower costs in the buyer’s currency. Going forward, copper market sentiment will be influenced by macro-economic data (especially from China), US dollar volatility and the direction of the oil price. But for this year, we are keeping a close eye on Chinese import demand levels. Demand from China is still relatively low, but the most recent import data show signs of an early revival. In the meantime, we expect price support due to positive global macro-economic developments.

Balance tightens further in nickel and zinc markets

The market balance for nickel and zinc is set to tighten further in 2016. This year we will witness a surplus in both metals markets, but it will be negligible relative to demand (0.5% of total consumption). During 2015, supply side issues are set to kick in (including zinc mine closures), and this will result in deficits in 2016. The prospect of future shortages pushes up prices, and this is one of the reasons why the zinc price has rallied so strongly this year. Zinc prices are expected to increase further on supply side issues, combined with a limited number of new large mining projects in the pipeline and suspended mining due to start-up problems with greenfield projects. Nickel, on the other hand, has lost heavily since 1 January. This is mainly due to rising LME stocks and the very weak performance of the stainless steel market so far. But the nickel market will tighten further in the quarters ahead and this is about to lift prices going forward.