Industrial metal prices in thrall to sentiment

by: Casper Burgering

In this publication:
Uncertainty in industrial metal markets persists due to investor wariness. We see overcapacity continuing to dominate the steel sector this year, which will dampen prices. Basic metals markets are fundamentally healthy, but sentiment is still dictating prices.

Industrial Metals Monitor-Apr 2016.pdf (419 KB)

Soft but bumpy landing for Chinese economy

Concerns about the global economy and the demand for industrial metals continue to prey on people’s minds. And this will determine the direction of investor sentiment – and thus partly also the metal prices – in the coming period. Despite improving prospects in the Chinese property and automotive sectors during the first quarter, many stakeholders in industrial metal markets remain sceptical. Their main worry is whether Chinese demand for industrial metals will hold up this year. There is some justification for these fears, as a further cooling of the Chinese economy will logically dampen demand for industrial metals. Our view, however, is that the Chinese economy is heading for a period of gradual cooling. This will no doubt be accompanied by occasional shocks. In this process we also expect that demand for industrial metals may weaken somewhat, but will nevertheless continue to grow.

Sentiment plays key role in industrial metal prices

Early in 2016 sentiment regained the upper hand (due to shocks in the Chinese stock market) and basic metal prices were once again on the receiving end. Global steel prices stood their ground and remained virtually stable in this period. The month of February brought a price recovery for all industrial metal markets, but basic metal prices were forced to retreat again in March. The bumpy trend and volatility in basic metal prices makes it clear that sentiment is still dictating events. Prices in the steel market rebounded on the back of the announced capacity reductions in China, the recovery of iron ore prices and cautious optimism about end demand for steel. However, the turbulent start to 2016 has set the tone for the rest of the year. We think that economic shocks (from China, but also the US and Europe) will continue to feed investor wariness, causing persistent uncertainty in industrial metal markets.

Steel, iron ore and zinc are the gems so far

Global steel and iron ore prices have gained substantial ground so far. Steel prices moved higher in all regions, with particularly strong rises in the emerging countries. Prices advanced over 50% in the CIS relative to 1 January, and by 28% and 39% respectively in Latin America and China. The US and Europe also saw prices climb further, albeit at a slower pace (10% and 16% respectively). While underlying demand remains weak in parts, corrections on the supply side can provide fresh impulses. The aluminium market remains fundamentally weak, preventing any significant upward price movement. Nickel prices are under pressure. This market is strongly linked to the stainless steel sector, which is where the weakness currently lies. Copper prices is slightly down and, in view of the global economic unrest, the path forwards promises to be erratic. The star performer in the basic metal market is the zinc price, which is being driven by tightness in the market. This tightness is not only evident in the refined market but also in the supply of concentrates from mines.

Hopes of greater concentration in European steel market

The steel sector in Europe is in defensive mode. Cheap Chinese and Russian steel imports pose a threat and import duties have been imposed to turn the tide. However, overcapacity is the most pressing problem, as this has pushed prices to their current rock-bottom levels. Low prices have forced companies in Europe to take unpopular measures, such as plant closures. Moreover, the current market conditions may well spur heightened merger & acquisition activity. Parties within the top 20 steel companies are eyeing opportunities (Tata’s interest in ThyssenKrupp is one example). Mergers and acquisitions often lead to the closure of inefficient capacity. Which would be a welcome development as Europe, like China, is still contending with too much capacity. We see overcapacity continuing to dominate the steel sector in the coming period. Because despite pledges from China to drastically reduce its steel capacity, this problem will continue to dog the steel world for some time yet.

Higher steel prices are improving margins

The envisaged decrease in global production capacity and the introduction of import duties have boosted sentiment in the European steel market, which is translating into higher prices. Since 1 January the price in North Europe has risen by 6% and margins have followed suit. But is this upward price trend sustainable? The global steel market remains highly dependent on events in China. So the next question, logically, is whether China will live up to its promise to reduce capacity. This is by no means certain, as earlier ambitious Chinese plans (from 2014) never came to fruition. Equilibrium in the global steel market would help to shore up prices, but whether this can be achieved depends largely on the extent and timing of the capacity reductions. The contraction in steel output in China since the beginning of 2016 is encouraging, but the pace is still too slow.

Optimism about copper market is evaporating, but why?

Copper prices have recovered strongly since February of this year. There were several causes. Apart from the stronger oil price and weaker dollar, capacity reductions and supply disruptions also played a role. In addition, stocks in LME warehouses have already shrunk by 40% this year. However, since the last week of March, the copper price has dipped again. Evidently, confidence in a growing end consumption of copper is still too low. In our view, however, the macro-data actually point to a more positive direction in the coming months. More specifically, the Chinese property sector is showing signs of a fragile recovery and the contraction in Chinese industrial activity is decelerating faster. Oil prices, too, have received a new impulse from the strong reduction in US stocks and from hints in the Fed’s minutes that no new interest rate increases are on the cards in the near term. That is favourable for the price.

Ample availability continues to dampen price

The LME aluminium price remains under pressure and a strong upturn in the price seems unlikely for the time being. The aluminium market lacks healthy foundations. The market still needs time to digest the large stocks in LME warehouses, overcapacity (notably in China) and the exports of aluminium from China. The fairly stable demand and relatively low energy costs are the only bright spots at present. In Europe, too, aluminium remains abundantly available. The short-term danger is that China may step up the output of aluminium even further in response to the sharp increase in the aluminium price quoted on the Shanghai Futures Exchange (SHFE) since February. This could be an incentive for many inefficient companies to continue producing after all. In this scenario even more aluminium will find its way to the export market, as the domestic market is already saturated. And that is not a good prospect for prices.