Industrial metals Monitor: Higher metal prices serve to maintain oversupply

by: Casper Burgering

In this publication: Several industrial metal prices have increased again, driven mainly by sentiment. In base metal markets, the price of oil, the dollar and speculative movements play a major role. Strongly rising steel prices provide no incentive to cut production capacity in China.

Industrial Metals Monitor-May 2016.pdf (456 KB)

Sentiment improved, but risks remain

In China, the macroeconomic picture has improved, but despite this positive trend the risks have not disappeared. Recent figures show a more stable economic situation and major metal consuming sectors (including real estate and automotive) are reflecting a cautious recovery. But this is largely due to government stimulus and questions concerning the degree of the recovery’s sustainability remain. Still, the unease has somewhat diminished, which translates into an improvement in sentiment. The US economy came to a standstill in the first quarter. It appears that US consumers are more conservative in their spending, while growth in industrial output and export growth remain relatively weak. The situation in the eurozone is not much better. Many indices continue to suggest that the moderate economic recovery will continue this year. Meanwhile, Latin America is facing serious economic problems. Brazil in particular is showing a strong growth contrac-tion, but Argentina is also experiencing an economic slowdown this year.

Stable growth path in Chinese consumption of base metals

growthMany countries are exhibiting a similar economic growth pattern. The economic progress is aimed at creating a more sustainable economy and improving the population’s living standards. Usually, industrialization and urbanization get a boost, which is accompanied by an increase in industrial activity and investment in industrial capacity. Eventually, the national income (GDP) per capita rises, and consumption of industrial metals per capita increases. In developed economies (such as the US and the eurozone), the consumption of industrial metals per capita is more cyclical. In China, on the other hand, the per capita consumption of industrial metals has been showing a more stable growth path since 1998, thanks in part to investment from the government and state enterprises. Given the current position of China, the country still has considerable room for growth, and that provides a good foundation for the demand for industrial metals.

Enough green numbers

So far this year, many industrial metal prices have increased. Globally, steel prices have risen sharply, while steel manufacturing prices (iron ore and coking coal) booked strong gains following positive sentiment in steel markets. However, the increase in steel prices was independent of fundamental drivers, and was mainly driven by improved sentiment surrounding the Chinese steel industry. This raises questions concerning the sustainability of higher steel prices. In the base metals markets, the zinc price has witnessed particularly strong improvements. China imported more refined zinc during Q1 (partly due to a decrease in the supply of zinc ores) and that was reason enough for price increases. The increase in the aluminium price seems to be mainly driven by speculation, because end user demand remains somewhat weak. Since 1 January, the nickel and copper prices have been under pressure. Both markets are still struggling with a lack of confidence in demand, but industrial activity in China is also disappointing. In addition, a stronger dollar has hampered base metal markets.

Copper price reflection of China’s economy

Since the start of 2016, the copper price is in an upward trend with some deep troughs and peaks. This may indicate that sentiment on the Chinese economy is improving given that China is a top consumer of copper. And because Copper is used in a relatively large number of economic sectors – more than other base metals – its price is directly correlated with economic activity. Copper is widely used in China for power grid expansions and investments in this sector have increased by 36% this year. The copper price is also influenced by movements in the oil price and the dollar. But speculation investors also play a strong role. This can significantly affect the volatility of copper prices, even in the absence of a fundamental reason for price movements. Going forward we expect stronger copper prices.

Sufficient aluminium hampers market

Although the outlook for worldwide aluminium demand is positive – with average growth expected at 5.2% in 2016 – we do not think the aluminium price will show significant upward movements this year. This market simply has too many negative elements to digest. Aluminium production will grow by 5.6% in 2016 and stocks in LME warehouses are still relatively high. In other words, there is already enough aluminium on the market and that is having a negative impact on prices. Moreover, so far we have seen little real producer discipline in China, because current price levels provide no incentive for inefficient producers to cease production or truly cut capacity. Given the persistent oversupply in China, its aluminium exports will remain high. And the expectation is that this oversupply will further increase this year, which is a bad scenario for potential market balance in the short term.

European steel market recovers relatively late

The steel market in Europe has adopted a cautious attitude and responded conservatively to the improved sentiment in the global steel market since the end of January. Initially, prices in Europe increased relatively slowly. The subdued demand for steel in this region, the sufficient supply and the import of relatively cheap Chinese steel, held prices in their grip. But when the European Commission announced import duties on certain types of steel, European steel prices also started to increase more strongly. The prices in southern and northern Europe have risen by an average of 36% since the start of 2016. But here, too, there is a lack real fundamental drivers to sustain the growth rate in prices and positive sentiment prevails. Many steel scrap prices have also risen, but the extent of the increase largely depends on the type of scrap, the volumes of supply and the quality. Scrap prices were up during the first quarter of 2016, broadly following the trends in the market for raw steel. However, this market is still suffering from oversupply.

More steel, more problems

steel 2The trends in the global market for crude steel are dominated by China. The government announced ambitious plans to reform the steel sector in order to reduce redundant capacity. That brought on a wave of optimism in the steel sector and global prices took flight. But the sharp rebound in prices provides little incentive for the more inefficient steel mills – who were about to cut capacity – to cease production. Therefore, stronger steel prices are not helping to solve the problem of excess capacity. In March, production in China increased again by 2% year-on-year, after a long series of monthly production contractions. Exports of crude steel also showed significant growth. And with the strong growth in imports of materials for steel making, it does not appear that many factories intend to show sufficient producer discipline to reduce capacity. We think prices will correct at the end of Q2.