Pressure on metals markets under construction

by: Casper Burgering

In this publication: Prices of base metals and steel increased this year by 9% and 2%, respectively. Market balances base metals indicate deficits, but cyclical trends will dampen price growth. Sentiment in China’s steel market is positive but overproduction still dominates.

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Global economy maintains solid growth path

Many confidence indicators – from producers to consumers – have been rising for several months now and are currently at high levels. In many countries, some indicators have reached new record highs. But so far, harder data on actual economic activity has not yet improved. We think increased sentiment will translate into intensified business activity. Construction activity and car sales – two major metal consuming industries – have been showing steadily improving growth figures for some time now. Industrial output still remains subdued in many major economies, and we think that this will soon change for the better. Our view is that economic growth in the eurozone will not be spectacular this year and next, but we do foresee slight economic growth improvements. The economic outlook for the US remains good. Recent figures on the labour market and retail sales show more steady growth. For the Chinese economy, we expect the gradual slowdown to continue.

Strong link between metal prices and economic trends in China

Sentiment improved in industrial metals markets during the fourth quarter, which was reflected in a strong recovery in prices. This price trend continued in early 2017. The prices of base metals and global steel are still in an upward trend and increased this year by 9% and 2%, respectively. Since mid-October 2016, both base metals prices and ferrous metals prices have been positively affected by promising macroeconomic data from China. China’s role in the industrial metal markets is clear. China has a share of nearly 50% in total consumption of all base metals. And in the production of crude steel, China has a 50% share of global output. Therefore, monitoring trends in the Chinese economy remains relevant. Beijing has taken steps to cool housing markets, which are showing signs of overheating in several cities and regions. And with China’s cooling real estate market this year and next, growth in demand for industrial metals is likely to decline as well.

Strong rise in iron ore prices, sharp fall in coking coal price

The biggest price spikes have been in the ferrous markets. The iron ore price has experienced a strong rally, while the coking coal price has dropped sharply since the start of 2017. These price trends eventually translate into the price of steel. Approximately 1.3 tonnes of iron ore and 0.6 tons of coking coal are required to make one tonne of steel. The sharp increase in the iron ore price therefore has a stronger impact on the price of steel than the decline in the coking coal price. On balance, global steel prices increased slightly. Meanwhile, the price of aluminium rallied following the announcement that China wants to reduce its aluminium smelting capacity going forward. So far relatively little capacity has been withdrawn from the market, but apparently investors have enough confidence. The copper price increased due to the strike in the largest copper mine in the world (Escondida, Chile). The zinc price is stuck on an upward price trend, thanks to the prospect of ore shortages in 2017. A shortage of ore supply is also the reason behind the increase in the nickel price.

Base metal inventories at relatively low levels

Base metals markets are fundamentally healthy in early 2017. Demand growth for industrial metals from China is stable and investor sentiment concerning demand is still good, despite the economic slowdown in China. Deficits are expected this year in the copper, nickel and zinc markets. Global supply growth is inadequate to meet all the demand, which is positive for prices. We think inventories will continue to decline over the next two years and that they will approach pre-crisis levels. There is sufficient nickel and aluminium available in weeks’ consumption in the next two years. But we think that nickel inventories will decline rapidly in 2017 and 2018 due to the expected deficits and ore availability. Aluminium inventories will increase slightly over the next two years. Availability of aluminium will remain good, but if China actually reduces capacity, the market balance will improve.

Dollar volatility impacts copper prices

The recovery in the copper price during the fourth quarter of 2016 was mainly due to a series of good macroeconomic data coming from China. We believe that the upward trend in the copper price will continue during the first quarter of 2017. The shortage of copper and good demand prospects have the potential to push up the price further. During 2017, prices will also remain under the influence of macro trends (especially from China), the trend in oil prices, interest rate hikes by the Fed and the development of the dollar. China’s economy will cool further and its problems remain big (including high debt levels, shadow banking, risk of bubbles).Oil prices will only see a moderate recovery this year. Meanwhile, the Fed will provide more headwind. Our base scenario is that there will be three rate hikes in 2017. This will lead to a stronger dollar, which will put pressure on the copper price. But we think that the dollar rally is behind us. Our new Q2 and Q3 2017 forecasts for EUR/USD are 1.05. Expectations of ECB tapering to push EUR/USD to 1.10 end of 2017.

European steel and scrap prices recovering

Overproduction in the steel industry remains a persistent problem and it does not appear a solution is imminent. The centre of gravity is located in China, which must sacrifice a large part of its capacity to bring greater balance to the global steel sector. China has big ambitions to reduce steel capacity, but so far the reductions have been relatively small. As long as overproduction in the steel sector is the leading theme, upward price trends will remain weak. Demand for steel in Europe – particularly from the automotive industry – is currently good. The import restrictions on cheap Chinese steel reduces the pressure on European steel producers. This has improved sentiment in Europe. Since the end of 2016, the prices for steel scrap in Northern and Southern Europe have also increased. The question remains how sustainable the upward price trend is, because this trend will largely be determined by China.

Sufficient availability of iron ore and steel in China

Sentiment on the Chinese steel market is currently good. Demand growth for Chinese steel has increased in recent weeks. The price of Rebar steel – Reinforcing bar, used in construction – has experienced a particularly strong rally, thanks to the Chinese infrastructural plans. But the sustainability of this current buoyant sentiment is questionable. Inventories of steel and iron ore have been relatively high in early 2017. Iron ore inventories were up sharply in the second half of 2016 and are now at record levels. Steel inventories in China also increased strongly in the fourth quarter of 2016. This was partly due to the decrease in steel exports in light of the import restrictions in the EU and the US. Furthermore, the Chinese property market is under pressure. The government has raised interest rates on mortgages and also further tightened requirements on down payments for home purchases. This will eventually reduce the demand for steel. In addition, China is still under international pressure to reduce steel capacity and the country must introduce stricter pollution measures.