Metal prices under stress, but not burned out

by: Casper Burgering

In this publication: US economic policy plays a significant role in the trend of metal prices. Decreasing inventories in LME warehouses, supply constraints and robust demand for base metals will contribute to higher prices going forward. Steel from China and Europe is still competitive, despite the US import tariffs. Margins of European steel plants are relatively high.

Industrial-Metals-Insights_September-2018.pdf (369 KB)

Industrial metals markets (base metal and ferrous metal markets) are experiencing hectic times. Normally, the direction of metal prices is primarily determined by the economic trends in China. This influence is still considerable, but for a few months now the tumult on metals markets mainly originated in the US. US economic policy – the combination of trade and monetary policy – and the uncertainty that this provokes, puts downward pressure on metals price trends. The industrial metals markets are very cyclical in nature and the prices react strongly to news that could potentially damage future demand. In these uncertain times, investors therefore abandon riskier assets such as base metals.

Base Metals: Good fundamental basis for stronger prices going forward

The uncertainty caused by US economic policy is creating a lot of stress in base metals markets. The trade war between the US and China, including the retaliatory measures, determines sentiment. In addition, the tightening of the US monetary policy – resulting in higher interest rates – is adding to the nervousness amongst investors. The moment that US economic policy uncertainty increases, base metals prices fall. This is mainly because the global impact of the US monetary policy tightening is very high.

The combination of US trade and tighter monetary policy has created significant global economic turmoil over the last couple of weeks. For example, the economies in the emerging markets are under great pressure. This is not only because rising interest rates in the US are causing higher borrowing costs for these countries, but also because the availability of liquidity has been decreasing. This has an indirect impact on the future demand for metals. As a result of the trade war between the US and China, many investors in metal markets are also worried about the resilience of the Chinese economy. The question is whether the current turmoil will come at the expense of Chinese economic growth in the long term. A negative scenario is the most obvious outcome of a further escalation. Finally, the strengthening of the US dollar is also having a strong negative impact on metals prices. Because metals are traded internationally in dollars, a stronger US dollar makes metals more expensive in counter currency terms.

The recently announced new round of US import tariffs against China had relatively little impact on base metal prices. Indeed, prices even increased and that indicates that this new round has already been priced in. For the time being, the tit-for-tat measures will continue to influence base metal prices in the short term, which will increase volatility. But because of the more positive fundamental trends in the longer term, we expect stronger prices going forward. Conditions on the supply side are expected to worsen in most markets in the coming months. Less supply at the current level of demand will bring deficits in most base metal markets. Combined with further decreasing inventories in LME warehouses, prices will increase. In addition, the long-term demand projections for base metal also paint a favourable picture. Demand growth will be fuelled by further growth in the electric car sector and planned global infrastructural investments.

Steel: Chinese steel remains competitive

The US import tariffs on steel have put a wedge between the Hot Rolled Coil (HRC) steel price in the US and steel prices in the rest of the world. The US steel price rose sharply because domestic capacity is insufficient to meet total US demand. As a consequence, the global flow of steel shifted. A large portion of the export steel that was previously destined for the US is now offered elsewhere. The increased supply of steel in regions outside the US has resulted in weaker prices.

One of the consequences of the greater divergence between the steel price in the US compared to other regions is that the price competitiveness of imported steel in the US remains relatively high. Including the US import tariffs, the difference between EU and US steel price is only USD 45/t, or 5%. In contrast, the price of Chinese steel imports into the US is even more interesting. The difference between the steel price in China and the steel price in the US – including all additional costs and the import tariffs imposed by the US – is, on balance, USD 55/t in favour of Chinese steel. This means that imports of Chinese steel remain an option.

The import restrictions imposed by the EU on Chinese steel seem to be more effective. The import of Chinese steel into Europe – including all additional costs – is USD 62/t, or 10%, more expensive.

We think steel prices in Europe will increase further. The demand for steel from large end-users will remain robust during the fourth quarter. However, the price increase will remain limited as end-users will address their existing inventories. This will reduce the growth in demand for steel. The steel price in the US will fall further in the coming period and that will make US steel more price competitive. The new NAFTA agreement offers the possibility to import steel from Canada and Mexico. This extra supply in the US will depress domestic prices. The steel price in China will drop slightly in the coming period due to the sufficient availability of steel. Meanwhile, as soon as the Chinese government starts implementing a stricter capacity reduction policy for environmental reasons, this will have an upward effect on the steel price.

Steel (raw materials): Margins of EU steel mills are relatively high

The price of iron ore is still relatively low. There is sufficient iron ore available in the market. That means that any significant increase in demand – as has witnessed in recent weeks – will only have a limited impact on price. The demand for higher quality iron ore has increased as a result of China’s environmental policy. Higher quality iron ore requires less energy, which means less pollution and thus mills can maintain their level of production. On the coking coal market, the price has increased in the last few weeks due to restrictions in supply (especially in Australia). The current level of the price of coking coal and the trends in the coking coal price have a relatively significant influence on the cost structure of steel mills.

The margins of steel mills in Europe are relatively high. The biggest influence on the trend in margin development comes from the price of coking coal, iron ore and scrap. The share in the total cost structure of steel plants of these three combined (including the transport costs of these raw materials) is more than 67%. Thanks to the relatively low price of iron ore in recent months, steel mills have maintained healthy margins. And with these healthy margin levels, steel mills are more inclined to purchase (strategically) additional raw materials for making steel.

However, the growth in demand for raw materials for steel production may come to an end in the coming months as a result of the Chinese environmental policy to be implemented over the coming winter. This policy – which will be announced by the end of September – will probably reduce the capacity of heavy industries. This means that, on balance, there will actually be less need for these raw materials.