Stock check - industrial metals update

News | 12 April 2017

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China's plan to close 30% of its aluminium smelter capacity has boosted prices and confidence, while further supply issues have presented themselves across industrial metals but demand and confidence remain high, says Casper Burgering

The Chinese economy is in calmer waters. It is performing relatively well in early 2017 and the government is insistent on maintaining macroeconomic and financial stability.

Despite the positive economic trends, concerns and uncertainty about the state of the Chinese economy remain high. Currently, the bulk of the worries involve the housing market. Sales of new homes, investments in real estate and housing prices are still relatively high. This increases the economic concerns about a bubble in the making. The cooling of the housing market is now a top priority for Beijing, while recently introduced legislation should release some tensions.

The government has taken the first steps towards tackling the debt problem with a tighter lending policy. These sorts of measures can disrupt long-run growth prospects for the demand of base metals. That being said, during Q1, business activity in many metal end-using sectors is still positive on a global scale.

Weaker dollar raises industrial metals prices

Since the start of 2017, both base metals and steel prices have maintained their upward price trend. This is partly due to the movements in the US dollar. Normally, the dollar has an inverse relationship with many metal prices. Since base metals are traded in dollars on the world market, a stronger dollar adds to a weakening of demand for base metals. A higher dollar means higher costs in the counter currency and this has
a negative impact on demand.

Conversely, if the dollar weakens against other currencies, it has the tendency to increase demand for base metals. Since the start of this year, the dollar has weakened against the euro by approximately 2%. This has helped push the price of base metals higher. We think that weakness in the dollar will persist. ABN AMRO expects a EUR/US$ exchange rate of 1.10 by the end of 2017. As a result, our expectation of a weaker dollar will not qualify as a form of headwind for the trend in base metals prices.

Figure 1: 2017 and 2018 GDP expectations

Source: ABN AMRO Group Economics

Supply-side issues set the tone

Overproduction is the cause of the price trend in the coking coal market, while supply is increasing further in the iron ore and steel markets. Sufficient demand for steel will keep market sentiment upbeat and this will result in stable prices in the coming period. The aluminium market is dominated by China's announcement to close 30% of its aluminium smelter capacity. The closure should be settled this winter and this has boosted confidence as well as the aluminium price.

The copper market has had to digest a range of developments on its supply side. Strikes in the Escondida mine in Chile reduced the availability of copper ores, and heavy rains and floods in Peru and a dispute over mining rights in the Grasberg mine
in Indonesia all contributed to lift the copper price.

Nickel has been the only metal in the base metal complex under pressure in terms of pricing since the start of this year. Nickel inventories are still relatively high, the inflow at London Metals Exchange (LME) storehouses continues to rise and availability is generally good. The sentiment in zinc remains positive and the price trend of zinc has been on an upward trajectory for some time. The fact that 8% of China's zinc smelter capacity will go into maintenance soon has also helped to lift prices.

Sentiment is positive and availability is good, for now

The net position of investors in base metal markets was positive throughout 2016 and this positivity has continued into 2017. Investors seem to have enough confidence in long-term base metal markets prospects, particularly in aluminium, where the number of short positions (speculation on a price reduction) decreased and the number of long positions (speculation on a price increase) rose.

The copper market started 2016 hesitantly, but had gained confidence by the end of 2016, mainly because of a series of good macro-economic data from China. Currently, many investors have a wait-and-see attitude. Recently, more volumes of base metals found their way to warehouses of the COMEX, LME and the Shanghai Futures Exchange (SHFE). And this increase in inventories has made many investors more cautious. They now look forward to data from major economies that will provide more guidance on the direction of future demand for base metals.

Availability of base metals in the refined market is currently good. That dampens price gains and has kept premiums for immediate delivery relatively low. We are seeing the most activity on the supply side of the base metal markets at present. On balance, we believe that only the aluminium market will record a surplus this year. In 2018 and 2019, the aluminium market is expected to show a deficit. These shortages will mainly be due to China's ambition to close 30% of its smelting capacity by
next winter.

If China actually succeeds in the planned capacity reduction, that should push prices up. However, it should be noted that, with the announcement of the measure early in 2017, the aluminium price rose sharply. As a result, a large part of the measure has already been priced in. Parallel to the deficits in base metals markets, total inventory will decrease until 2019. But given the slow pace of stock declines, availability of base metals will remain sufficient.

Figure 2: Industrial metals prices in 2017 (% change in prices since 1 January 2017)

Source: Thomson Reuters Datastream

Steel utilisation rates below long-term average

Global utilisation rates for making crude steel averaged 70.3% in February. This confirmed the upward trend that has been seen since late 2016. That said, at this stage, the utilisation rate is still 4.7% points below its long-term average. A similar situation is also reflected in occupancy rates for intermediate goods, such as medium plate steel and hot rolled steel. After a peak in 2014, utilisation rates decreased until mid-2016, and ended far below their respective long-term average.

The growth of steel demand weakened during this period and production prevailed. Utilisation rates in China also fell. The trend in utilisation rates of Chinese Rebar (used in construction) and wire rod (used in construction and the automotive industry) has been on a downward path since 2010. The centre of gravity of overproduction lies in China, and tackling this overproduction has finally become a top priority.

Iron ore inventories relatively high

Although the huge iron ore inventories at Chinese ports form a negative indicator for iron ore market trends, we assume that this build-up of inventories will not directly lead to a market correction. The need for good quality iron ore from abroad remains high in China. Over the past months, demand for steel in China was very volatile. In mid-February, the outlook for steel demand was still positive, the sentiment was good and that pushed prices higher.

The reason for the optimism was mainly due to the fact that stakeholders were awaiting an announcement of a series of new stimulus programs during the National Congress of China on 5 March. But the plans presented during the congress were not very specific where the ferrous sector was concerned. As a result, the outlook for stability in the future demand of steel has become more uncertain. Over the coming months, the sector will mainly be affected by the intention of the Chinese authorities to close some induction furnaces. If the government succeeds, the global steel industry will become more balanced.

Casper Burgering is a senior sector economist for manufacturing and industrial metals at ABN AMRO

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