Each Quarter FastMarkets and Sucden Financial produce an analysis and forecast report on the Precious and Base Metals. Below is the Metals Market Economic Outloook and Summary For Q2 2015, to read the full report covering all the metals in pdf form click here.
Subscribers to FastMarkets Professional have access to the report before it is published here.
Market Overview
Outlook improving while stimulus provides support – Weak demand has remained the main story in the markets this year despite the belief that the world’s major economies had pulled out of recession and achieved renewed economic momentum at the start of the year. Although the US seemed have reached escape velocity after the end of its third quantitative easing (QE) programme, it became a victim of its own success, ultimately hindered by its strengthening dollar in a race to the bottom across currencies. And it was hoped that while China’s numerous stimulus measures were enough to kick-start growth, inherent economic weakness became apparent, prompting a lowering of its 2015 GDP growth target after the slowest expansion in 24 years in 2014. In Europe, ECB president Mario Draghi’s ‘whatever it takes’ stance had already started to wear thin, with a full-blown QE programme already believed to be on the cards. But the extent of the risk that Greece would pose to this recovery was unforeseen. With conflicting data of late, market volatility depends on how three questions are answered.
Will Beijing stimulate its economy further with another liquidity injection?
Despite the government bringing forward 300 infrastructure projects with a value of $1 trillion to this year to spur economic activity, the Chinese economy has continued to falter, exacerbated by global weakness. This was confirmed by the reduction in the growth rate target to ‘around seven percent’ from 7.5 percent in 2014 – China failed to hit its target in 2014, the first such failure since 1998. Although Chinese economic weakness would normally be bearish for base metals, Chinese Premier Li’s assertions that Beijing would look to prop up the economy should GDP growth move towards the lower end of its 2015 forecast range has changed the status quo by making negative data also positive for base metals via the increased potential for consumption-driving stimulus. This has been bolstered by the IMF’s cut to its 2015 growth forecast to 6.8 percent from 7.1 percent. Still, earlier concerns about China’s slowdown have weighed on prices in the first quarter. The two manufacturing PMIs continue to diverge, with the official number rising to 50.1 and the HSBC reading falling to 49.6 in March, clouding the true state of the sector. The return of the official PMI, which covers many large and often state-owned companies/factories, to expansion for the first time this year suggested a boost to demand. But the HSBC PMI, which focuses more on small-and-medium-size enterprises (SMEs), failed to maintain its return to expansion. This indicates that the smaller players remain under pressure from reduced demand and tight credit. This is likely to maintain speculation for further stimulus from Beijing to keep growth above seven percent – further stimulus could therefore halt the downward trends in base metal prices.
Can the ECB reinvigorate growth and reverse the eurozone’s deflationary spiral?
The ECB has finally launched its highly anticipated QE programme to spur spending and drive inflation towards its mandated two-percent target. The ECB will purchase €60 billion per month of public and private sector assets provisionally until September 2016, giving a total programme size of around €1.2 trillion. With the ECB needing to buy around €850 billion of government bonds to reach its balance sheet target, from where will it buy? Only investment funds and non-Eurozone entities are likely to be willing to sell but this may be seen as a less effective way of spurring European economic spending, although a knock-on effect would likely still be felt. QE, in addition to the previous three targeted long-term refinancing operations (TLTROs), appears to have succeeded in stoking inflation and reversing the deflationary slide, with the rate of deflation having fallen month-on-month since January. The CPI is currently forecast at -0.1 percent in March, which would be the highest level since November. If confirmed and the present rate is sustained, the eurozone would be on track to return to inflation this month. But with record OPEC output, low oil prices (driven by a flooded spot market due to a lack of available storage) could stymie inflation. Despite a reduction in the ECB’s inflation forecast for 2015 to 0.0 percent from 0.7 percent, it raised its forecast for 2015 growth to 1.5 percent from 1.3 percent. A return to inflation should therefore bolster growth in the bloc, increasing its global competiveness via further euro weakness – the single currency has already fallen close to parity with the dollar. A revival in European economic growth could provide considerable confidence to global industry and via that to base metals via restocking.
When will the US Federal Reserve look to raise rates?
Markets had been expecting the FOMC to raise rates either in June or September, driving the dollar index to around 100 and putting commodity prices under downside pressure. But the replacement of the word ‘patient’ in the FOMC minutes with ‘reasonably confident’ and assurances by chair Janet Yellen that rate rises remain data-dependant shifted speculation away from June towards September. In addition, recent data, including the fall in fourth-quarter GDP growth to 2.2 percent from five percent in the third quarter and March’s weak employment report, suggest the Fed may delay the first rate rise. This change in its stance triggered a downside correction in the dollar – it seems that dollar strength may have run ahead of the fundamentals. The pullback in the greenback has triggered short-covering and some bargain hunting ahead of the second quarter. We expect this will mean increased price volatility off of US data. The manufacturing sector, which had been slowing since the end of QE, hinted at a return to rising growth in February when the official manufacturing PMI signalled its first increase in the rate of growth since August. US official (55.7) and ISM (51.5) PMI data for March continue to diverge, painting two very different pictures of the US manufacturing sector. The ISM PMI, which has been signalling falling growth since October – when the Federal Reserve ended QE3 – indicates falling economic momentum while the US exports the strong domestic demand that initially enabled it to achieve escape velocity and effectively imports deflation, implying that the strong US dollar has become a hindrance to growth. But the improvement in the official number – it has been rising since January – signals that the manufacturing sector may have bottomed out and is now picking up momentum after reaching a more normalised level after the removal of QE-driven liquidity. We expect this sustained divergence to continue to give the Fed an excuse to delay making its first move on interest rates. With low oil prices and an economy that continues to look to be faltering, we do not expect the FOMC to act until there is confirmation of sustained strength in the manufacturing, employment and housing sectors, most probably pushing out a rate rise to September.
Geopolitical risks – The threat of a Greek exit from the eurozone and tensions over Ukraine and in the Middle East, which have picked up with Saudi Arabia’s involvement in Yemen, could create dark economic clouds and could hit market confidence hard. But fears of the euro breaking up since the onset of the financial crisis have come and gone; although there is no room for complacency, policymakers have shown their ability to reach last-minute deals even if they merely ‘kick the can’ down the road. At some stage they may run out of road but it is difficult to anticipate when that will be – it is likely to be triggered by a ‘black-swan’ event. As for the Middle East and Ukraine, the markets are now probably less vulnerable given low energy prices – again, although a deterioration could affect the markets, it is difficult to anticipate what will happen and therefore difficult to forecast an impact on prices. With the Ukraine conflict weakening Eastern European currencies, these countries might have been encouraged to export more metal, which may well have been reflected in weak aluminium, nickel, steel and palladium prices – while currency weakness may well have given producers an incentive to boost output, it may also have prompted destocking. Any step towards a solution to the Ukraine conflict could reverse these trends or at least halt them.
Oil’s multi-edged sword – The weak oil price continues to weigh on central bank actions to drive inflation higher and low inflation is not incentivising corporates to increase capital spending. Weak oil/energy prices have also increased producers’ profit margins, thereby encouraging higher output, which has had bearish implications for metal prices. But low oil prices will be benefitting the global economy in other ways – cheaper motoring, energy and heating should all boost households’ disposable income and lead to increased household/consumer spending, which in turn should underpin stronger manufacturing. But the lower metals prices are now starting to prompt more producer restraint, especially in steel, iron ore, nickel and aluminium.
Dollar’s direction all-important – The dollar has been racing higher since July last year in anticipation of diverging monetary policies. So far US policy has tightened in that QE has finished and a host of other central banks have been easing but the dollar has also anticipated firmer US interest rates, which so far have not eventuated. The recent pullback in the dollar index may well just be a long overdue bout of consolidation but there is a risk that, if the Fed is seen as having cold feet about raising rates, the dollar has run ahead of the fundamentals. With the world’s economy outside of the US suffering, the US may find one excuse after another to delay raising rates – if so, a dollar correction could well prompt a bullish adjustment in metals prices, especially in bullion.
Overall – The slowdown in Chinese growth has been one of the main bearish features weighing on sentiment; low growth in Europe has not helped either. The market also seems concerned and/or shocked by how much metal has come out of the woodwork in the likes of nickel and copper and whether we are moving into an era when financing metal may be less profitable, resulting in more metal from off-market stockpiles finding its way back to the market. The much-discussed shortages in zinc and nickel and aluminium’s move into a deficit do not seem to be underpinning prices, which has undermined confidence. Still, it now looks as if the markets stand a better chance of not being already long when the shortages arrive. This could lead to a sustained bull market from later this year but much will depend on how tightly off market stocks are held.
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