Overview and Analysis of the Metals Market for Q3 2015
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 Q3 2015, to read the full report covering all the metals in pdf form click here.
Subscribers have access to these reports before they are published through the research tab in FastMarkets Professional.
Market Overview
Outlook – We enter the third quarter amid considerable economic uncertainty. The headlines are all focused on Greece but as far as the metals markets are concerned the focus is still very much on the health of the Chinese economy. Sentiment in the metals has been dampened by the Greek saga and there has been some nervous risk reduction in case a ‘Grexit’ stalls Europe’s recovery, but concerns over China have set the tone for most of the second quarter. The market is not bullish about China, largely because the metal fraternity in China is not bullish. A look at the chart opposite shows the slowdown in growth in China’s fixed asset investment and in industrial production – the downward trends speak for themselves. But before getting too gloomy, it should be noted that much of the official metals data on China shows demand is falling, which we have to view with some caution when GDP growth is still around seven percent, which for a huge economy is still a very high rate, suggesting more metal is being consumed. The GDP growth in combination with the metals data suggests that industry is still destocking and/or buying on a hand-to-mouth basis. Tight credit is also making it hard for companies to hold as much stock as they may have become accustomed to. The government is providing further stimulus measures, cutting interest rates four times since November to 4.85 percent from 6.0 percent and also making it easier for local governments to sell bonds to raise finance, which should enable them to continue with worthwhile projects. The combination of stimulus, lower interest rates and giving more freedom to local governments is expected to bolster the economy; when that happens, the supply chain may well be destocked and need to restock.
Of course this view must also be considered in the light of the very recent crash in the Shanghai and Hong Kong equities markets. Whilst the markets have been overblown for some weeks now, the level of losses incurred in leveraged trading by retail investors has been high. The authorities have announced a raft of measures to help stabilise the markets, but it still remains to be seen how the market will recover and, more importantly, what will be the long term impact on consumer confidence. High on the list of areas to be further affected will be the auto industry which has already shown a 3.2 per cent fall in sales, June 2014 to June 2015, as discussed below, and in turn will impact imports from the major European car manufacturers.
Whether the stock market problems spill over into the banking, general manufacturing and industrial sectors is the issue causing concern and the root of the recent heavy falls in metals prices.
PMI data improving slowly – There were positive trends in May’s PMI data – the US, Japan, China and EU manufacturing readings picked up to average 51.3, indicating expansion. Of particular note was the relatively strong EU reading of 52.2, which was running above that of Japan and China but below the US reading of 52.8. So it is not all gloom and doom. The PMIs released early in July averaged an unchanged 51.3 across these regions – while there was further strength in the US, the EU and China, Japan’s expansion has slowed. The bulk of the increase in June came from the US where the ISM PMI recovered to 53.5, which further suggests the dips in March and April were weather-related. Japan’s reading fell to 50.1 from 50.9 and EU data improved to 52.5 from 52.2. Overall, the PMI data looks constructive – even though the HSBC data for China suggests contraction, it is at least slowing. In Europe, France is recovering, while Italy is expanding at the best pace.
US data mixed but some good numbers for metals – Although US PMI data may be lower than at this time last year, there are some encouraging signs – US new home sales are steadily recovering and there is plenty of room to recover further compared with the situation 10 years ago (see chart above); the unemployment rate is falling, hitting 5.3 percent from an average of 6.2 percent in 2014; and auto sales are still running at a high level of 17.2 million units (mu) on an annualised basis in June and at an average of 17 mu so far this year compared with 16.5 mu in 2014.
Global auto sales apply brakes – While US auto sales have been growing strongly, other regions are showing signs of slowing, notably China and Europe (see chart opposite). Auto sales in China grew at an average rate of seven percent in 2014 but have slowed to 3.8 percent this year. Although 3.8 percent growth in an annual market of 24 million units still means considerably more consumption of metal in tonnage terms, the market had been working on the assumption of growth nearer seven percent. Europe’s auto registrations have been strong, with 21 consecutive months of growth, but May’s growth slumped to 1.3 percent from a healthy average of 6.8 percent in the first five months of the year, which in turn was up from 5.5 percent in 2014. If growth in these two regions remains low, it could weigh heavily on metal demand. Additionally other markets such as Russia and Brazil have seen double-digit declines, with sales off 38 percent and 21 percent respectively in the first five months of the year. In China, part of the slowdown in vehicle sales can be linked to the rampant stock market – would-be vehicle buyers are using their cash to play the stock market rather than buy cars. With equities now less of a one-way bet, investors may put some of their profits back into buying durable goods.
Markets waiting for US Federal Reserve to raise rates – The uncertainty over Greece, concerns about China’s slowdown and fears of a repeat of a ‘taper tantrum’ in Asia may well mean the Fed still feels little pressure to raise rates. The market is expecting a rate rise in September but we would not be surprised if it is rolled further forward still, which may well keep the dollar capped for a while longer. This should help the US economy – the dollar’s earlier rise was hurting the economy by lowering demand for US exports, while cheaper imports were a headwind for domestic industrial production. Once interest-rate rises start, we would expect the dollar to begin trending higher, especially against the euro and yen, where various forms of quantitative easing are still being rolled out. It is arguable that, even if the dollar starts to trend higher again, it may not produce too much of a headwind for the metals because many metals prices are now well into their marginal cost curves (the main exception is copper).
Geopolitical risks – The threat of a Greek exit from the eurozone rose in recent days after its people voted against austerity measures in the proposed cash-for-reforms deal from its creditors but, because a Grexit was viewed as a slippery slope for the euro. 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 a last-minute deal and indeed this is what has happened at the eleventh hour. Judging by the lack of strength in gold and the lack of weakness in the euro, there has seemed to be a significant divide between the headlines and what the market expects.
Oil price falls again – The rebound in the oil price in March has helped to diminish the threat of deflation by giving inflation a boost; however, oil prices seem to have turned lower again more recently on expectations that sanctions against Iran will be lifted. This could further delay the need for the Federal Reserve to act. Weak oil/energy prices last year increased producers’ profit margins, thereby encouraging higher output, which has had bearish implications for metal prices. But low oil prices will once again benefit the global economy in other ways – cheaper motoring, energy and heating costs should all boost households’ disposable income and lead to increased household/consumer spending, which in turn should underpin a stronger manufacturing sector.
Overall – Sentiment in the metals markets has been poor mainly due to the slowdown in Chinese growth, which in turn seems to be prompting a combination of destocking and hand-to-mouth operating. Low growth in Europe and the uncertainty over Greece has not helped either but there may well be a relief rally now a solution has been found. The March-May rallies have mainly been unwound – aluminium, nickel, zinc, copper and tin are all extending below their March lows. Prices are still working lower because the market feels we are in an oversupply situation. Lead is still above its first-quarter lows but continues to descend. Looking forward, we expect a combination of structural changes to tighten supply in zinc, lead and nickel, while lower prices are likely to prompt supply cuts in aluminium; indeed low prices could also prompt producer restraint in the other metals before long, especially in the likes of tin and among secondary lead producers.
On balance, the path of least resistance is to the downside; this may well remain the case throughout the summer slowdown but supply responses either through mines reaching the end of their life or because low prices prompt production cuts are likely to firm up the fundamentals moving deeper into the second half. In addition, we feel destocking can only last so long and, given recent manufacturing PMI data, we are not too gloomy on the demand outlook – even in China.
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