Author Archives: Stuart Burns

The price of several metals has traditionally been looked at paired with that of another metal. For example, gold and silver prices are looked at in isolation and relative to each other, in part because both metals make up a major part of the jewelry trade.

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So, too, are zinc and lead prices, where the correlation is not from market applications but from the fact lead and zinc are often co-mined from the same resource.

Like precious metals gold and silver, less prominent platinum and palladium can be both mined and used in very similar applications. The Platinum Group Metals, or PGMs, are often magmatic in origin and rare in economic concentrations. The majority of the world’s platinum and palladium comes from South Africa, Zimbabwe and Russia, where early low-cost surface mines have long since given way to deep, expensive and complex operations.

As the name suggests, platinum as long been the investor’s favorite PGM and enjoys the widest number of applications.

Recently, however, its quiet PGM peer palladium has caught investors’ interest.

Palladium has traded at a discount to platinum because of platinum’s greater cost of extraction and its wider scope of applications. But one application in which palladium does excel is catalytic converters for petrol engines. The diesel engine’s relative loss of favor over the last 12 to 18 months to the petrol engine has boosted demand for palladium, driving up the price to the point that it exceeded that of platinum this month for the first time in 16 years.

On Monday, palladium exceeded $1,000 per ounce on the London market compared to its platinum’s $950 per ounce.

The reasons are not hard to find.

The platinum market is in surplus, but that of palladium is estimated by Joni Teves, an analyst at UBS quoted in The Telegraph, as experiencing a shortfall in production, which could push the market into a deficit of 830,000 ounces this year, as miners have cut back production.

In fact, John Meyer, analyst at SP Angel, is quoted as saying, “Marginal mine shafts have been closing at a rate of knots. We could see production in both palladium and platinum continue to fall as a result of ongoing rising costs. I don’t think the current rally (in prices) is enough to reverse that.”

Meanwhile, market demand is shifting.

Platinum that is used more in diesel engines has seen falling demand. With car sales growth featuring more in petrol-engine-dominated American and Chinese markets, and less in diesel markets like Europe, the demand bias has been for palladium, rather than platinum.

But even within Europe there is gradual shift from diesel to petrol.

Sales of diesel cars in western Europe fell from 45.1% of the market to 42.7% this year, according to industry research group LMC, with a forecast it will continue to decline to 39% by 2022 as petrol gains favor and hybrid or electric vehicle sales grow.

Some, though, are voicing caution.

Much of the enthusiasm for palladium has been investor-led — it is a small and relatively illiquid market, meaning not a large volume of positon taking is required to dramatically boost prices. Given time — and it would take time — catalysts could be altered to accommodate more platinum to the detriment of palladium demand, if the palladium price stayed at a premium to platinum over time.

In the longer term, electric vehicles are expected to sound the death knell for both metals (at least, with respect to automotive demand). Counter to this is the upcoming move by predominantly petrol engine China to increase its emission standards to the much tighter China 6a standards by 2020. Johnson Matthey says many manufacturers could leapfrog even this standard and aim to future-proof themselves to the yet more stringent China 6b standard expected in the middle of the next decade.

The enhanced PGM loadings such a move would require will maintain palladium demand — certainly well into the next decade — and could be the basis of investors’ longer-term enthusiasm for the metal.

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Either way, for the time being palladium has come out of the shadows and is having its day in the spotlight. For how long, we will have to see.

There are a number of variables that drive commodity prices, and at any one time that mix of factors will vary depending on the global economy, specific country performance, and supply and demand fundamentals, to name but a few.

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But one variable that has had a consistent impact over time has been the strength of the U.S. dollar relative to other currencies.

A strong dollar is bearish for commodity prices, as the dollar-priced commodity costs more in other currencies when the dollar exchange rate is strong. Conversely, the reverse is often true — a weakening of the U.S. dollar will see a rise in commodity prices.

So while it is far from the only driver of price, keeping an eye on the exchange rate and holding a sense of trend direction for the currency can be a useful indicator of price direction.

As the Financial Times notes, the U.S. dollar has performed poorly so far this year, falling about 6% on a trade-weighted basis. Investors were wrong-footed, the Financial Times states, early in 2017 when they bet that U.S. tax reform would push the dollar beyond already lofty valuation levels and help the American economy continue to outperform the rest of the world.

In support of our argument, metal prices have performed well this year, as the dollar has weakened. Where the dollar goes from here could have a bearing on whether the market continues to rise or goes in reverse.

The Impact of Proposed Tax Reforms

The dollar has followed the fortunes of the market’s view on President Donald Trump’s proposed tax reforms.

From the time he won the election through to the end of last year — when tax reform was much in the news and markets first considered the benefits of tax cuts and repatriation of foreign-held profits — the dollar strengthened some 5%.

Since then, it has depreciated steadily, hitting a 33-month low last week, according to another Financial Times article.

Much of that decline has been due to the market’s perception that growth is slowing in the U.S., while at the same time the prospects of tax reforms have dwindled in the face of a divided Congress.

At the same time, growth and confidence have picked up in Europe. The Euro, the world’s second-most highly weighted currency, has done correspondingly better.

Growth in Asia has also remained more robust than observers may have expected 12 months ago. At the same time, the market’s expectation of a December Fed rate rise has fallen to less than 30% probability with next June the more likely date. Meanwhile, in Europe the talk is more about rolling back quantitative easing.

The dollar’s performance could be transformed if Congress could agree on tax reforms. Even if many economists disagree on the actual benefits of the income tax reforms, most agree the repatriation of foreign profits holiday would have a profound impact on the economy and the dollar.

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At present, agreement on anything seems a long way from probable.

What Went Wrong at Kobe?

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Few topics, apart from metal prices of course, prompt more debate in the office of MetalMiner than supply chain issues.

So it should come as no surprise that hot on the heels of our article reporting last week’s news regarding Kobe Steel’s admission of falsifying quality data should be a more in depth analysis of what exactly went wrong — and, maybe more importantly, why it went wrong.

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The “what” is still difficult to pin down.

On the one hand, many sources, even highly respected sources like The Economist, say products were certified as having properties – such as a level of tensile strength – that they did not in fact possess.

Yet this does not square with the response of many of Kobe’s customers.

Aerospace firms like Boeing and Mitsubishi Heavy Industries who used affected products on the recent H-2A satellite launch vehicle, and automotive clients like Toyota, Honda, Nissan, Ford and GM, have variously said their preliminary findings are no material exhibiting properties outside of the standards has been used.

If that is the case (and it is still early days), what we could have is a case of incorrect procedures being employed, such as Nissan’s recall of 1.2 million cars after finding unqualified inspectors had been conducting safety checks.

Bloomberg explored the ongoing threat of substitution of steel with aluminum in automotive applications and the transport industry’s relentless pursuit of lower weight – and hence thinner materials – as somehow a reason for Kobe Steel falsifying data. But there is no evidence the quality issue has anything to do with weight reduction, or specifically new, thinner grades of steel.

The Money Argument

One angle in trying to understand why it happened is to follow the money.

There could be an argument that quality control can be the first casualty of a firm struggling for profitability. Kobe has not fared well in the face of a highly competitive international steel market, particularly in Asia.

As this chart courtesy of Morningstar shows, the share price has been in decline since the start of the decade.

Source: Morningstar

Without focusing on the 30% decline in the last week, the firm has been making rising losses in 2015 and 2016, although part of this has been down to provisions against bad debts according to the latest company accounts.

Could cost-cutting have been to blame? Possibly. Bloomberg quotes a spokesman for the company who said pressure to meet delivery deadlines was one reason behind the failure. But as the firm has said the falsification involves only 4% of its shipments, between September 2016 and August 2017.

The fact that there have been no specific reports of defective parts and no carmakers have yet to issue recalls or warnings to stay off the road could be just a case of luck that defective parts have gone to less critical applications or it could be that end users have run their own assessment and concluded chemical and mechanical properties met minimum standards. The period quoted does correspond to the loss-making period at Kobe, but does not square with admissions made by the firm.

A Reuters report article stated “Kobe had fabricated data to show its products met customer specifications” when in fact the material did not. It also quoted the company in saying “The misconduct involved dozens of staff and possibly stretched back 10 years.” That would not have passed multiple audits and inspections, not just by ISO but even more rigorous audits by automotive and aerospace end users. These statements, though, are general admissions and do not specifically state what was hidden or changed.

A Culture Issue?

Back to The Economist, who quote Toshiaki Oguchi of Governance for Owners Japan, a corporate-governance lobby group, who said “Japanese workers are ethical, but tend to hide wrongdoing rather than confront management. Kobe Steel ignored at least one whistle-blower who sounded the alarm over its substandard metal.” Maybe what we have here is a cultural issue, a minor non-conformance was covered up or divergence from the standard procedure was allowed to happen, no one was reprimanded, it happened again and over time so that gradually circumventing proceedures became common practice.

A report in the Japan Times just prior to the weekend supports this position, cataloguing both corporate wrongdoing and quality issues. For example, in 2006, Kobe was involved in a data fabrication scandal after an internal investigation found that data on soot and smoke released by one of its plants had been falsified frequently over a period of 30 years. In 2008, Kobe Steel subsidiary Nippon Koshuha Steel Co. was found to have cheated on steel inspection data. In 2016, shoddy legal compliance led to another quality-control issue at subsidiary Shinko Wire Stainless Co.

Both affiliates were listed among the data falsifiers in this year’s scandal.

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The Japan Times went on to say production units skipped inspections and engaged in unspecified data fabrication because they were under pressure to meet delivery dates and win more orders, leading to compromises on quality.

So much for kaizen and Japan’s much-lauded pioneering adoption of Deming’s principals of quality improvements.

This situation illustrates the clash of two cultures, the open culture of continual improvement which demands a no-blame admission of every failing in the interest of rectifying and improving, coming up against a corporate culture in which executives could not admit failure to meet internal deadlines.

In this clash, quality lost.

Who would have thought it — a major Japanese corporation caught falsifying inspection and quality data?

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gui yong nian/Adobe Stock

Japanese standards have come to be accepted as a byword for quality in the manufacturing industry — but it would seem in a world where even Germany’s premier automotive giants can cheat and deliberately mislead customers, so can the Japanese.

Who can you trust, consumers down the supply chain must be asking, if even Japanese and German manufacturers are prepared to lie and falsify quality assurance data?

The latest scandal to rock Japan’s manufacturing sector is an admission by the country’s third-largest steel producer, Kobe Steel, that for potentially up to 10 years they have been falsifying quality data.

As these goods have gone into aerospace, construction, automotive and transport applications, the only saving grace seems to be that checks so far suggest the material supplied has met the standards expected.

But as the investigation is in its early stages, there is plenty of scope for worse scenarios to unfold.

Some 20,000 tons of metals delivered to about 200 customers are said to have been affected this year, with not just steel but also aluminum and copper goods involved. The Financial Times reported products affected included: 19,300 tons of aluminum plate and extrusions; 2,200 tons of copper strip and pipe; and 19,400 cast and forged aluminum parts for customers such as Boeing, Toyota, Honda, Mazda, Mitsubishi Heavy Industries – maker of regional jets and the H-2A satellite launch vehicles.

Boeing issued a statement saying, “Nothing in our review to date leads us to conclude that this issue presents a safety concern, and we will continue to work diligently with our suppliers to complete our investigation.” That, however, hasn’t saved the share price from taking a pummeling.

Kobe shares are down over 40% this week. The cost of protecting the company’s bonds has quadrupled over the same period.

Source Financial Times

The company is desperately trying to get a handle on how widely and for how long the falsification of paperwork has been going on, and whether it also extends to Kobelco, the group’s maker of construction equipment.

Unfortunately for Japan Inc, Kobe is not alone in its misdemeanors.

Two weeks ago, carmaker Nissan recalled nearly 1.2 milliom vehicles that had been certified by unauthorized technicians. Last year, Mitsubishi Motors admitted to having overstated mileage figures for eight vehicles in its range.

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Is it too much to expect major corporations to tell the truth? They certainly trade on their brand image as reliable and high-quality manufacturers.

Such failures make something of a mockery of Western firms’ often disparaging comments about the quality of emerging-market competitors when their own systems and procedures appear little better.

You could argue OPEC, and those non-OPEC producers collaborating with the oil cartel to limit output, have done rather well this year.

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The oil price, as measured by the most traded Brent Crude number, has been relatively stable since the agreement to limit output was implemented last year and excess inventory has been falling, aided by continued robust demand.

Bloomberg reports the comments of OPEC Secretary General Mohammad Barkindo: “There is a growing consensus that … a rebalancing process is under way. We are gradually but steadily achieving our common and noble objectives.”

We would take issue with the claim the objectives are noble.

Stitching up the market to support higher prices is hardly a noble endeavor, exploiting as it does the leverage of the few (producers) over the many (consumers).

But evidence suggests he is right in that the market is more balanced now than a year ago.

The question is: where is it going from March of next year, when the current agreement to restrict output expires?

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There are reasons why miners — indeed, all producers across industries — seek to dominate market share.

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The biggest reason? Being able to influence the market.

Yes, economies of scale come with size and in the case of mines to metal integrated trader Glencore that dominance in the zinc market gives them influence over not just mine output but concentrates, tolling and refining in a way that is not rivaled by any other firm.

Nor is the firm too kind to do things by halves — when they decide on an acquisition, on a market move, on a position, they do it decisively and with conviction.

In October 2015, Glencore sent shock waves through the market by cutting a third of its output, some half a million tons, to address what was widely seen as an oversupplied market and to stabilize prices. It worked — in just two years, the price has risen from $2,000/ton at the start of 2015 to $3,300/ton today.

LME zinc price, from October 2015 to October 2017. Source: LME

A Financial Times article states Glencore’s Australian Mount Isa and McArthur River operations took the brunt of the 2015 supply cuts, with output reduced by 380,000 tons. In total, the Glencore shutdowns removed 3.5% of global mine production, as the miner curtailed output from mines in Australia, Peru and Kazakhstan. In the meantime, end-of-life closures at Century in Australia and Lisheen in Ireland helped tighten the market.

Arguably Glenore’s action, while painful for zinc consumers, have in the long run done the zinc market a favor.

The rise in prices has supported the case for investment in new mines, such as Gamsberg and Duglad, due to come online towards the end of the decade. But even miners recognize you can have too much of a good thing, and limiting further price rises would not only help consumers but would help mitigate the demand destruction that comes from prices rising too fast and too far.

With that in mind, will Glencore look to bring back some, or all, of its idled capacity in 2018?

The firm continues to bet big on zinc, announcing last week its plans to increase its stake in Peru’s Volcan Cia Minera SAA, Bloomberg reports. With new mines due to come on stream in 2019 and 2020, supply constraints to the zinc market will eventually ease somewhat. Doubts remain, however, whether they will be enough to see the market in surplus.

Deshnee Naidoo, chief executive officer of Vedanta’s zinc unit, said a more sustainable zinc price would be $2,500-2,800 per metric ton. Others may argue with her, but Glencore has shown it can move markets and has the means — like Saudi Arabia did in the 1990s and 2000s with oil — be the swing producer, stabilizing a market for the benefit of both producers and consumers.

Traders often get a bad press for short-termism and the blind pursuit of profit, but Glencore has shown it acts in the longer term, too, and is capable of taking a strategic view of the market, of taking short-term losses in the pursuit of longer-term gains. The firm is uniquely positioned in the zinc market to act as a benign stabilizing element, keeping prices at a profitable but not demand-destructive level.

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It is clearly not as simple to regulate mine supply as it was oil supply for Saudi Arabia. You cannot turn off a mine like you can the spigot of a pump.

But with so many diverse zinc resources, Glencore is in a better position that any to smooth out the dips and peaks, for the sake of its shareholders and for the market as a whole.

Sergii Figurnyi/Adobe Stock

We feel like we have been here many times before.

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The troubled history of Britain’s replacement nuclear power station Hinckley Point C (HPC) will have received scant, if any, coverage in the U.S.

But the story is an illustration of the blind alley in which nuclear power finds itself. The debate is one that is being (or will be) enacted in many other countries that rely on nuclear power as part of their energy mix.

Eight years behind schedule, HPC should have come on stream by the end of this year, but is not now likely before 2025 at the earliest (and probably later even than that distant date).

In the meantime, repeated delays have added to the costs.

A Rising Price Tag

Now estimated at £19.6 billion ($26 billion), it would be one of the most expensive structures ever built in the U.K. Last year, the British government pushed the financial risk onto French power generator and owner-to-be of the plant EDF Energy as part of a deal that has already settled on an eyewatering £92.50/MWhr fee for power produced, index linked for 35 years, the Financial Times reported.

Since that part of the agreement was made in 2013, inflation has pushed that figure to over £100/MWhr, the Financial Times reported, compared to offshore wind at £60/MWhr and unsubsidized new natural gas generation at even less.

Never mind the rights and wrongs on how an inept series of U.K. government politicians and civil servants got lobbied into agreeing to such a position. The fact remains no one, probably not even EDF themselves — and certainly not their shareholders — really wants the project to go ahead.

Fortunately, alternatives are emerging.

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Iakov Kalinin/Adobe Stock

As a microcosm of how power generation is evolving around the world, the U.K. is not exactly a perfect example.

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But many of the trends being played out there are, to a greater or lesser extent, mirrored in other countries.

Striving for Coal-Free

The U.K. government has undertaken to be coal-free for electricity power generation by 2025, which is some pledge for a country sitting on coal reserves said to be sufficient for 300 years of demand (albeit much of it is at depth and not as economically attractive as it may sound).

In 2012, the U.K. produced 40% of its power from coal, much the same as in the U.S. at the time. Unlike the U.S., where coal now makes up a declining but still substantial 30% or so, in the second quarter of this year coal usage in the U.K. fell to 2.1%.

In fact, on April 21 – a particularly windy day – the U.K. was coal-free for 24 hours for the first time since the onset of the Industrial Revolution.

The major beneficiaries will come as no surprise for anyone familiar with British weather.

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A Reuters report last week suggests relief is in sight for Western manufacturers of aluminum semi-finished products under pressure from growing Chinese exports.

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Headlining how China’s semi-finished aluminum exports fell for a third straight month in August, the article cites punitive duties imposed by the United States and India on Chinese aluminum foil as a reason for the decline. Semi-finished exports stood at 360,000 metric tons last month, Reuters reported, quoting revised customs data. That figure is down 3.2% on the same month a year ago and down 7.7% from 390,000 tons in July.

Although the monthly export figure is the lowest since February 2017, the first eight months of this year still showed a 5.2% increase versus the same period in 2016. Further data seemed to conflict with the argument that the foil duties were the cause of the decline in recent months. January to August foil exports were up 10.1% at just under 800,000 tons. Although they have dropped in recent months – down 4.9% year-over-year and down 6% from July, those drops only account for 5-6,000 tons per month of lost semis exports. The vast majority, 30,000 tons per month of reduced exports, are coming from extrusions.

Quoting Paul Adkins of AZ China, the report identified a substantial 29% slump in exports of extruded aluminum bars, rods and profiles as the main cause for the overall falls in semis exports despite an increase in flat rolled numbers. The main culprit appears to be U.S. tariff action against extrusions and helps explain why Chinese extrusion mills have been so aggressive in Europe in recent weeks, dropping conversion premiums for extrusions (possibly in an attempt to make up for lost sales to the U.S.).

With Chinese extrusion mills on less than 30-day delivery schedules they are clearly not overly busy. This suggests that although domestic demand has been steady, it has not been as strong an influence on primary metal prices as investor appetite for bidding up the futures markets would suggest. That has more to do with environmentally motivated capacity curtailments creating a narrative of shortages — resulting in speculators building strong net long positions and substantial primary metal prices rises — than it does any genuine tightness in supply.

An Aluminium Insider article discussing the findings of a report called the China Beige Book by a private, China-based analyst raises questions about the sustainability of recent rapid price rises and if they are based purely on the premise of reduced supply.

The study states that, despite numbers released by Beijing, overall capacity in the aluminum market has experienced a net rise over the last six consecutive quarters. At the same time, the economy is experiencing a slow-down. “Sector-wide growth took a dive across the board—revenue, profits, output, export orders, volumes, hiring, capex, borrowing, wages, and sales prices,” explained the report, suggesting perceptions of tight supply are misplaced and speculator-driven.

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If that is the case, European extruders may not be alone in facing increased competition this winter from China’s semi-finished product mills, as they seek to secure markets for a wide range of semi-finished products propelled by a cooling domestic market.

Steel prices in China have been rising, but iron ore prices have been falling — what’s going on there?

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China is shutting domestic iron ore mines at an accelerating rate, forcing steel companies to import iron ore from overseas, which would normally be supportive for the iron ore price.

The answer it would seem, as is so often the case, has more to do with speculators’ view of future fundamentals than actual current fundamentals.

Strong Chinese Demand for Steel

Steel prices in China are strong because steel demand remains robust, despite exports being crimped by protectionist measures in North America, Europe, India and elsewhere. Domestic demand is holding up well.

Meanwhile, supply-side action by Beijing is cutting swathes of steelmaking capacity. Initially, much of the cuts came to “illegal” production, such as EDF scrap based long products mills — which has happened largely under the radar — but also older, less efficient and more polluting steel plants. All of this follows Beijing’s pledge to cut 50 million tons this year as part of an environmental drive to reduce air pollution by November (the start of the winter heating season).

Source Financial Times

After strong price rises this year, investors have done well and are now taking their profits ahead of a perceived fall in demand, as steel curtailments really begin to bite later in the year. It would be a brave speculator who bet against the wave of negative sentiment toward the iron ore price, including even the Australian government, which has been warning of price falls.

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