Author Archives: Stuart Burns

Once masters of the universe, or at least the commodities universe, major traders like Noble Group and Glencore PLC are now suffering from the fall in commodity prices. In theory, a trader could make money in a rising or falling market protecting their position in a bear market by hedging their exposure, but in practice some elements of the price can be hedged and some cannot.

Free Sample Report: Our Monthly Metal Buying Outlook

According to the Financial Times, Noble Group’s profits before interest and tax in its metals and mining segment fell 98% in the first half of the year; particularly hurt, the newspaper says, by the collapse in physical delivery premiums causing massive write downs on aluminum positions. In the US, the Midwest Premium is down 67% this year, an unhedgeable exposure position takers in the industry have had to take on the chin.

Premiums Fall, So Do Profits

In Europe, the premiums are trading near levels last seen in 2010, barely above $100 per metric ton. While in Japan, premiums for third-quarter shipments were agreed at around $100 per mt, compared with $425 in the first three months of the year.

The FT quotes a trader saying, “It’s a pretty nasty drop. What happens is, all the big boys have gotten crushed. They’re sitting on stock which then becomes worth a lot less, so you’ve got to mark it down.”

Why the delivery premiums fell so far and so fast is eloquently summed up in an article by Reuters’ Andy Home some weeks ago. The collapse has all the hallmarks of a collapsing bubble and, like most bubbles, wasn’t sparked by one event but several impacting in parallel.

First, the LME aluminum warehouse rule changes, first muted and then finally implemented, initiated behavior changes by the warehouse operators, reducing load-out queues and slowing new deliveries. At the same time, the stock and finance trade moved increasingly to off-LME market storage reducing pressure on premiums by reducing demand for LME warehouse space.

Global Aluminum Premiums

Global aluminum premiums July 2013 to last May. Source: ThomsonReuters

Meanwhile, that once lucrative stock and finance trade – the cause directly or indirectly of the load-out queues and high premiums – has become less attractive. As recently as 2013, the LME curve structure could generate a gross rate of return of up to 12% for holding aluminum for 15 months, according to Home. Read more

As if we needed any reminder of how close the link is between energy and aluminum smelting a Financial Times report this week reveals details of how Beijing has engineered the transfer of assets between a cash strapped power generation group, the State Power Investment Group (SPIC ), and a loss-making alumina and aluminum smelting group Aluminum Corp. of China (Chinalco).

Free Sample Report: Our Monthly Metal Buying Outlook

In the process, Chinalco will become the world’s biggest aluminum company by production leap-frogging from third place over the US’ Alcoa, Inc., and Russia’s UC Rusal to take the number one spot. According to the FT, Chinalco will add 2.7 million metric tons of annual smelting capacity to its present 3.8 million metric tons when it inherits SPIC’s smelters, easily pushing it ahead of Rusal and Alcoa. Read more

The China Non-Ferrous Association announced this week that leading Chinese aluminum smelters intend to axe 2.4 million metric tons of capacity in the next couple of months.

Free Sample Report: Our New Monthly Outlook

Nearly all the world’s net gain in production capacity has come from China this year and, while estimates vary, a portion of the industry, even in China, is certainly losing money at current prices.

That is the case in the rest of the world, too, with UC Rusal and Alcoa, Inc. both contemplating further closures. Inside China, the growth of new smelter capacity has been in the northwest, often based on captive, low-cost coal deposits for power generation and utilizing the latest smelter technology that, combined with large economies of scale, has made these Chinese smelters some of the lowest cost of production in the world.

aluminumingots_500

The aluminum surplus, and a weak economy at home, have finally forced Chinese smelters to cut production.

Read more

Stock markets around the world have rebounded after Monday’s dramatic falls, even so pension and investments funds have been severely depleted even after the bounce back.

Free Sample Report: Our Monthly Metal Price Outlook

In China, though, where it all started, the market has continued to fall, down another 7.6%. When the Shanghai Market last “corrected,” Beijing stepped in with a $400 billion fund to buy stocks, ordered state-owned companies to buy shares, banned large shareholders from selling and even launched a criminal investigations into short sellers in a desperate effort to prop up the market.

Chinese Stocks Still Falling

Clearly, although that bought a temporary calm it has not lasted and the market went into free fall again this week. Tellingly, Beijing has not stepped in this time, acknowledging that even China does not have the funds to turn global equity markets. Li Jiange, vice chairman of state-owned investment company Central Huijin is quoted by the Washington Post as saying “The trade volume of the market can reach 2 trillion yuan ($300 billion) a day, which means if it collapsed no one could save it,” adding “The issues of the market should be handled by the market itself.”

US dollar vs. RMB

Beijing’s way out involves producing in yuan and selling in dollars.

This time, the Peoples Bank of China have simply cut interest rates, for the fifth time in nine months, by a quarter percent to 4.6%. It also cut its one year deposit rate to 1.75% in a vain attempt to bolster the economy, and reduced banks reserve requirements in another attempt to get them to lend more. Read more

Well for one thing it means our retirement funds will likely be worth less, at least in the short to medium term. On the plus side, our mortgage will likely stay cheaper for longer and metal prices will remain lower for longer.

Free Sample Report: Our Monthly Metal Price Outlook

Why? well if the Fed was worrying about a China slowdown in July, they must be in full-on panic mode by now. If the Federal Reserve was to raise rates next month, to stave off the possibility of inflation picking up next year, it would strengthen the dollar, making imports more attractive and making life tougher for US exporters.

China’s Deep Slowdown

The collapse of stock markets around the world has been precipitated by fears of a China slowdown becoming far deeper and more prolonged than previously thought – although why this appears to be such a surprise to investors today compared to 2-3 weeks or even 2-3 months ago I fail to see, the writing has been on the wall all year.

Traders in London

The signs that China’s economy could lose steam were there, but it still caused global stock market panic.

However, as the herd mentality sets in all those stop orders get hit and the fancy algorithms cut in selling stocks and becoming self-fulfilling as they drive prices down. Hedge funds have been aggressively shorting the market, not just for stocks but for commodities too. It would be a brave man who bet any pause was the start of a bounce back, markets could have a lot further to fall.

Back to the Fed and China: weaker demand from China will mean lower demand for commodities. For a few commodities, China has become a net exporter but across the board the world’s largest consumer is reversing what was once a one-way bet on demand. Read more

The answer as you can imagine is not a simple one, it will impact prices in a number of ways and different commodities will be impacted in different ways.

Free Sample Report: Our New Monthly Outlook

So far, it has been seen as a bearish development mostly for macro reasons – that Beijing felt the need to allow the currency, the yuan/renminbi, to fall to bolster export industries, particularly manufacturing. It is certainly true that real GDP growth is slowing and is probably already under 7%.

aluminumingots_500

Oversupply of aluminum could get worse with a devalued renminbi.

Worse, most of the sub-indexes in China’s General Manufacturing Purchasing Managers’ Index have weakened this month, with output, new orders, new export orders and employment all deteriorating. Up to now, the employment prospects for China’s 10 million new entrants each year had held up well, but some indicators show the job market is weakening according to the Financial Times. Read more

Following our recent article on the seaborne iron ore market, some may assume the landlocked domestic contract supply market for iron ore and pellets is immune from the volatility found in Asia.

Free Sample Report: Our Monthly Metal Price Outlook

To some extent that’s true, there isn’t a spot or futures market in the same way as we see in Asia, but the market is far from immune to global prices and prices have fallen in North America as they have elsewhere.

That makes Essar Steel’s decision to proceed with the massive $1.9 billion development of North America’s richest iron ore deposit across 150 kilometers of Minnesota’s Mesabi Iron Range particularly brave in today’s market.

Source FT

Source: Financial Times

Essar Steel is said by the Financial Times to be ramping up construction on a $1.9 billion mining and processing facility, with a planned completion in the second quarter of 2016. It will be one of the largest construction projects in North America by capital expenditure according to the paper and Essar hopes to produce 7 million metric tons annually of high-grade iron ore pellets for 70-80 years from the resource. Read more

Just when iron ore miners thought sentiment couldn’t get much worse, Goldman Sachs Group comes out with a report predicting iron ore prices will tumble by 30% over the next 18 months according to a Bloomberg article this week.

Free Sample Report: Our Monthly Metal Price Outlook

The bank is saying the rebound seen over the last five weeks is merely a blip and that normal business will shortly resume.

Source: FT

Source: Financial Times

Supply growth is set to continue, the report states, but, and this is crucial, China has reached peak steel and from now on steel production will only contract in China.

More Inventory Than Necessary

As shipments pick up from Australia, Brazil and India, the seaborne market will become awash with inventory and prices will be further driven down. Iron ore is seen by Goldman as averaging $49 a ton this quarter, and $48 in the final three months of 2015. Before falling further next year to $46 in the first quarter and $44 the following quarter. With little or no market discipline, the bank suggests 2016 will see average prices around $44 per ton. In the words of the report’s authors “the summer of 2015 is the calm before the storm.”

Free Download: Latest Metal Price Trends in the August MMI Report

Steel consumers can, therefore, expect mills’ raw material prices to continue to weaken as seaborne prices gradually knock on to contract prices elsewhere. With demand lackluster and too much finished steel chasing too few orders, even as markets like North America and Europe show encouraging signs of GDP growth, steel prices will have little to support them this year and next. Good news for consumers, tough times for producers working with low-capacity utilization and stronger domestic currencies sucking in imports.

 

The US is taking its first tentative steps toward exporting oil.

Free Sample Report: Our Monthly Metal Price Outlook

No, Congress has not approved large-scale oil exports, it is not about to repeal the 1975 export ban brought in after the early ’70s OPEC inspired oil crisis. Congress is split with republicans broadly supporting a lifting of the ban but democrats against it, keen to limit further fracking on environmental grounds, according to the Financial Times. The Obama administration has, instead, given the okay to limited exports to Mexico.

Why No Blanket Repeal of the Oil Export Ban?

More to the point, neither party wants to be accused down the line, as oil prices inevitably recover, of being responsible for reduced domestic supply as the cause of higher prices. Most economists, though, suggest increased exports would lower global prices and, as a result, would mean lower domestic prices, but of course no one knows until a large-scale lifting of the ban is agreed to.

Meanwhile,the US can legally export to Canada, the only country to whom export rules do not apply. The US already shares hockey, Seth Rogen and country/western music with Canada, after all, so why not oil?

The US exported a record 586,000 barrels of crude a day in April to Canada according to Bloomberg. This was light grades needed by Canadian refineries to blend with high-viscosity heavy tar sands or for locations where US supplies are closer to a Canadian refinery than Canada’s own reserves. Read more

Contrary to so many other elements of the trade relationship between China and the rest of the world, supply chain experts had come to expect a relatively benign relationship between the yuan renminbi and the US dollar. Over the past decade, China’s central bank has either permitted the renminbi to creep slowly upward against the US dollar – at a pace considered glacial by the standards of foreign exchange markets, the FT reports in a recent article – or held it steady in times of stress, such as the global financial crisis of 2008-09.

Free Download: Latest Metal Price Trends in the August MMI Report

But this week’s flash devaluation, by as much in one week as the currencies have moved in the last year, has sent shock waves through the markets and upset the long-held and, in hindsight, somewhat complacent view that, at least in terms of that currency pairing, the renminbi was destined to rise with the dollar.

Economic Aftershocks

In many ways, the shock is greatest for China’s Asian competitors who had planned on a continued appreciation and are now faced with the possibility of a more competitive China on their doorstep.

You would expect China’s exporters to be delighted with the move but a combination of gradually appreciating currency since the dollar peg was removed in 2005 and rising inflation, particularly wage inflation, has resulted in many Chinese manufacturers finding themselves at a considerable disadvantage to competitors in Bangladesh, Vietnam, and other low-wage countries even after this modest devaluation.

Such manufacturers of low-value products, such as textiles, were looking for a renminbi devaluation in excess of 10% against the US dollar, and who is to say that that may not come about? Beijing is clearly rattled by the slide in the economy’s GDP, by some measures the real growth rate is well below the headline 7% and still falling so we should not rule out the possibility of further falls in the exchange rate.

Borrowing Boondoggle

However, Beijing will have one eye also on debt financing. To the extent that exports may be boosted by a lower exchange rate, debt financing costs are increased. Not just China but many developing countries that have borrowed heavily on the external finance markets have been fearing the impending rise in the Federal Reserve prime rate and the accompanying rise in the US dollar that will, it is widely expected, accompany the Fed’s move.

As the US dollar has risen this year against global currencies, companies and states have found their external finance costs increse. China is far from alone in this respect and is much better prepared, with huge US dollar foreign reserves, to weather such a rise, but other developing market economies are not so fortunate as this graph from the Financial Times based in BIS data illustrates the extraordinary rise in debt levels

Source: FT

Source: Financial Times

The FT uses a couple of examples to illustrate the problem at company level. Read more