If given the option, we prefer the glass half full than the glass half empty, so an article in the London Telegraph and many other newspapers this week reporting RBS Bank’s latest client note makes depressing reading, but unfortunately worthy of discussion.
The note advises clients to “Sell everything except high-quality bonds. This is about return of capital, not return on capital. In a crowded hall, exit doors are small,” RBS has advised clients to brace for a “cataclysmic year” and a global deflationary crisis, warning that major stock markets could fall by a fifth and oil may plummet to $16 a barrel.
It All Must Go!
Nor is RBS playing a new tune, since November they have been warning the oil price and stock markets are headed lower, sure enough the oil price has continued to fall, dropping to a 12-year low of $30.41 for Brent and $30.43 for West Texas Intermediate this week.
Source: Telegraph Newspaper
The markets are clearly spooked and by a number of factors. China’s stock market is being kept alive only on the oxygen of government support via state enterprises buying shares. Oil consumption has stalled due to slow growth and warm weather, and oil supply continues to grow as Iran gears up to enter the market.
Metro International Trade Services — the dominant London Metal Exchange warehouse operator in Detroit but also with depots across the US, Italy, South Korea and Malaysia — was ever the stand out contrarian operator.
Indeed, it was the fabulous profits the firm was generating that encouraged Goldman Sachs to buy the company in 2010, and it was the prospect of lower profits and regulatory oversight that probably prompted them to sell in 2014 to Swiss-based but British-owned investment house Reuben Brothers.
Metro and Pacorini’s Load-Out Game
It’s probably not unfair to say Metro, along with Glencore’s Paccorini, were the black sheep of the warehousing family in the years following the financial crisis, as they engineered massive load out queues, lasting up to two years, in order to generate vast rent profits from metal stuck waiting in the queue to be loaded out.
Aluminum ingots, possibly waiting at a Metro International warehouse for load out.
Consumers and processors put up with that for a while, but under threat of legal action the LME moved to tackle the problem in recent years and a number of rule changes have effectively forced warehouse firms to limit intake when queues are over a certain length. Increase load out rates and changes this year will force firms to reduce rent on metal in the load out queues.
Open and Transparent Warehousing
As a result, the warehouse business has been forced to operate on a more fair and open basis, charging rents on a competitive basis against other LME warehouses without the benefit of being able to offer massive incentives, in the form of secret discounts or up-front payments, to encourage firms to store metal in their sheds. Read more
As our editor said last week, the road to hell is paved with good intentions, an apt phrase for the events unfolding in China this week.
Regulators were obliged last year to relax tight controls over the currency in order to qualify for Reserve Currency status from the International Monetary Fund for the yuan/renminbi but had probably not foreseen the consequences. Indeed, many are still not seeing the collapse of share prices on the Shanghai Stock Exchange this week as a currency-related issue.
If You’re an Investor, It’s Your Money Getting Purposely Devalued
Anyone holding shares or a pension will be painfully aware that some $2.5 trillion has been wiped off the value of global equities this week, in just four days, events starting in China have rippled around the world causing one of the worst starts to the year for stock markets since the 1980’s.
On the Shanghai market, trading was stopped on Monday as “circuit breakers” closed the market after shares plunged 5% and, again, Thursday trading was canceled for the day after just 29 minutes when the CSI300 fell more than 7%.
Under the “circuit breaker” system, created after the plunge in shares last August, if an index rose or fell 5%, trading was halted for 15 minutes. If it dropped by 7%, trading stopped for the rest of the day.
So what prompted the sell-off? Many have been saying the Shanghai market is a bubble waiting to burst for quite some time, but is it a sudden epiphany among investors that prices are overvalued? No. Actually, it has little to do with share prices and a lot more to do with currency and ill-judged rules imposed by Beijing to try to control the market, Beijing’s actions often have unforeseen consequences in such situations.
What is the Real Value of a Controlled Currency?
First, the currency: as we mentioned above Beijing allowed the yuan to respond more readily to market forces. We won’t say float, but the trading bands were widened and the currency has fallen for much of 2015 against the rising dollar. This got investors worried, even if the Shanghai market was not shaky, a falling currency makes shares less valuable over time.
Further, holders of yuan,companies and investors made up of China’s rising middle and wealthier classes, see the cost of foreign investments such as houses, land, companies, rising almost daily in yuan terms.
Valuation of the yuan moved to a basket of currencies last year rather than a loose peg against the dollar with the promise by Beijing that it would remain more stable against the China Foreign Exchange Trade System basket. That was December, since then the currency has slid for three straight weeks and the central bank has burned through $140 billion trying to defend it.
Falling Production Data Adds to the Misery
Combine that with a fall in China’s Purchasing Managers’ Index composite for both manufacturing and services to below 50 and frightened investors took flight, dumping shares in a repeat of what we saw last August after Beijing’s snap devaluation of the yuan as this graph from the New York Times illustrates.
Source: The New York Times
In an attempt to calm the panic selling, Beijing has actually made matters worse. The end of a share sale ban, that was imposed last year wherein investors were prohibited from selling for a lock-in period, was extended. Believing they were going to continue to be locked in to shares that were falling in value and, naturally, becoming spooked by company insiders selling shares, investors rushed for the exits. Beijing then had to move fast to extend the ban into 2016, which has helped calm markets temporarily but done nothing the address the underlying causes.
2015 was certainly a year of commodity price volatility. We don’t need to post graphs or quote numbers to illustrate the extent of the fall in prices from steel and iron ore. Through base metals to energy we, and just about everyone else, have written extensively about the fall in prices in recent months.
But 2016 is unlikely to see falls of the same order as last year. Indeed, there has been something of a dead cat bounce in prices late last month. For a number of reasons aluminum, iron ore and oil prices have all seen an uptick although few are predicting this is the start of a rally. Most would hold it is simply a reaction to wider geopolitical developments and will, in time, be seen as volatility around a continued downward trend line.
2016, However, is seeing the first major divergence in interest and, hence, exchange rates since the financial crisis. The Federal Reserve‘s tepid rate increase last month has not, as often happened pre 2008, been mirrored by moves in Europe, Japan or the emerging economies.
Indeed, expansionary monetary policy is the order of the day in Europe and Japan where Quantitative Easing (QE) is likely to continue in 2016 and interest rates will remain near zero. A recent Economist article noted the gap between American and German bond yields that reflects this divergence in future interest rate expectations.
Late last year, five-year Treasury bonds yielded 1.785%; German bonds with the same maturity had a negative yield of 0.14%. That is the biggest gap since the creation of the euro. The same article went on to suggest currency risk could become a big source of turbulence in financial markets this year.
The volatility of the dollar versus the euro and yen, as measured by contracts traded on the Chicago Board Options Exchange, stayed below 10% for much of 2013 and 2014; in 2015 it rose to 10-15% and Bank of America-Merrill Lynch think that bullishness about the dollar is the most crowded trade in the markets at the moment.
Yet, that bullishness could be overdone. The dollar had a strong run in 2015, the strongest pace since the early ’80s, at that, and much of the positive bets are being made on the basis that the Fed will continue to tighten. It could be argued that much of that expectation has already been priced into the rise of the dollar against global currencies.
The Dollar’s Rise
What if it is overdone? A further rapid rise in the dollar could affect the US economy. Sure, it would reduce import prices, and hence inflation, but it would also cut export competitiveness and impact GDP. Stagnant GDP growth and weak inflation would, as we have seen not just in the US but in the UK and Europe, further delay interest rate increases by the Fed. The pretext for a stronger dollar would then evaporate and the “one way bet” could reverse sharply.
With the rest of the world expecting near-zero domestic interest rates, the probability of loose monetary policy, possibly further QE and the trend toward allowing previously fixed-dollar-peg currencies to devalue the divergence between the US and the rest of the world, will likely widen. Under those circumstances, a continued strengthening of the US dollar could negate pressure on the Fed to raise rates as far or as fast in 2016 as current expectations.
Investor sentiment (call it herd instinct) is a big one, but so are market fundamentals, particularly supply and demand trends. A third is macroeconomic and political developments which we have had more than our fair share over the last few years. We can guarantee that you will see current trends develop further and new ones unfold in the year ahead.
The Saudi-Iranian Political Conflict
Witness Saudi Arabia’s execution of umpteen “terrorists” (fast becoming a modern day euphemism for any undesirable) this week, including — crucially — a leading Shiite cleric Sheikh Nimr al-Nimr, causing outrage in neighboring Iran and igniting riots across the region from Turkey to India. The tension this caused the price of oil to spike 2% on Monday, although the long-term impact is likely to be limited, relations between Iran and Saudi Arabia couldn’t have been much worse before the incident and so haven’t much further to fall, short of outright war.
Crude Oil Hits lowest level since 2009. Source: @StockCharts.com.
The point I am making is macroeconomic and macro-political developments impact the base metals and energy markets in ways distinct from supply and demand fundamentals. So what can we expect for 2016? First, it is election year. November will see a new President and while we all have our personal hopes and dreams, as an outsider I can say dispassionately I suspect it will probably be Hilary Clinton and a Democratic Senate. Politically, though, it will be a bumpy year in the US with much of the media and popular focus turned inwards rather than to global developments.
Major Changes Coming in Japan
On the other side of the world, Prime Minister Shinzo Abe’s three arrows have failed to lift the Japanese economy and the country fell back into recession late last year. However, while we have heard plenty of rhetoric over the last three years there does seem to be the suggestion that structural change is finally on the way and he may finally be getting serious about stimulating corporate Japan into investing at home and freeing up labor markets. 2016 could be the year Japan Inc. finally picks up.
One reason why inflation is so persistently low, globally, is falling commodity prices, not least of which is oil and it’s linked sister, natural gas. Benchmark oil and natural gas prices have collapsed last year, down a third and by two thirds since the fall started in 2014. Oversupply is unlikely to go away this year unless Saudi Arabia has a major change of heart, or collapse of confidence, as supply is set to increase with the arrival of Iranian oil. Demand continues to slow. It should be said, however, that oil consumption is not falling in top consumer China, it is still growing at some 2.5% in spite of recent attempts by Beijing to slow growth by suspending gasoline subsidies.
Low Gas Prices, Strong Demand
Reuters wrote recently that global gasoline demand has been strong, thanks to rising car sales. China’s November car sales jumped 20% from a year earlier the paper said last month, putting the world’s biggest automobile market on track for annual sales growth of 5-7%. Almost 25 million new cars are said to have hit China’s roads in 2015, and by 2020 most analysts expect annual sales of 50 million.
On the supply side, shale producers in the US, whose demise admittedly has been greatly anticipated but not seen to any significant degree, can’t — at $40 per barrel — hold out much longer and 2016 will see a drop in production. Open interest on the futures markets suggests most investors are anticipating prices of between $50 and 80/barrel later this year with some analysts talking of over $100. We can’t see that in the current circumstances but we do see more upside than down by H2 2016.
What This Means for Metal Buyers
Prices for industrial metals have plummeted this year. Copper and zinc are down a quarter and nickel 40%. A rising US dollar will keep pressure on base metals as will continuing weak manufacturing data coming out of China. The groundwork is being laid for higher metals prices later in the decade as investment is being slashed and both mining and refining capacity mothballed, but most would expect these medium term trends to remain muted in 2016 and it could be 2017 to 2018 before they force a tightening of the supply market.
There appears to be no probability of a return to the dynamics that drove the super cycle of the last decade. Prices will rise due to tightening supply, not rising demand, and with global growth muted that’s unlikely to be during this year.
Indeed, one development that could postpone a rise is further devaluation of the renminbi. The Bank of China is likely to be reducing push through further interest rate cuts this year as the economy slows, while the Federal Reserve will be tightening. Much as Beijing would like a stable link the reality is further weakening towards 7Rmb to the dollar is likely during 2016 making Chinese base metal exporters more competitive on the world market and encouraging greater exports.
It will be interesting to see the extent to which Beijing balances it’s twin priorities of environmental progress – reducing pollution by shutting unnecessary production capacity and removing incentives for cars – with it’s priority to maintain growth and employment. Last year saw considerably progress on environmental issues, this year that trend may slow if growth becomes more of an issue.
At the same time, the Japanese have started settling first quarter 2016 physical delivery premiums at $110 per mt, 22% higher than the previous quarter, the first time they have risen in a year.
What is behind the increase in the aluminum prices? Adobe Stock/uwimages.
Meanwhile, probably not unconnected, Japanese port stocks have fallen at the country’s three major ports. Stockpiles fell in November by 7.5% to 401,000 mt according to Reuters. Over the in US, the Midwest transaction price, which includes the LME price and premium that buyers pay to take delivery of the metal, has risen steadily this month to $1,736 per metric ton by December 24, up from $1,599/mt on 28 October, which was its lowest point since May 2009. Read more
We sometimes indulge our more geeky side and cover topics that, while metals related, are never going to significantly move the needle on metals consumption, pricing or supply and demand. We reserve the right to be geeky.
While a recent development recently discussed by Mark Shackleton, Professor of Finance and Associate Dean Postgraduate Studies at Lancaster University definitely falls under the “geeky” heading, it could, one day, potentially move the needle for tin demand if the economics permit.
Carbon Capture and Carbon Taxes
One of the biggest dynamics in the next 10 years will be how legislators approach carbon emissions. If they seek to control emissions by putting a significant price on carbon, it will have profound implications for the metals industry, along with just about every energy-consuming activity out there.
Following the financial crisis of 2008/9 there was widespread fear that countries, feeling they were under siege in a post-apocalyptic world, would be fighting for market share and using protectionism to put up the barriers.
In reality, although there was a rise of protectionist action it was muted, particularly considering the dire position in which some countries found themselves. Perversely, it seems that low prices and a slow down in China has done what the financial crisis didn’t. Protectionist action is on the rise and even as economies slowly recover next year expect anti-dumping action across the world to get worse not better.
Protectionism Foils Rusal
Steel and aluminum have hit the headlines most this year, not surprisingly as the volumes are greatest for these major commodities and, arguably, China’s excess capacity is worst in these two metals than any other. But it is not just China that has been the subject of anti-dumping action. Brazil gratefully received news the EU was not persevering with a 17.6% levy on aluminum but UC Rusal is incensed that the European Commission turned a provisional 12.2% duty introduced in July on aluminum foil from Russia into a definitive five-year levy. That duty targets Rusal, the only Russian producer of the aluminum foil covered by the trade protection, according to Bloomberg.
Still it could have been worse, back in July there were reports the EU would impose a 34% duty on Russian foil, as Rusal is the only producer, any duty increase hits the company hard. The foil currently sold by Rusal to Europe is produced by its business units Ural Foil and Sayan Foil but there were suggestions the firm would try to get around the duty by supplying foil from it’s Armenian subsidiary.
We wrote recently about the rapid inroads (if you will excuse the pun) aluminum has made into the automotive market, particularly for body parts that have been almost the sole domain of steel since before the Model T.
Then we wrote more recently on the fight back being made by steel, spearheaded by the major steelmakers such as ArcelorMittal to develop high-strength alloy steels that can be used in ever thinner gauges without sacrificing rigidity or strength, and the use of hot stamping that reduces spring back and die wear.
Well now it is with some trepidation that we report both aluminum and steel are facing a new kid on the block, the new contender is not even a metal, it’s carbon fiber.
BMW is investing heavily in carbon fiber production research. Source: Adobe Stock/ GordonGrand.
Ahh, but you will say carbon fiber has been around for at least a couple of decades. Goodness, aren’t half the world’s largest airliners made out of the stuff? And isn’t it dreadfully expensive and time consuming to make anything out of it? Read more
It hardly qualifies as unintended consequences, at least as meant by Locke or Adams, but the outcome of Saudi Arabia’s recent actions in trying to squeeze out higher-cost oil producers has almost certainly gone further than the oil-producing nation had anticipated.
It has gone much further than just about any analyst or oil industry expert was predicting 12-to-18 months ago.
Indeed, since summer the price of oil has continued its downward trend, exhibited for much of last year. If some Organization of Petroleum Exporting Countries (OPEC) members were hoping the recent summit in Vienna would stabilize prices or, better still, support a price recovery, they have been sadly disappointed. Read more