Three-month London Metal Exchange aluminum since 2012. Graph: MetalMiner.
We recently wrote that aluminum would need to fall further in order to cause additional non-Chinese closures to balance the market. Chinese aluminum exports surged 35% year-on-year in the first half of the year, adding to global excess supply of the metal.
Three-month aluminum on the London Metal Exchange closed on Friday below $1,650/metric ton, hitting a six-year low.
Three-month LME copper since 2012. Graph: MetalMiner.
Copper prices keep doing the same thing over and over: lower peaks, lower troughs. Copper’s fundamentals are nothing but bearish, due to excess supply from mines and weak Chinese demand for the metal. We recently highlighted some Chinese numbers showing poor demand from key sectors.
Commodities have been in a falling market since 2011, but, so far, this year has been more of a flat market for commodities. We expect to see some movement soon. The rising US dollar has been a key factor in driving commodities down and although the dollar is still strong, it has been taking a break for the past seven months from its meteoric rise while posting a flatter trajectory. A more stable dollar this year clearly helped commodities to stay flatter as we can see in the next graph.
Dollar index (green) vs CRB Commodity Index (blue), one year out. Graph: MetalMiner.
Both, the dollar index (in green) and commodity Index (in blue) are within their one-year range. For the last couple of months, however, commodities are starting to fall again, approaching record lows while the dollar is rising again.
We recently talked about a similar flat behavior in the stock market and how technology indexes could be leading stocks’ recent gains. Back to commodities, it seems like base metals are the ones taking the lead, and they are pointing down.
Industrial Metals ETF one year out. Graph: MetalMiner.
The recent Chinese market sell-off might explain the bad performance of base metals compared to other commodities, as they are more sensitive to buying activity on the ground level.
What This Means For Metal Buyers
The first half of 2015 has been relatively stable for commodities. However, as we see base metals recently sinking, we can expect to see more volatility across the board.
The Economist modestly puts parentheses around the word correct in an article this week introducing a beefed up version (unlike the article we will leave the Burger puns there) of the old index which seeks to create more finely nuanced price comparisons, taking into account the relationship between GDP of the country as a totem for local wages and the price of a Big Mac.
PPP vs. Wage Disparity
As the Economist says, the old model is based on the theory of purchasing-power parity (PPP), the notion that, in the long run, exchange rates should move towards the rate that would equalize the prices of an identical basket of goods and services (in this case, a burger) in any two countries. So the index should highlight which currencies are over or undervalued, and hence which direction we can expect them to go over time.
The new index tries to account for the entirely reasonable argument that we would expect a product, in this case a Big Mac, to be cheaper in poorer countries because wages will be lower. The Economist uses the relationship between prices and GDP per person to create a set of adjusted results and, of course, the data is displayed in a series of graphs based on any one of five currencies – the US dollar, Euro, Japanese yen, GBP sterling and Chinese yuan, allowing the user to see to what extent the index believes the local currency is over or undervalued to these five.
What’s Going on in Venezuela?
Pity those at the bottom of the scale; Venezuela, Ukraine, India, Russia, Malaysia, South Africa and Egypt. If the index is right, their currencies have a huge potential on the upside. Of course, it isn’t quite that simple or every currency speculator in the world would be using the index to trade on sure fire medium-term bets.
Many of those at the bottom of the chart have profound economic problems impacting their exchange rates, countries like mismanaged Venezuela, Ukraine and South Africa or sanctioned Russia, but, all the same, the charts make interesting reading, and in an area of study – economics – that some would argue is at best a pseudo science, who’s to say the Big Mac index is any worse than any other measure?
A quiet revolution is going on in the US power generation market, and it may be giving a lesson for those countries dithering over whether to allow hydraulic fracturing (fracking) of oil and natural gas deposits identified but not yet proven.
According to the FT, April was the first month in US history that gas-fired electricity generation surpassed coal-fired generation, (although it came close in 2012 when gas prices were also very weak). By comparison, in 2010 coal provided 45% of US power. In April of this year 31% of US electricity was generated by natural gas compared to 30% for coal, and the trend continues.
In gigawatt terms, wind power is growing even faster than natural gas, flattening the latter in the league tables. US coal capacity dropped by about 3.3 GW during 2014, and the US Energy Information Association predicts it will shrink by a further 12.9 GW this year, while wind power capacity rose by 9.8 GW and gas by 4.3 GW.
Source: Financial Times
The reasons are more complex than simply low natural gas prices, although that, undoubtedly, is a major factor. The Environmental Protection Agency’s failed attempt to force environmental compliance by the back door this year encouraged some coal-fired utilities to see the writing on the wall and either mothball plants or invest in new technology to accommodate the mercury emission and other pollution targets, raising costs.
With the exception of the very specialized grain-oriented electrical steel (GOES) market and the Renewables MMI®, all of our indexes lost ground in June and could not gain traction amid falling commodity prices and a strong US dollar.
The one index that was steady from last month, which tracks raw material inputs of the renewable energy sector, has been stagnant for two years and, until trends show otherwise, its steadiness is more a measure of a lack of market activity than anything close to a turnaround or a new trend toward increasing prices.
The Stainless MMI is flirting with two-year lows and our Raw Steels index is up against lows not seen in years as well. Weakness in the Chinese stock market has put additional pressure on metals that were already reeling from the effect of the strong dollar. This is bad news for steelmakers, miners, refiners and smelters by itself, but coupled with increased supply in most of the metals we track, it’s become a real deterrent to profitability.
Moreover, both Europe and the US have higher-than-normal inventories of semi-finished products at service centers. Mill lead times remain short suggesting weak demand. Weak demand will continue to place downward pressure on prices.
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Weakness in emerging markets continued to spread out and Chinese stock shares plunged in June.
FXI China ishares since 2014. Graph: MetalMiner.
China’s stock market rallied in the first quarter. Then, Beijing suspended initial public offerings to tighten the supply of available stocks while the Chinese central bank helped to promote brokerages’ margin finance operations, allowing investors to borrow cash to buy stocks. Those actions helped boost stock shares in the short-term, but they have proven not to be sustainable in the long-term. Read more
For almost 3 months now, oil prices have moved in a very narrow range. However, this month prices fell 15% in a matter of days, breaking that range and stressing the bearish sentiment among commodity investors. Some analysts point out that the decline was caused by a jump in rigs drilling for oil in the US.
CME Group Oil price, one-year out. Graph: MetalMiner.
The increase in rig count came as a surprise as it was the first gain since December.
However the increase was very small and we doubt this caused prices to decline that sharply.
Why The Plunge?
Another factor to watch is the historic Iranian nuclear agreement with the US and five other world powers. This deal might have risen the bearish sentiment as Iranian oil output is expected to increase. Oil from Iran will take time to return, and will not have a market impact before next year, but given that the global petroleum market has an oversupply of about 2.5 million barrels per day, the mere prospect of new oil doesn’t help market sentiment.
We believe, whatsoever, that the main driver of the sharp decline has been China’s stock market tumble. Base metal prices were the most impacted but commodities fell across the board and not even oil showed any resilience to the effect of China’s sell-off.
What This Means For Metal Buyers
The fact the oil prices broke below their recent price range is just another reason to expect further weakness in commodity markets, which will likely put a lid on industrial metal prices this Fall.
On Wednesday, Greece formally asked for a three-year bailout. The European Union’s leaders have given a Sunday deadline on whether formal negotiations on this bailout program make sense or not.
So, How Will a Resolution Impact Metal Prices?
First, let’s start with: Greece is not China. Greece is not a major producer or consumer of metals. Therefore, its economic situation doesn’t have that big of an impact in the supply and demand balance of any base metal.
Some argue that a Greek exit could worsen the European economy. That, in theory, could deteriorate global demand for metals, driving metal prices down. Nonetheless, others (including me) think that a Greek exit would be beneficial for both Greece and Europe.
Austerity measures have already proven to be painful for the country over the past few years, leading to its economy slowing further, making its deficit even worse. A Grexit, however, would leave Greece with the ability to print money, which would increase inflation but allow Greece to meet its national obligations in a potentially more viable way than raising taxes and reducing pensions.
Officially, the country is on track for 7% growth this year, stellar by most other countries’ standards, but in China’s case they have millions to lift out of comparative poverty and the lower the GDP growth, the less wealth generation there will be to achieve that aim. China’s per capita GDP is still a fraction of the US’ despite being the second-largest economy in the world.
NBS: Growth Exaggerated?
Recent data from China’s National Bureau of Statistics (NBS), though, suggests growth may, in reality, be even slower than headline figures suggest, according to the FT this week.
Reviewing the first quarter numbers in more detail, the FT suggests the 7% growth figures the NBS is quoting are hiding a marked slowdown in investment and consumption. GDP growth is measured by three components the paper says – consumption, investment and net exports.
Net exports add to national expansion to the extent that the country exports more than it imports, but the contribution has traditionally been a very small part of China’s GDP number in spite of the country running a massive export-orientated economy for the last decade or more. Investment and consumption make up the majority of China’s GDP, for the whole of 2014 net exports contributed just 0.1% of the 7.4% growth reported for the year, already China’s slowest annual rate of expansion in a quarter-century.
Exports Up, Growth Actually Down
In the first quarter of this year, however, net exports contributed 1.3% of the headline 7% growth, while consumption and investment accounted for 4.5% and 1.2%, respectively. Without the boost from net exports, therefore, first-quarter growth would have been much lower — at about 5.7%.
Nor is the growth in net exports due to a strong export performance, it is due to a fall in import costs as commodity prices have slumped. First-quarter exports were up only 4.9% on the same period last year, but the collapse in global commodity prices meant that the value of China’s imports over the first three months of the year fell 17%, resulting in a large surplus. Unless commodity prices continue to fall in the second half of the year that contribution may disappear toward year end.
Source: The Financial Times
Beijing is aware of this. Interest rates have been cut four times since November in an effort to boost consumption and investment, but the collapse of an overheated stock-market is not helping the situation.
How to Fix Debt-Created Growth?
The Shanghai and Shenzhen stock exchanges, which have lost about 30% of their value since hitting seven-year highs last month, are looking increasingly vulnerable to further falls, adding to worries that Q2 growth may be even lower.