Commentary

China’s campaign to cut environmentally polluting steel, aluminum, power generating and similar industries, like cement plants, is understandably catching the headlines.

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For producing industries like steel and aluminum, the cutbacks have supported prices. The expectation is the closures made this year will accelerate during the November to March heating period, when there will be forced closures of plants, even some that have passed the environmental tests.

All this has supported the expectation that there will be supply shortages in the face of an economy that continues to grow strongly and where recent PMI data supports current growth levels persisting at least through to the end of the year.

Yet while the headline announcements are all about capacity cuts, a recent Reuters article illustrates they are only part of the story.

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Indians’ love of gold is a story with which many around the globe are familiar.

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Just how deep is this love? A recent research report by one of India’s well-known equities firms said India had consumed — hold your breath — around $300 billion worth of gold in just the last decade.

The analysis by Kotak Institutional Equities said gold prices had gone up by 300% between FY 2008 and FY 2017. But the love story has not been the same in the last five financial years (FY 2013-17), when only half the gold consumption of the past decade was recorded, not to mention virtually flat gold prices.

It’s no wonder that under the new Goods and Services Tax (GST) implemented as of July 1, gold, according to some, has been given special treatment. The tax has been kept at 3%, nowhere near the 18% suggested by some experts.

GST is a uniform tax across India, doing away with almost all other forms of taxes for businesses. So high is this precious metal on an average Indian’s shopping list that even the 3% tax, up from the current 1.2%, has raised the hackles of buyers. Some have even suggested that the “high” GST (in reality, just 1.8% more) would once again lead to the smuggling of gold into the country.

A report by news agency Reuters, for example, quoted named and unnamed gold traders and buyers as saying smaller gold shops could be more inclined to sell without receipts, potentially hitting sales.

Indians have been familiar with the “black” gold economy.

Except for certain periods, gold smuggling has always been a part and parcel of India. In 2013, for example, when the government raised import duties on the metal to 10%, smuggling went up. The World Gold Council (WGC) estimated that smuggling networks had imported up to 120 tons of gold into India last year.

The Kotak Institutional Equities report opined that it was “unhappy” with the special treatment given to gold vis-à-vis GST. India’s policy on inflation management achieved remarkable success, which should reduce gold’s function as a “store of value,” the report said.

Gold Demand on the Rise?

A WGC report in June highlighted the potential impact of the GST on India’s gold demand. It said the new tax could have a negative impact in the short term as the industry went through a period of adjustment, but the net impact in the long term was likely to be positive. The WGC expected India’s demand for gold to be 650–750 tons in 2017 and predicted it will rise to 850–950 tons by 2020.

According to another article in the Mint newspaper, analysis of household survey data seemed to suggest that one reason why regional governments in India may have lobbied for a low tax rate on gold was because gold purchases were not exclusive to the rich.

Even though the rich tend to buy more of it, possession of gold was a universal phenomenon across income classes, according to the Household Survey on India’s Citizen Environment & Consumer Economy (ICE 360° survey) conducted by the independent not-for-profit organization, People Research on India’s Consumer Economy, which was partly financed by the WGC.

The report found that one in every two households in India had purchased gold in the last five years. The survey also revealed of 61,000 households polled in 2016, 87% of households owned some amount of gold in the country.

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While we read presidential tweets, or worse, listen to megalomaniacs gloat about successful missile launches, a quiet shift has been going on in the financial markets.

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Political risks as a driver of exchange rates have either faded into the background or have already been fully priced into non-dollar currencies. Meanwhile, the driver in currency markets has shifted back to central bank actions and the macroeconomic factors that drive them.

You only have to see the sharp reaction in Europe to recent comments made by Mario Draghi, president of the European Central Bank, concerning “reflationary pressures” at work, causing an immediate 2% spike in the Euro, to see the market’s focus is firmly back on inflation-related indicators, with wage growth in the different currency areas taking on a particularly critical role.

The Associated Press reported last month that inflation across the 19-country Eurozone held up better than anticipated in the face of waning energy prices — a sign that the region’s economic recovery is reverberating across the single-currency bloc.

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In a recent interview, Rusal Deputy CEO Oleg Mukhamedshin reaffirmed his company’s commitment to the Paris climate-change accord and indicated that it will continue investing in the research and development of lightweight aluminum alloys, both to distance itself from the commodity end of the market and to provide improved materials for lightweighting.

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The interview with the South China Morning Post was reported by Aluminium Insider largely within the context of Rusal and Russia’s continued commitment to tackling climate change following President Donald Trump’s rejection of the process.

To what extent one takes any Russian company’s commitment to climate change is a debatable and personal point, but in one area Rusal’s stated commitment to meet 100% of its power needs from renewable power sources by 2020 has a much stronger economic argument than the simple angle of climate change.

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Reports of platinum’s demise have been much exaggerated — or so this month’s report from the World Platinum Investment Council (WPIC) would argue.

Sales of diesel vehicles in some parts of Europe have taken a beating in recent months over concerns that authorities will raise costs or otherwise make living with diesel engines a less attractive proposition for owners, due to negative sentiment post-Dieselgate. Total car sales have dropped in some European markets, including the U.K.. However, where sales have held up there’s been a definite swing to gasoline vehicles rather than diesel.

The markets have read this trend as meaning platinum demand will fall — but maybe not surprisingly, the WPIC is taking a more optimistic view.

Regardless of buyers’ short-term preferences, the WPIC says the auto industry has an overarching challenge in the years ahead that will support platinum demand. Automakers will face fines if they do not meet new EU CO2 targets by 2020, but the report lists the industry’s rather limited options.

First, the industry could boost sales of battery electric vehicles (BEV). However, with a consensus expectation of BEVs taking no more than 5% of the market by 2025 due to lack of charging infrastructure, it seems unlikely BEVs are the short-term solution.

Source: World Platinum Investment Council

Second, the industry could sell a higher percentage of hybrids. Recent trends, however, suggest demand for hybrids, despite Volkswagen’s Dieselgate, is still growing too slowly. Demand is certainly not growing fast enough to reach those emissions targets, which are just 2 ½ years away.

So, the third option — and to be fair to the WPIC, probably the most likely option — is for automakers to clean up diesel. The technology already exists to meet the most stringent nitrogen oxide (NOx) targets set for 2022, but the industry needs to do more than it has done in the past to prove to the buying public the performance figures they publish can be achieved in the real world.

The WPIC points to French automaker PSA, which has undertaken to publish independently certified, real-world CO2 test results for its vehicles. PSA also recently announced it will do the same for NOx results.

It is only by automakers voluntarily — or maybe by legislation — being forced to accept third-party verification of their emission figures that they will be able to rebuild consumer trust and deflect harsher government legislation on diesel engines in the future.

Not surprisingly, the attraction of the WPIC is significantly cleaner diesel engines will require increased platinum-group metal (PGM) loadings, even as the industry shifts from the current lean NOFX trap (LNT) system to the more effective selective catalytic reduction (SCR) technology. According to ExtremeTech, when announcing Ford’s switch to SCR, it reported that SCR is more costly, but it’s also generally considered more effective than LNT.

Of course, the platinum price has more drivers than just the demand for the catalysts in the automotive market. Investor demand in the form of ETFs, physical demands in the form of jewelry, and chemical and catalyst demand from the chemicals industry are all significant drivers on the demand side.

But much of recent negative sentiment toward platinum has been due to controversy over the diesel engine’s ability to meet emission targets.

And in that sense, platinum’s fortunes will in part ride on the coattails of the auto industry’s ability to re-establish the diesel engine as an environmentally acceptable propulsion unit.

Whatever the topics that are down on their respective agendas, it seems unlikely Prime Minister Narendra Modi will enjoy the same cordial relationship that he had with previous President Barack Obama.

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President Donald Trump has shown scant interest in international leaders unless he sees a clear short-term advantage. So, whereas Saudi Arabia and Israel received the famous presidential charm, fellow NAFTA members Canada and Mexico have been more the brunt of threats and Europe has largely been treated with disdain.

India has barely featured on Trump’s radar since coming to power, beyond garnering criticism for receiving foreign aid and allegations of stealing American jobs.

So it is to be expected there will be some prickly discussion around the new president’s plans to curtail the number of H1B visas, a move the Washington Post observes would harm big Indian outsourcing companies, such as Infosys and Wipro, and deprive Silicon Valley of much-needed imported talent.

The Trump administration is also likely to raise concerns about the U.S. trade deficit with India, following a blossoming of trade during the Obama years that has resulted in India enjoying a $30 billion trade surplus with the U.S.

But one particularly thorny subject that could make its way onto the agenda is a long-running trade dispute in which India took the U.S. to the World Trade Organization (WTO) after Washington failed to comply with the WTO settlement body’s ruling over countervailing duties imposed on Indian steel imports. The ruling back in December 2014 concerning duties on hot-rolled carbon steel flat products was deemed to be in breach of WTO rules under the agreement on subsidies and countervailing measures agreement.

The U.S. has largely ignored the ruling, so the two leaders’ meeting would be a good opportunity to kickstart a review. However, so tenuous is the relationship that it will be interesting to see whether mention of steel disputes or tariff barriers make their way into media statements or the closing statements of either party.

Under Obama, India and the U.S. moved closer together and the two countries, not least as the two largest democracies in the world, have always championed their common qualities over their differences — but Trump’s view of the world is significantly different from that of the Obama administration. Beyond tackling North Korean nuclear ambitions, Washington doesn’t seem to have a Southeast Asian policy any more.

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The leaders held a friendly joint press conference in the Rose Garden on Monday, during which Trump called himself a “true friend” to India and touted the two nations’ “shared commitment to democracy.” He also added that the bond between the two countries “has never been stronger.”

He also made remarks in reference to the U.S.’s trade deficit with India.

“I look forward to working with you Mr. Prime Minister to create jobs in our countries, to grow our economies, to create a trading relationship that is fair and reciprocal,” Trump said Monday. “It is important that barriers be removed to the export of U.S. goods into your markets and that we reduce our trade deficit with your country.”

However, quite where India fits in the new administration’s view of the world is unclear. Hopefully the leaders meeting this week will bring a little more clarity in the future.

There seems little doubt and even less debate that the tragic fire at Grenfell Tower in London was, if not caused by, then certainly greatly exacerbated by the aluminum cladding on the outside of the building.

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The original fire was started by an exploding refrigerator on the fourth floor of the 24-story public housing block. The residents thought they had the fire under control, but the refrigerator was positioned against an external wall. Flames then escaped out of the window and ignited flammable insulation between the building’s external aluminum cladding and the original external wall.

Source: The New York Times

As the diagram shows, taken from an excellent evaluation of the tragedy in The New York Times, the highly combustible insulating polyethylene panels positioned between the old wall and the external cladding acted like a chimney, funneling heat and flames vertically.

Within a few minutes, what had started as a minor fire engulfed the whole building and incinerated the floors above.

Although the total number of dead may never be known — some of the occupants were illegal immigrants and, as such, unregistered — and is potentially even unknown to anyone outside of the flat they were occupying, it is believed about 79 people died.

Hard questions are rightly being asked: Why was cladding installed that included insulation that was known to be flammable?

What isn’t being as widely debated in the U.K. yet is the contents of that New York Times article highlighting that the use of such flammable materials is forbidden in the U.S. and many European countries — yet, for reasons that are not entirely clear, those materials are permitted in the U.K.

Lax Regulations Played a Role in Tragedy

The cladding itself does not appear to be the sole culprit.

Grenfell Tower was clad, according to The New York Times, with an aluminum product known as Reynobond PE, consisting of two sheets of aluminum sandwiching an insulating core. Reynobond PE is made by Arconic (formerly known as Alcoa). Arconic has been selling Reynobond PE in the U.K. for years, but takes a different marketing approach in the U.S. and much of Europe.

In the U.S., fire regulations insist that polyethylene sandwich Reynobond should not be used in buildings taller than about 33 feet, that being the height firefighters’ ladders can readily reach. The firm’s literature clearly states that non-flammable or fire-resistant insulating materials should be used on buildings over this height.

Yet despite repeated warnings over the years, British building regulations, rather than tightening up in this area, seem to have been relaxed.

In the case of Grenfell Tower, the installation material used between the wall and the external cladding was also made of a very similar, highly combustible plastic to that used in the panel sandwich core. When the fire from the exploding refrigerator escaped out of the window, it was able to readily access this exposed installation, allowing an inferno to rapidly establish itself between the cladding and wall, and rising up 25 stories, gutting everything above the fourth floor. In the process, the cladding also caught fire, showering burning debris on firefighters and those seeking to escape the building below.

The aluminum itself is unlikely to have reached a temperature at which it would have caught alight, but with the melting point of about 660 degrees Celsius and fire authority estimates of temperatures exceeding 1,000 degrees Celsius in the upper parts of the tower, the aluminum panels will have readily melted in the heat. Aluminum does not burn until nearly 7,000 degrees Fahrenheit, or nearly 4,000 degrees Celsius, but with the panel surfaces melting it provided no protection to prevent the flammable sandwich core from igniting along with the insulation installed in the space between the panel and the wall.

Whether aluminum cladding can survive from this disaster in the U.K. as an architectural product specified on new and existing buildings remains to be seen. Even if totally fire-resistant insulation were specified, it would be a brave architect that clad a new residential building with aluminum panels in the future.

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The tragedy is that the 79 deaths and the huge cost of upgrading some 600-plus similar high-rise buildings in the U.K. could have been avoided if the British fire regulations had drawn on experience bitterly learned from earlier fires in the U.S., Europe and elsewhere.

The facade of the Federal Reserve Bank. Aaron Kohr/Adobe Stock

Economists rarely agree on much, but the current debate on whether to raise the U.S. Federal Reserve’s base rate and to reverse quantitative easing is generating more disagreement than normal.

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One of our favourite economic journals, the Economist, argues in an article last week that the Fed’s narrow focus on a 2% inflation rate is proving detrimental to encouraging productivity growth in the U.S. economy.

Citing numerous sources of research, the paper suggests a more relaxed, less rigid limit would allow the Fed to take its fixation off the current low level of unemployment and refrain from holding back future growth as a result of further rises in the base rate.

The headline unemployment rate of 4.3% is the lowest in 16 years, and stands at levels that in previous recoveries would already be fueling wage rises and inflation. Yet despite unprecedented levels of quantitative easing and only just off record low interest rates, inflation has remained benign (to the consternation of economists far and wide).

Having increased rates three times in the last six months, the Fed is not only intending a further rise this year, Chairman Janet Yellen indicated in a report last week that the Fed intends to begin shrinking the balance sheet caused by quantitative easing by the end of this year at the latest and possibly as soon as September.

Initially, the plan is to start asset sales at a modest $10 billion dollars a month, increasing in steps each quarter until it reaches $50 billion a month, according to a report in the Telegraph.

The combination of increasing base rates and the withdrawal of dollar liquidity through bond selling would have a profound impact global impact.

The announcement elicited a response from Ben Bernanke, Yellen’s predecessor as chairman of the Fed. He urged the Fed to allow the economy to grow gradually into the 4.4 trillion Bond portfolio and not to take the risk of reversing quantitative easing too soon. The worry is that is the pincer movement of firmer rates and withdrawal of liquidity would prompt a stall in the global recovery, potentially pushing the U.S. back into recession.

The Fed has very little room at current interest rate levels to cut rates in the event of another recession. Last time it had 4.75% plus QE — at this point it has just 1% and a full QE balance sheet. How would it cope?

Professor Tim Congdon, founder of the Institute of International monetary research, is quoted in the Telegraph as saying if the Fed really goes ahead with reversing QE there will be trouble three to six months later, and the economy could tank in 2018.

That may be a worst-case scenario, but it does illustrate the polarization of views and underlines the fact we are in uncharted territory. No central bank has ever created such a huge balance sheet as the Fed following the last financial crisis and, honestly, they have very little idea of what impact unwinding it will have.

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The law of unforeseen or unintended consequences looms large and suggests a little more flexibility around inflation may be a price worth paying to allow time to more gradually return the finances to “normal.”

In the week when the world pensively awaits the U.S.’s Section 232 judgement — a move promised by President Donald Trump during his election campaign and aimed largely at China — a recent Reuters report on Chinese steel exports makes interesting reading.

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Source: Reuters

China’s steel exports have been sliding for months.

According to Reuters, China’s January-May export total was 34.2 million tons, down 26% from last year’s equivalent period and the lowest level since 2014. The year drop in export tonnage amounted to 12.1 million tons — roughly equivalent to Canada’s production over a full 12-month period, Reuters reported.

Yet bizarrely enough, China produced 72.78 million tons of steel in April, an all-time record Reuters says. The following month, China tallied the second-highest monthly total at 72.26 million tons.

Meanwhile, profits on products like steel rebar have surged to $162 dollars per ton this month, as inventory levels have fallen and demand has remained robust (particularly from the construction sector). Investment in real estate is running at an annual growth rate over 6%, Reuters reports. Although there are fears of overheating in some regions, real estate has been stronger for longer than analysts outside the market expected.

As we noted in a piece yesterday reviewing the 232 probe, China’s share of the U.S. import market for steel products has been falling for the last couple of years, mainly due to successful anti-dumping cases. China no longer appears even in the top 10.

So, what exactly is going on in China with respect to steel production and demand? Can we take it that Beijing’s actions to tackle excess steel production have finally resolved China’s deflationary impact on global steel markets?

First, Reuters notes that China has been quite successful in permanently closing previously shuttered steel plants, as well as in in tackling older and more environmentally damaging mills. Those actions combined has resulted in the removal of some 100 million tons of capacity.

In addition, Beijing’s focus on environmental issues has hastened the closure of induction furnaces, which use scrap rather than iron ore as their input and are often labelled as producers of sub-standard products (and, hence, unapproved). Unapproved equates to illegal by Beijing — as such, their production and their closures does not figure in the normal statistics. A significant proportion of China’s rebar production came from these mills, which explains the record profits being earned by surviving state-owned manufacturers of the same products as they capitalize on the removal of these scrappy competitors.

Unfortunately, nobody expects China’s construction market to continue at the current pace and a slowdown is in the forecast for the second half of the year.  Replenishment of low inventory levels will maintain steel mill production runs for a while, but as Reuters notes, China’s mills have a notoriously poor record in adjusting output to demand. So, we should expect that as demand eases, inventorying levels will rise, prices will fall, and access production may well begin to leak through exports onto the international market.

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While America’s anti-dumping legislation will largely protect that market from Chinese material, the rest of the world may find itself under pressure next year from greater availability of Chinese steel at falling prices, further fueling an already rising tide of protectionist sentiment in both developed and emerging markets.

So far, June is busting out all over, but not in the way metals producers would like.

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Market observers may actually observe a possible change in trend (note: the current bull market, which began in May 2016, appears to have run out of steam).

First, the Fed hiked interest rates by 0.25% last Thursday. Though expected, it will most likely not impact markets in an abrupt way.

Let’s take a look at some of the key indicators:

Dollar Up

Source: TradingEconomics.com

The most recent Fed rate hike breathed a little life into the dollar, which has fallen for most of this year.

We believe this could have a direct impact on the metals industry — namely, causing prices to fall.

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