Non-ferrous Metals

Our Copper MMI jumped 5% to 62 points. Copper prices finally made some gains in March, rising to the highest level in four months. So what’s causing copper prices to rise? and, is this finally a legit rally?

Fundamentals Improving?

Trade data showed some glimmers of optimism for copper producers as China’s February copper imports surged 50% year-over-year. Many people see the rise in imports as a sign of demand picking up. However, while imports rose, Shanghai Futures Exchange inventory levels hit new records. This seems to suggest that Chinese copper imports are rising but they aren’t backed by end-user demand.

Copper_Chart_April-2016_FNL

There are also opinions that copper is rising on expectations of a future supply deficit. Some people believe that the market will get into deficit in 2017 as no new mines came onstream due to low prices.

Compare Prices With The March 2016 MMI Report

However, those are just long-term expectations and things might end up looking quite different to what people are forecasting now. So far, most would agree that copper-output cuts spurred by lower prices aren’t enough to end a surplus this year.

It’s All About Oil

You can drive yourself crazy finding the reasons that explain the oil rally. Indeed, you can probably find fundamental reasons to be either bullish or bearish on copper. However, in a market driven my macro-factors, it’s quite clear to us that this rally is not reflecting a change in copper’s fundamentals.

Crude oil (in black) versus copper (in blue) 1 year out

Crude oil (in black) versus copper (in blue), one-year out. Source: @StockCharts.com.

In the chart above we can see the huge correlation between copper and oil prices. Rising oil prices are the main explanation for rising copper prices. Investors are keeping a close eye on oil and its price movements have a huge impact on the performance of other commodities, including copper.

Legitimate Rally?

We recently pointed out that oil prices could struggle near $40/barrel and pull back. Over the past few days we just saw that, oil falling back down to the $30s, which also brought copper back below $5,000/mt.

Free Sample Report: Our April Metal Buying Outlook

Copper’s rally is still normal in the context of a bear market. Indeed, exactly one year ago we saw a similar rally in copper prices that soon enough translated into a price slump. The beginning of March was a good opportunity to buy some volume but it’s still not clear if copper will be able to trade well above today’s levels. That will likely depend on the fate of oil prices and investors’ sentiment on commodity markets.

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Our Aluminum MMI rose 2.7% in March, thanks to a jump in Chinese and Korean prices. However, London Metal Exchange prices lagged.

Chinese Production Down; Non-Chinese Production Up

Aluminum in China jumped to its highest price point in about six months. Chinese production seems to have fallen sharply over December and January which would help explain the strength of the local rally in prices.

Aluminum_Chart_April-2016_FNL

Meanwhile, according to the International Aluminium Institute (IAI), non-Chinese global output rose by 3.7% in the first two months of 2016, an acceleration from growth of 2.5% in 2015. That’s a surprising outcome for a market burdened by high stocks and with prices hovering near a six-year low.

Compare Prices With The March 2016 MMI Report

Higher production excluding China has also led to steady aluminum Midwest premiums, which are hovering near $0.09 per pound. Aluminum has also recently moved from backwardation to contango as new supply has come in.

Is China Really Cutting Production?

Chinese figures are always obscure. That makes it really hard to know if China is actually cutting production or not. Some Chinese state-owned aluminum groups like loss-making Chalco are not in a good financial position and it is possible that they will be cutting production, especially in return for government assistance in stockpiling metal. On the other hand, privately owned groups like Hongqiao, Jinjiang and Xinfa are rapidly overtaking western giants such as UC Rusal both technologically, in terms of capacity, but most importantly in terms of production costs. Hongqiao is now the world’s largest aluminum company, a distinction it took from Rusal. These groups might want to increase production to gain market share if unprofitable companies actually cut production.

Aluminum Prices Missing the Broad Metals Rally

Although prices in China rallied, aluminum LME prices finished the month down. While most base metals gained in Q1, aluminum has simply missed the rally.

Free Sample Report: Our April Metal Buying Outlook

Nickel is another metal that finished the quarter down. So far, the poor performance of these two metals gives less credibility to the broad rally in base metals.

Chinese Exports Down

One of the major challenges for the global aluminum industry has been the rise in Chinese aluminum exports but recent trade numbers are encouraging for global aluminum markets. In February, China’s aluminum exports declined more than 33% year-over-year, the lowest in two years.

What This Means For Metal Buyers

The long-term outlook for aluminum is still poor. Aluminum will likely need a bull commodity market to make a substantial rally. Prices in the short-term could rise however, following the recent strength in the base metal sector and the fact that bargain hunters might want to lift prices after the slump seen last year.

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A note issued by Barclays recently told customers that, although investors have been attracted to commodities as one of the best performing assets so far in 2016, returns are unlikely to be sustained in the second quarter of the year.

Free Download: The March 2016 MMI Report

“This could make commodities vulnerable to a wave of investor liquidation that we estimate could, in a worst case scenario, knock as much as 20-25% from current price levels,” the note to investors said.

Copper and Oil Under Pressure

This would take the price of oil back to the low $30s per barrel and copper to the low $4,000s per metric ton, the analysts said. Channeling its inner bear, Barclays said that the recent price appreciation does not seem to be founded in improving fundamentals, and that the key markets already face overhangs of excess production capacity and inventories.

Net flows of investment into commodities totaled more than $20 billion in January and February, the strongest start to a year since 2011.

“The kind of commodity investment that is taking place currently is not the long-term buy-and-hold strategy for portfolio diversification and inflation protection that underpinned the huge inflows of the previous decade,” the Barclays note said. “It is much more short term and opportunistic, as is clear from the relatively short holding period for (exchange traded product) buyers in oil. Many have been liquidating on the recent move up in prices, having held their positions for only 5-6 weeks.”

The UK investment bank goes further to say both copper and Brent crude could fall by as much as a quarter of their current positions if a mass selloff occurs. The following chart illustrates the precarious position that both commodities find themselves due to recent speculation.

FT_Commodities_scorecard_First_quarter-bar_chart_550_032816

UBS Warns of Volatility

This could easily be dismissed as a the overly cautious forecast of a single investment bank, but it’s not just Barclays. UBS is also warning its investors about short-term swings and, in some ways, is going beyond the Barclay brothers’ analysis in telling them that commodities may be more susceptible to chaotic swings than ever before. Read more

Building owners and other construction project stakeholders should anticipate non-residential construction costs to increase 3% to 4% on average this year with most markets reporting robust activity and healthy employment in Q4 2015, according to Mortenson’s Construction Cost Index.

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The Minneapolis-based general contractor releases the index quarterly and it prices representative non-residential construction projects in six representative geographies throughout the U.S.

Mortenson-Graphic-Q4-2015_550_032216

Source: Mortenson Construction.

Mortenson Chief Estimator Dennis McGreal and Director of Design Phase Development Nathan Lingard recommended building owners and other stakeholders expect cost increases of 3.5 to 4% in 2016 for construction components such as structural steel and steel framing.

Still, according to the report, all of the markets studied are considered healthy according to data from the U.S. Bureau of Labor Statistics. The Mortenson Construction Cost Index tracks building component trends in 30 categories with many component prices flat to moderately up in the fourth quarter of 2015.

Employment Situation

“There continues to be a lot of activity in the markets we track although average project size is reduced relative to recent years,” said Clark Taylor, vice president of estimating at Mortenson. “Construction employment is leveling out and price escalation should be more consistent with long-term averages. We believe this should allow customers to more accurately plan for increases in the next year.”

Free Download: The March 2016 MMI Report

The labor shortage was a huge problem in construction in 2015. While the cost increases predicted likely won’t shelve any projects, the bigger news is that Mortenson is reporting construction employment growth has slowed in most of the metros it followed. A respite from the shortage could do wonders for labor costs for construction projects.

Three-month aluminum on the London Metal Exchange gained 0.8% to close at $1,573 a metric ton after touching $1,589 per mt, its highest since Oct. 15, Reuters reported this week.

Free Sample Report: Our March Metal Buying Outlook

The price has been powering upward since late January and the spread between cash and delivery in three months has moved into backwardation indicating a tightening spot market. The premium for LME cash aluminum over the benchmark three-month contract jumped to $18 a ton this week, the strongest since April 2015, indicating tight near-term supply, the news service said.

Surcharge Increases Coming?

At the same time, some big aluminum producers are said to be seeking an increase in physical delivery surcharges of 14-18% for  the upcoming Q2 primary metal shipments to Japanese buyers. Aluminum isn’t alone in showing recent strength, copper has also touched $4,771 per mt, its highest level since November 2015 as reports of reduced supply from Chile, down 13.8% in January, surprised the markets.

On the other side of the fence sit the technical boys such as Reuters’ Wang Tao who produced this graph in the last few days and commented that aluminum’s failure to break the $1,585 resistance level suggested it was heading back down, maybe to $1,527. A reversal that could already be underway over the last few days.

Source Reuters

Source: Reuters

In our view, the physical market remains well supplied, even the nearby tightness is an expression of one or two parties holding the nearby LME warrants and squeezing the market.

Free Download: The February 2016 MMI Report

That same tightness, though, is deterring stock and trade financing, leaving more metal freely available on the physical market. So, we see this price strength as a short-term move and remain bearish on the basis of the underlying fundamentals. Notwithstanding this one dominant warrant holder’s ongoing squeeze into early March, which may drive prices higher in the short term. In the medium term, we are expecting a softening of prices and believe it is much more likely.

Copper also joined the industrial metals’ party in February. Three-month copper on the London Metal Exchange hit a (fittingly) three-month high in the first week of March, finally showing some signs of strength. It was about time, giving a good window of opportunity for buyers to buy some volume.

Compare Prices With The February 2016 MMI Report

Truth be told, there weren’t really any bullish developments within the copper market in February. The price rally looks more like it was caused by a weaker dollar and momentary stabilization in global markets. Indeed, copper was one of the weakest metals in February.

Chinese Imports Down

China’s imports of unwrought copper and copper semi-finished products came in at 440,000 metric tons in January, down 17% from December 2015. Copper imports are still high compared to historical levels but they have come down significantly compared to the strong numbers seen in December.

Copper_Chart_March-2016_FNL

Some people use China’s copper imports as an indicator for copper demand. Therefore, higher imports in Q4 last year could be interpreted as strong Chinese demand for copper. However, lower numbers in January combined by a surge in inventory registered with the Shanghai Futures Exchange (SHFE) make us think that the rise in imports in Q4 looks more like a massive stock-building exercise than actual demand growth.

PMI Problems

In February, China’s official manufacturing purchasing managers’ index fell to 49 which was below market expectations. It also came in below the reading of 49.4 in January. February’s reading is the worst official manufacturing PMI since November 2011. It also marks the seventh consecutive month that the manufacturing PMI stayed below 50 (a PMI reading below 50 shows the shrinking manufacturing activity in China).

Despite bad Chinese economic numbers, copper managed to rise with global markets, as if the bad news is being cheered on in hopes of more stimulus. But previous government’s attempts to boost the economy failed. Certainly, investors’ sentiment on China will need to make this copper rally sustainable in the longer term.

Meanwhile, in the US PMI data rose to 49.5 in February from 48.2 in January and that was higher than expectations. However, it’s still below 50, showing that the sector is shrinking. Although the fact that the index is closer to 50 is somewhat positive.

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Our monthly Aluminum MMI rose to 73 points in March, its highest reading in four months.

Compare Prices With The February 2016 MMI Report

After a period a period of price stability, aluminum prices are finally showing the first signs of strength, thanks in part to a weaker dollar in February. Indeed, in our monthly outlook we already recommended subscribers to buy up in volume.

Aluminum_Chart_March-2016_FNL

So what is suddenly causing this strength in aluminum prices?

First, before we get too bullish, let’s remember that aluminum prices are still near historical lows. This price bounce comes after significant declines in previous months and, not only aluminum, but all base metals have risen in price recently. However, some indicators within the aluminum industry are giving aluminum producers some reasons to become more optimistic.

China’s Exports and Production Down

In January, China exported 380,000 metric tons of aluminum, down 12% from the same month last year. This is good news for international markets but, to be fair, one month doesn’t tell much of a story and certainly the aluminum exports will have to continue to come down if the aluminum market wants to see a deficit this year.

In January, China produced 2.5 million mt of aluminum, down 4.5% from January 2015. This was the second consecutive month where Chinese aluminum production fell on a year-on-year basis. Aluminum producers are getting quite optimistic on the combination of lower Chinese exports and production.

Surplus or Deficit?

Although aluminum has been in a surplus for almost a decade, there is not a divided opinion on whether aluminum will continue to be in surplus this year or not. Alcoa, Inc. seems the most optimistic of all, foreseeing a record aluminum deficit this year with demand outpacing production by 1.2 mmt. Other producers are less optimistic and major brokerage houses such as Goldman Sachs even have a bearish forecast for 2016, predicting a record surplus this year.

What This Means For Metal Buyers

The trend in Chinese aluminum exports and production is a key factor to watch for the next few months. The slowdown in aluminum exports might have been driven by the steep decline in aluminum prices last year. As prices recover from January lows, we could see an uptick in Chinese exports.

Free Sample Report: Our March Metal Buying Outlook

Weakness in the US dollar is another key factor to watch, so is the performance of the rest of the industrial metals. Finally, China’s worsening slowdown has been ignored over the past month, however it could bring the bearish sentiment back. If the Chinese government is unsuccessful in boosting its economy and global economic activity cools off further in the coming months, industrial metals might start to lose the recent upside momentum.

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GE is pursuing oil and gas deals in Iran and Norsk Hydro is cutting its aluminum demand forecast.

Oil and Gas, GE and Iran

General Electric is exploring potential business opportunities in Iran and the chief executive of its oil and gas division visited the country recently, a company spokeswoman recently said.

Free Sample Report: Our February Metal Buying Outlook

The visit by Lorenzo Simonelli, CEO of GE Oil & Gas, comes at a time when Iran is aiming to boost its crude oil exports and recover the oil market share it lost as a result of international sanctions imposed over its nuclear program.

Norsk Hydro Cuts Demand Forecast

Norsk Hydro, one of the world’s largest aluminum producers, cut its 2016 forecast for aluminum global demand, including China, to 3-4% from 4-5% previously, as it reported quarterly earnings that beat forecasts on Wednesday.

Free Download: The February 2016 MMI Report

Prices of aluminum — used in the aerospace, construction and automotive sectors — have been hit by concerns about oversupply, compounded by worries over a Chinese economic slowdown.

Although other base metals made new lows in January, aluminum prices held steady. The aluminum MMI fell only one point to 71.

Free Sample Report: Our February Metal Buying Outlook

What didn’t fare well in January was Alcoa‘s stock price, which fell sharply to its lowest level since March 2009.

Alcoa stock plunges in 2016 hitting a 7-year low

Alcoa stock plunges in 2016, hitting a seven-year low. Source: MetalMiner analysis of @StockCharts.com.

Lower aluminum prices were the main cause driving the company’s shares down over the past months. In addition, the recent turmoil in stock markets is not helping matters. A combination of both caused Alcoa’s stock price to plunge in January.

Midwest Premiums

Rising domestic premiums have helped Alcoa improve its margins. Since September, premiums in the U.S. rose from the lows of $0.06 per lb., mainly because of the production cutbacks announced by domestic producers in Q4 2015. However, we haven’t seen falling stockpiles and we’ll probably not see a major bounce-back in premiums. Indeed, over the past couple of months, MW premiums have stabilized at around $0.09 per pound.

Aluminum_Chart_February-2015_FNL

There are a few factors preventing premiums from rising much more. First, some of the proposed cutbacks have been partially rolled back. Alcoa previously announced the closure of its Intalco smelter in Q1, but now the company will keep running until the end of Q2. Century Aluminum is running its Mount Holly smelter at half capacity despite its previous announcement of a complete shutdown.

In addition, domestic aluminum producers will find it hard to succeed in increasing their premiums while global sentiment remains negative. Despite the relative scarcity of material created by domestic producers, there is still a glut of material elsewhere in global markets. Finally, any significant increase in domestic premiums would attract more imports into the country, especially coming from China.

Stockpiles

The main problem with the aluminum industry is that smelters in China keep running and refuse to cut production. The other problem is high inventories. Even though official London Metal Exchange inventories have been trending lower since mid-2013, unofficial stocks have actually increased. According to CRU, global aluminum inventory including unofficial stocks stands at around 15 million metric tons.

Moreover, China wants to keep stockpiling instead of cutting production. In January, top aluminum smelters in China agreed to form a joint venture to stockpile aluminum. These measures will only keep Chinese smelters producing more aluminum while material only goes into financial deals. However, the market knows what China is up to, and investors won’t buy aluminum until shutdowns happen. The stockpiling game will only keep prices low for longer, potentially making the problem even worse once that aluminum enters the supply chain.

Compare Prices With The January 2016 MMI Report

For as long as China doesn’t change its approach, the best that aluminum producers can hope is for prices to stay at current levels.

Actual Aluminum Prices

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Our Aluminum MM index rose 3% to 72 during the month of December from 70 in November.

Free Sample Report: Our January Metal Buying Outlook

Is this upward move something to be worried about? Or excited about? We don’t think so.

Aluminum_Chart_January-2016_FNL

As soon as prices rise a tick, people try to find the fundamental reason for that price increase. Sometimes they can even, somehow, make the case that the outlook is set to improve. But in the case of aluminum, nothing really improved in December.

First, aluminum has declined more than 30% on the year-to-date. A 3% increase after such a price slump means nothing. Indeed, aluminum producers should be worried that prices are not able to make a decent rally from these low levels. That only means that investors are only interested in selling, not buying.

Supply and Demand

Fundamentally, we didn’t see anything this month to make us more bullish on aluminum. The State Reserves Bureau in China announced intentions to buy a 1 million tons, or possibly twice as much, to help smelters awash in the metal. Some might take this as bullish news, but we doubt that can make the outlook any brighter. To us, this purchase would only represent a change in ownership of existing unsold stock, irrelevant to the future global market balance.

There is no shortage of metal and aluminum continues to flood out of China. December marks another month without significant production cuts. There have been reports that Chinese smelters plan to reduce some of the excess capacity but it seems like markets would like to see some real action on this front. In China, the most smelters have done involves taking smaller capacity offline for “maintenance.”

The slight increase in aluminum prices was mostly because of a weaker dollar in December which also helped most industrial metals hold their value during the month. China’s slowdown is the long-term price driver and we recently saw Chinese manufacturing numbers disappoint, adding more worries about overall weak demand. That alone, will likely keep a lid on aluminum prices.

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