The long awaited bounce back of the US dollar looks like it may have finally arrived and with it a massive unwinding of commodities positions. The dollar has reached a six month high against the Euro and the Pound as commodity prices generally have tumbled 21% since the July 3rd.
Metals prices in general have fallen and physical stocks have risen as producers and traders have offloaded physical positions onto the market. Although we have been calling out a market adjustment for some time, when it arrives it immediately raises the question where does it go from here and what are the implications for buying strategies going forward?
In the short term, base metal prices are being driven by a combination of the strengthening US dollar, a continuing weakening of demand in Europe, unwinding of speculative positions and (this is the tough one to gauge) a perception that Asian, particularly Chinese metal demand, is slowing. This time of year is traditionally a quiet period in Europe but there is no doubt the Eurozone growth is slowing significantly. Buyers in Europe and Asia appear happy to sit on the sidelines as prices come down, further dampening demand. When buyers come to re-stock however it could have an effect supporting prices for certain metals where there are potential supply constraints, such as nickel and copper.
In the first half of the year, Chinese demand for refined copper dropped 23.1 percent to 687,013 tons. Chinese imports have been unprofitable this year due to a wide Shanghai Futures Exchange discount to London Metal Exchange copper prices. However, a recent improvement in the arbitrage between the two exchanges and a steepening backwardation (a backwardation is when the spot price exceeds the forward price and happens when there is a physical tightness in the market for prompt delivery) in Shanghai were signs that the spot market is finally tightening. The gap between SHFE and LME has been narrowing suggesting that Chinese demand may be picking up in anticipation of the end of the Olympic Games. To put the overall copper cycle in perspective, the LME market rose from $3/lb at the beginning of the year to $4/lb at the beginning of July only to sharply fall to near January levels this week. Although world stocks have been rising, between 50 and 79% of LME copper stocks were held by one firm as of July 30, according to a LME figures. You have to wonder what is going on there, why would one company have such a dominant physical position in the market? We don’t have a concrete answer to this one but if any readers have the inside edge we would be interested to hear more.
Although tin has come off dramatically from June/July highs of $24,000-25,000/ton it is now showing support at current levels so it is not unreasonable to believe prices are likely to have a limited downside going forward. The market is somewhat supported by concerns about Indonesian supplies going forward.
Nickel prices have come down a lot bringing down stainless prices, going forward this should support an increase in stainless usage and hence a gradual increase in demand. The question is when that demand will manifest itself. Producers are continuing to cut capacity and with the Eurozone going into a slow growth phase it is unlikely to be anytime soon. However we do not see a significant enough improvement in the stainless market to impact nickel before Q2 2009.
Lead has recently been supported in the short term by stock withdrawals in California following the closedown of a recycler but generally the market is weak on the back of excess production and falling demand for batteries. As with zinc the low prices will initiate the closure of marginal mines, gradually bringing the markets into balance. Although prices have come down a lot this is only just beginning to impact plans for new mines or production levels at existing mines. It could be the end of 2009 or into 2010 before the world is back into a demand/supply balance and the market tightens enough for prices to rise significantly.
Aluminum is dependent on power supplies. As oil comes down, the case for aluminum is weakened. There is plenty of production capacity with new facilities coming on stream. China has meanwhile raised export taxes on aluminum alloy from 0% to 15% effective August 20th as exports have switched from primary to alloy. With the market in surplus but vulnerable to power shortages or cost increases we see the downside for aluminum limited. It is currently trading at $1.23/lb on the LME for cash having peaked at $1.50/lb in early July. There is the potential for aluminum to rise again next year although we don’t see $1.50/lb again this side of 2010, much will depend on power costs and global demand.
Tomorrow we will look at the steel and ferro alloys markets.
–Stuart Burns & Lisa Reisman