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2015 Turned out to be the worst year for metal producers in the past few decades. Not only because of the size of the price decline, which was big, but because prices have fallen from what many considered low levels back in 2014.

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With prices at these low levels, and with so many producers underwater, next year is going to be a very interesting one. I think we can call 2015 a painful year for metal producers and my guess is that we will end up calling 2016 a bloody one, but before we enter the new year, let’s review what were the most important highlights of the 2015:

China Got Into Real Trouble

China was the great rescuer of the world economy in 2008 with the launch of an unprecedented stimulus package that triggered the biggest infrastructure investment boom in history, which led to higher commodity prices.

NYSE Composite Index acting like in 2007's top

The New York Stock Exchange’s Composite Index acting like in 2007’s top. Source: MetalMiner analysis of @StockCharts.com data.

The Chinese economy started to get in trouble in 2011. I just saw an excellent video that already, in 2011, explained what China was getting itself into. It wasn’t until 2015 when China’s economy really hit a brick wall, or at least when the market actually acknowledged it. In 2015 we saw China’s stock market crash (yet to hit the floor), Chinese exports hit record levels, and desperate government actions to spur growth such as the devaluation of its currency. China was without a doubt, the most important factor driving metal prices down this year.

The Rising Dollar

Metal prices fall on a rising dollar. Metals are priced in US dollars and they become more expensive to foreign buyers when the dollar appreciates. In 2015 we saw the US dollar index hit an 11-year high, that had a huge depressing effect on metal prices. After hitting that new high, the dollar has managed to hold its value and, just recently, made another bullish move, triggering more sell-offs in metals.

2015 was also the year when the Fed finally increased interest rates for the first time since 2006. So far, we can’t really tell its impact on metal prices, but, in theory, higher interest rates should boost the dollar higher in 2016 as higher borrowing costs domestically make the dollar more attractive to yield-seeking investors, adding more pressure to metal prices.

Higher interest rates also mean higher financing costs which could potentially accelerate production cuts long term as producers struggle to pay their debts. This might eventually help balance the oversupplied market sooner rather than later.

The Oil Price Slump

Oil had its steepest decline in 2014, but 2015 only served to push prices even lower. Low oil prices have a double negative effect on commodity prices:

First, oil is not just a commodity, itself, but an asset closely followed by commodity investors. Falling oil prices make investors move away from commodities and, of course, industrial metals. In addition, oil is the main benchmark for energy prices. Lower energy prices mean lower transportation costs and lower production costs, especially for those energy-intensive metals like aluminum.

We now have oil below $40 per barrel and heading south. 2016 is going to be an interesting year for metal prices and it will be critical how these factors play out. Will demand come back to rescue the loss-making producers? Or will we have to see blood before metal prices hit the floor?

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Falling commodity prices are not necessarily bad for the US economy and certainly a falling commodity market since 2011 hasn’t stopped the US stock market from rising. But that might have changed recently.

When Low Prices Cause Serious Pain

The market has underestimated the demand erosion that China’s economic rebalancing created. Metal producers are awaiting a comeback in demand to meet the overcapacity built up over the past few years. Falling prices are not only hurting metal producers but any commodity producer. Especially, in the oil industry, which is suffering its biggest downturn since the 1990s.

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With earnings down, a sharp cut in exploration and production investment has made more than 200,000 oil workers lose their jobs. Investors are well aware of it, and shares of companies in the energy industry have fallen over 40% since their peak last year.

XLE Energy Sector ETF down 40% since its peak

XLE Energy Sector ETF down 40% since its peak. Source: MetalMiner analysis of @StockCharts.com data.

In addition to expectation that the two digit Chinese annual growth rate would last forever, almost a decade with borrowing costs near zero has led to a situation where there is still new commodity producing capacity yet to be built as well as existing capacity that doesn’t close and low-cost credit has permitted even unprofitable production to be maintained.

What Can We Learn From the Housing Bubble?

Housing prices in US peaked in 2005 and by 2008 prices had already come down more than 30%. But it wasn’t until the summer of 2008 when the US stock market crashed. The decline in prices and increased foreclosure rates in 2007 among US homeowners caused big financial institutions to declare bankruptcy. The economic pain and loss of jobs made equity investors throw in the towel and the stock market crashed.

US Stock Market Set For Trouble

We already pointed out last year that the stock market was topping out. Ever since, we’ve had over a year of choppy action. US stock indexes have shown only back-and-forth action, making 2015 a tough year for equity investors.

NYSE Composite Index acting like in 2007's top

NYSE Composite Index acting like in 2007’s top. Source: @StockCharts.com.

This market action is typical before a meaningful move down. The smarter investors start to sell, while the not-so-savvy investors keep buying. This creates hesitation followed by up and down moves and some sharp declines (which we have already seen). Markets aren’t able to make new highs, forming a topping pattern, underscoring that sellers are starting to win the day.

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I believe Chinese demand is not going to come back, lift prices and save producers’ businesses. The recent interest rate hike also means higher financing costs which could potentially accelerate production shutdowns as producers struggle to pay their debts. Similar to what we saw in the housing bubble, this will bring economic fear and loss of jobs.

We might need to see a wave of shutdowns to balance the oversupplied commodity market, triggering further sell-offs in US equities, which might eventually coincide with the end of this bear commodity market.

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NYSE Composite Index acting like in 2007's top

NYSE Composite Index acting like in 2007’s top… right before the housing bubble burst in 2008. MetalMiner analysis of @StockCharts.com data.

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It’s been 3 days since the Federal Reserve raised interest rates by 0.25% last Wednesday.

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The decision didn’t surprise anyone given that analysts forecasted a 78% likelihood that the Fed would raise rates in December and, so far, markets have reacted as we expected:

Dollar Up

Dollar rises on Fed's decision

Dollar rises on Fed’s decision. Source: MetalMiner analysis of @StockCharts.com data.

Initially, it looks like the rate hike helped boost the dollar higher last week. Higher borrowing costs domestically make the dollar more attractive to yield-seeking investors. The US dollar index is barely below its 14-year high, a level that it will likely retake soon.

Commodities Down

One of the side effects of a rising dollar is lower commodity prices. Commodities are priced in US dollars and they become more expensive to foreign buyers when the dollar appreciates.

CRB Commodity index continues to fall

CRB Commodity index continues to fall. Source: @StockCharts.com.

Gold, oil and many base metals hit new multiyear lows last week. Nothing seems to stop the bear commodity market and, in theory, higher interest rates shouldn’t do anything but cause more pain to commodity producers.

Is There Any Bullish Effect on Metal Prices?

Yes, indeed. Even though higher interest rates could add more downside pressure to this bear market, it could potentially make commodities hit bottom sooner.

Free Download: The December MMI Report

How? Low rates in the past decade fueled a massive investment in production facilities, which has led to the glut driving prices down. Higher interest rates also mean higher financing costs which could potentially accelerate production cuts longer term as producers struggle to pay their debts. This might eventually help balance the oversupplied market sooner than later, giving support to metal prices.

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Crude oil hit new multiyear lows last week after the Organization of Petroelum Exporting Countries’ meeting in Vienna last week failed to address a growing supply glut.

Crude Oil Hits lowest level since 2009

Crude oil hits its lowest level since 2009. Source: @StockCharts.com

Although many people believed that oil prices had found a floor earlier this year, we didn’t subscribe to that view.

Free Sample Report: Our Annual Metal Buying Outlook

The latest decline suggests that further declines might be around the corner. Low oil prices have a double negative effect on commodity prices:

  1. Oil is not just a commodity, itself, but an asset closely followed by commodity investors. Falling oil prices make investors move away from commodities and, of course, industrial metals.
  2. Oil is the main benchmark for energy prices. Lower energy prices mean lower transportation costs and lower production costs, especially for those energy-intensive metals like aluminum.

For these reasons, it’s not strange to see that the trend of industrial metals looks very similar to that of oil prices:

Industrial Metals ETF

The Industrial Metals ETF is going the same direction as oil. Source: @StockCharts.com.

What This Means For Metal Buyers

The recent decline in oil prices is just another indicator hinting that metal prices will continue trending lower as we enter 2016.

Free Download: The December MMI Report

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Spot iron ore prices hit a fresh 10-year low after falling below $40 per metric last week.

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Weakening steel demand is causing a slump in finished products and raw materials prices. Our Raw Steel MMI didn’t take a break in December, falling 4.2% to 46 points, yet another all-time low.

Raw-Steels_Chart_December-2015_FNL

Early this year, many believed that the steel industry would recover during the second half of the year, even steel companies’ 2Q15 better-than-expected-earnings results raised optimism of a possible recovery. We didn’t subscribe to this view. The slump in steel prices continues and the fiscal 3Q15 financial results of most steel companies failed to cheer up investors.

The market has seriously underestimated the demand erosion that the economic rebalancing in China has created.

Overcapacity Still an Issue

Steel producers are still waiting for demand to meet the overcapacity built over the past few years. In addition, almost a decade with borrowing costs near zero has lead to a situation where there is still new capacity yet to be built and also existing capacity that doesn’t close. Low-cost credit has permitted even unprofitable production to be maintained, and while production levels are well off their peaks, there have been few permanent capacity closures.

Chinese Producers

The excess of production is still a concern in China, given the high levels of debt that producers there are dealing with. While many steel companies are able to cover debt costs out of operating profits, other companies are still borrowing from one bank to pay the older debt to another.

In November, Chinese steelmaker Tangshan Songting Iron and Steel, with an annual capacity of 5 million metric tons, said it would cut output due to debt pressures. Despite China cutting interest rates, as demand and prices collapse, banks are starting to tighten lending to the steel sector and losses are stacking up. Many mills are having a hard time extending their loans while they lower steel prices in competition to get contracts. The plunge in Chinese steel profits and and prolonged worries over weak demand might force more and more Chinese producers to close, removing exports from the global market before we see a recovery in prices.

Free Download: The November MMI Report

Steel prices, like the rest of base metals, were impacted in November by a strong dollar and the bearish sentiment that this adds to commodity markets. There are few to no indicators pointing to a recovery in steel prices anytime soon.

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Crude falls to new seven-year low

Crude oil falls to new seven-year low. Source: @StockCharts.com.

Crude oil fell on Monday below $40 per barrel after the Organization of Petroelum Exporting Countries’ meeting in Vienna last week failed to address a growing supply glut. This is the lowest level since February 2009.

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The December Aluminum MMI index fell 3% to 70 points, yet another all-time low.

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Aluminum prices fell in November, although they held much better than other base metals such as copper or nickel. Still, three-month aluminum on the London Metal Exchange hit a new low at $1,432/mt. As with the rest of the base metals complex, a strong dollar is driving prices down.

Aluminum_Chart_December-2015_FNL

In market news:

China Is Still Overproducing

According to the latest data, Chinese aluminum output has risen 18% on the year to date despite falling demand. This has led to a 14% increase in aluminum exports this year (to date). One of the reasons China doesn’t cut production is its smelters’ ability to withstand low international prices.

Recently, China’s government announced its plans to introduce more competition into its power sector that could potentially lower electricity prices there. Given that power makes up 40% of the cost of producing aluminum, Chinese smelters’ margins would significantly improve on lower electricity prices.

Chinese smelters this year already pressured domestic power companies to reduce electricity tariffs and some smelters have managed to reduce costs by 35%. In addition, energy prices keep falling. Crude oil, a good benchmark for energy prices fell yesterday near seven-year lows.

Rio Tinto Bets On Bauxite Prospects

While major companies are delaying new mines as prices slump, in November Rio Tinto Group approved a $1.9 billion bauxite project in northeastern Australia. The company is more optimistic than most, as it expects a rebound in demand in the short term, meaning the next three years. The mine is expected to open in 2019 with an annual production of 22.8 million metric tons of bauxite, the raw material that is used to make alumina, a key ingredient in the production of aluminum.

China To Buy Up Aluminum

It is said that China will stock up its aluminum reserves by buying 900,000 mt of aluminum at current prices to reduce the oversupply that has battered markets. This seems like a bad idea, just like Beijing’s poorly thought-through intervention in the stock market last summer when it stepped in to buy shares to prop up the domestic market.

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Most likely, the actions will only produce a temporary price boost if anything. Also, it could be counterproductive as it might encourage mining companies to put off the needed production cuts, prolonging the market pain.

What This Means For Metal Buyers

Aluminum prices continue to trend lower. Current macro-drivers keep suggesting more market lows to come. China’s action to rebalance the market looks like a sign of desperation, suggesting that a sustainable price recovery is not around the corner.

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Our December Copper MMI fell 9% to 60 points.

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Three-month copper on the London Metal Exchange hit fresh lows last month, trading as low as $4,444 a metric ton, the lowest level since May of 2009. In the face of low prices, more shutdowns were announced during the month of November but so far, they haven’t lifted prices at all.

Copper_Chart_December-2015_FNLIn early November, Glencore announced that it would reduce its copper production more than expected. The company is now aiming to cut output by 455,000 metric tons by the end of 2017, 14% up from its previously announced figures. Glencore’s cuts came after Freeport-McMoRan announced a pullback in production.

Toward the end of the month, 10 leading copper producers in China announced plans to cut output by 350,000 mt in 2016. In addition, producers urged Beijing to buy up excessive supply to combat falling prices. The State Reserves Bureau already said that it would buy aluminum, nickel, indium, and zinc.

But supply cuts haven’t been big enough to make a sustainable impact on the market. Moreover, there are still manny producers unwilling to cut production despite the low prices. The head of the world’s biggest copper miner, Codelco, said in November that they won’t cut copper production as prices slump, pointing to the fact that if the company suspends production then it would be difficult to restart, so they would rather try to lower costs. Also, there is skepticism about how many of the announced cuts will actually be made and how long they will last.

In addition, refined copper output in China rose 6.8 % in the first 10 months from the previous year. Meanwhile, disappointing Chinese import data increased demand concerns in November, contributing to the slump in prices. So far, supply cuts haven’t been enough to balance the other side of the equation: Excess material, shrinking Chinese demand and a strong dollar. Prices might have to come down farther before we see a turnaround.

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Last Thursday was a big day in currency markets. The dollar fell sharply against other currencies while the euro saw its value rise.

Dollar Index falls on ECB and Fed talks

The US Dollar Index falls on ECB and Fed talks. Source: @StockCharts.com.

The European Central Bank disappointed investors after presenting a package of stimulus measures smaller than expected. The ECB surprised the market as many expected the central bank to bring stronger stimulus measures, including a larger cut to the deposit rate which was cut only by 10 basis points to 0.3%, quite a smaller cut than what most investors expected.

On top of the disappointing stimulus measures, the Federal Reserve said that rate increases will come but they are likely to follow a gradual path.

The Fed sees a strong dollar and low inflation as contributing factors to proceed gradually on rate hikes. Therefore, although a rate hike is still expected in December, the diverging monetary policy between the US and Europe seems to have narrowed after the talks.

In theory, higher borrowing costs domestically make the dollar more attractive to investors seeking yields than other currencies. Based on how markets reacted on Thursday, investors might have lost a bit of enthusiasm on the dollar after the Fed and ECB talks, which could throw some cold water on the dollar’s current bull market giving some short-term support to metal prices.

What This Means For Metal Buyers

So far, this is only a one-day decline and buyers need to focus on the big picture. Longer term, things are still pointing to a strong dollar and depressed commodity prices. A smaller stimulus by the ECB doesn’t seem to be enough to stop the dollar from rising as we move forward, but it is something to keep an eye on.

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