CommentaryMarket Analysis

Never let it be said that metals markets are not dynamic (and I am not talking about metals prices).

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After the financial crisis, the one area of the market that was making money was the stock and trade financiers, plus the warehouse companies on whom they depended for safe storage. In 2010, Goldman Sachs bought Metro for some $450 million and proceeded to cream the market as inventory swelled to record levels. Stuck behind massive load-out queues, warehouse companies pulled in guaranteed rents.

But following implementation of strict LILO and queue-based rent capping (QBRC) rules by the LME, queues ran down and, maybe coincidentally (do you believe that?), the grey market stock and finance firms exited the LME warehouse system in droves.

According to FastMarkets, total stocks in LME-listed warehouses are currently just above 2.5 million metric tons, down from their peak of 7.6 million tons back in July 2013 (before the warehousing reforms were bought in). In Europe, the total area allocated for LME metals storage sheds dropped by 18% from June 2017 to 2018, down to 1,747,114 square meters. Previously, Glencore dominated Vlissingen, more than half of warehousing space has gone in the past year.

The situation is arguably even more brutal in Asia.

Busan in South Korea, plus Malaysia and Singapore — locations that all expanded rapidly a few years ago — have seen volumes collapse.

In Singapore — home to most LME aluminum metals in Asia, according to FastMarkets — live aluminum stocks have plunged by half to 91,725 tons over the last year, while Busan has seen a 71.8% drop in aluminum from a year ago and a 66.6% drop in copper.

It could be tempting to brand firms exiting the market to rats abandoning a sinking ship — but who can blame them?

With falling volumes, it is proving tough to turn a profit.

Noble sold out to Australian and Singapore investors in early 2017 and its Worldwide Warehouse Solutions (WWS) has now gone bankrupt, while Katoen Natie of Singapore has closed its LME operations in Asia following irregularities. Henry Bath, a firm that has seen markets rise, fall and rise again over more than 200 years of trading, and will likely ride out these trials, has taken over their sheds.

Warehouse companies put the swift decline in margins down to a fall in volumes and the exodus of the stock and finance trade. LME stocks of aluminum at 1.145 million tons have returned to where they were before the financial crisis.

According to CRU data quoted by Reuters, shadow stocks held off warrant but often in the same warehouses as LME stocks have fallen from 10 million tons at the start of 2016 to just over 6 million tons at the end of Q2, and are still falling. That is a massive loss of revenue for storage firms and in part explains why the big names, both in warehousing and finance, saw the writing on the wall and got out in recent years.

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So, this is an industry that is maybe not in crisis, but is certainly facing challenges and radical change.

Who would have thought wind’s transformation from subsidy-supported to self-financing power source would happen so quickly – not this publication, that’s for sure.

Apart from diehard environmentalists, most consumers have been opposed to renewables on the basis they cost significantly more and turbines are an eyesore on the landscape.

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But in the span of less than 10 years, public opposition has declined. Opposition has not gone away entirely, but it has softened as we have become more familiar with the sight of slowly rotating turbine blades on the horizon and with the realization that its costs are falling dramatically.

A recent article in The Telegraph reports on how the cost of power production from onshore wind farms has dropped so far it undercuts conventional coal, natural gas and nuclear options.

The below graph from 2015 shows onshore wind as the cheapest option; costs have come down further since then.

Source: Wikipedia

Calling it the “subsidy-free revolution,” the Telegraph article reflects our own surprise at how quickly the change has taken place.

To be fair, offshore power still requires some subsidy because of the greater cost of installation and maintenance. Even here, costs continue to fall and subsidy is a route the authorities prefer to entertain because of public opposition to what was seen as the blight of onshore turbines dotting the landscape.

In large part, this is because turbine sizes have increased and, as a result, efficiencies have increased.

Source: The Telegraph

The industry is seeing it as a major investment opportunity, generating jobs while at the same time reducing the country’s overall carbon emissions.

A figure of £20 billion covering both onshore wind and solar over the next 10 years is mooted, all of which would be subsidy-free.

The latest figures are sounding the death knell for nuclear power in the U.K., but as usual the government hasn’t caught up with the numbers.

Nuclear power is costing a massive £92.50 per megawatt hour and is partly justified on the basis that a base load of power is always required to fill in renewables variability.

However, battery parks like Glassenbury in Kent are springing up that can meet gaps in demand, but nothing like a 2 GW nuclear power plant; still, a few MW here and there is slowly adding up.

But, like renewables, costs will need to come down for investment to flow into battery parks. That is, they’ll need to come down to the extent required to negate the need for quick fireup of conventional power sources to fill in gaps during cold snaps or, as renewables rise, as a percentage of the whole to fill in for periods of low wind or at night for solar.

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Still, a low-carbon future, at lower power costs and with the benefit of economic growth from investments – what’s not to like?

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The U.S. and India are scheduled to sit across the table this week in Geneva to discuss the case filed by India with the World Trade Organization’s (WTO) dispute settlement mechanism over the U.S.’s imposition of import duties on steel and aluminum.

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The talks will be held under the aegis of WTO’s dispute settlement mechanism, according to a news report by the Press Trust of India.

India is part of the group of nations — which includes China, Russia and Norway, among others — to have filed separate dispute claims on the topic with the WTO. The meeting is part of the consultations the U.S. will be holding with all such countries on July 19-20.

It may be recalled that the U.S. had imposed a 25% tariff on steel and a 10% tariff on aluminum imports from India. India’s exports of the two commodities to the U.S. stands at about U.S. $1.5 billion per annum. India had initially tried to raise the issue with the U.S., and then informally with the WTO, calling the move an “abuse of global trade provisions that could spiral into a trade war,” — sentiments similar to the one expressed by India’s neighbor, China.

In May, India dragged the U.S. to the WTO dispute settlement mechanism over the imposition of import duties.

Consultation is the first step of the dispute settlement process. Incidentally, both the countries are already involved in disputes at the global trade body in the areas of poultry, solar, and export subsidies, to name a few.

According to another news report, senior trade officials of India and the U.S. will meet later this month in Washington to conclude negotiations on a “mutually-acceptable trade package.” Quoting an unnamed official source, it said the meeting comes amid an escalation of the global trade war.

Since India’s proposed additional tariff worth U.S. $235 million on 29 U.S. goods — including almonds and apples — are retaliatory in nature, any rollback of the additional duty on Indian steel and aluminum by the U.S. will lead to a withdrawal of corresponding taxes by the Indian Government on U.S. goods, too.

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The U.S. sees good prospects for its companies in the Indian civil aviation, oil and gas, education service, and agriculture segments.

It was another busy month in the world of metals.

Then again, these days quiet months in metals or in trade, generally, are few and far between.

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Trade tensions continued to rise, as $34 billion in tariffs on Chinese goods went into effect (China responded in kind), and an additional $16 billion in tariffs are under review. This week, President Donald Trump announced the intention to impose an additional $200 billion in tariffs on China, ratcheting up the stakes even further.

Meanwhile, a Section 232 investigation focusing on imports of automobiles and automotive components is unfolding. More than 2,300 public comments were submitted as part of the U.S. Department of Commerce’s review process, and public hearings are scheduled for next week.

Meanwhile, in metals markets, most base metals were down last month, with steel being the exception.

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A few highlights from this month’s round of Monthly Metal Index (MMI) reports:

  • Since peaking at $7,316/mt in June, the LME copper price dropped 12%.
  • The subindex for grain-oriented electrical steel was the only MMI to post an increase on the month.
  • The U.S. silver price hit its lowest level since January 2017, while U.S. gold bullion dropped to a one-year low.
  • Aluminum prices were also part of the general downtrend, as prices continued to move away from this year’s April peak (after Russian companies and their owners, including aluminum giant Rusal, were slapped with sanctions by the U.S.).

Read about all of the above and much more by downloading the July MMI report below.

There will be significant winners and losers to the current U.S.-E.U. trade war, but none more so than in the automotive sector.

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Size matters when it comes to reshuffling production among plants to avoid import tariffs. According to the Financial Times, larger companies like Toyota, Volkswagen, and the Renault–Nissan–Mitsubishi Alliance (RNM), all of which make roughly 10 million vehicles a year, have the capacity to move production between plants.

Toyota is probably the best placed, with two-thirds of its cars sold in each region already made within the borders of that region. The VW group, with 122 factories around the world, has considerable flexibility and, like Toyota, has been a pioneer in flexible manufacturing systems that allow it to make a range of vehicles at each site.

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President Donald Trump will not be the first commander-in-chief to find that waging wars on multiple fronts is a strategy with significant drawbacks.

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Taking on America’s NAFTA partners, Canada and Mexico, at the same time as the European Union is encouraging multiple retaliatory measures at a time when most people believe the real target was always intended to be China.

Many hold-up Caterpillar as the bellwether of U.S. industry, but if Caterpillar is the bellwether then Harley-Davidson must surely be the most iconic of American manufacturers. Its unique style of motorcycle is recognized and admired the world over and has come to epitomize the confident, free-spirited American dream.

So, when a firm like Harley-Davidson, which was repeatedly lauded by the president during his election campaign as an American icon and job creator, announces that it is going to have to shift production of its bikes overseas to avoid retaliatory tariffs imposed by the European Union, you have to ask if something is going a little wrong with the trade policy.

In a New York Times article, Harley-Davidson is quoted as saying the move “is not the company’s preference, but represents the only sustainable option to make its motorcycles accessible to customers in the E.U. and maintain a viable business in Europe.” Europe is the firm’s second-largest market after the U.S. However, as popular as its bikes are, the E.U.’s recently announced 31% import tariff — levied in retaliation for U.S. steel and aluminum import tariffs imposed by the president, the E.U. claimed — will, in the firm’s opinion, decimate sales.

Currently, Harley-Davidson incurs a 6% import tariff into the E.U., a cost the company appears comfortably able to absorb and still compete with domestic E.U. and Japanese motorcycle makers. But an increase to 31% would see on average a price increase of $2,200 per motorcycle, according to the article (although with the cheapest Sportster retailing for over $12,000 and top of the range models going for well over $20,000, that figure seems conservative).

Harley-Davidson agrees passing on the price increase to consumers is not viable. While no plans have been announced, the word is India may be the recipient of Milwaukee’s finest.

Not that India would be a significant market for Harley-Davidsons, as they have a heavy tax burden on larger bikes and you almost never see anything larger than the Royal Enfield 350 Bullit on the streets – the exception being the smart set in downtown Mumbai on their Ducatis and higher-end Japanese bikes (but that is still a small niche market).

Harley-Davidson sold 40,000 bikes in the E.U. last year and has vowed to absorb the tariff hike to preserve market share, at least for the remainder of this year, a move that could wipe out one-third of the company’s net profit. But Harley-Davidson does have options — it already manufactures in Brazil, Australia, India and Thailand, with India and Thailand becoming increasingly important assembly points.

These tariffs look set to hasten that trend, at least for sales outside of the U.S., as U.S. component costs rise due to import tariffs and retaliatory tariffs make U.S. manufactured goods less viable.

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Harley-Davidson is not alone in feeling the heat of such tariffs. Bourbon makers, orange juice producers and even playing card manufacturers are said to be in the same position.

But none are as quintessentially American as Harley-Davidson.

It may seem like we are on the brink of a trade war Armageddon.

Certainly, stock markets have reacted negatively to the threat of a trade war between the world’s two largest economies, the U.S. and China.

But the reality is we are in the midst of a crude, clumsy and haphazard negotiating process — one that ultimately will be settled.

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The process of threat, bluster and bullying is typical of a property mogul’s approach. It likely works well in that market, but is anathema to diplomats and industrialists who prefer a more nuanced, thoughtful and largely (although not exclusively) collaborative approach.

Unconventional as President Donald Trump’s approach is (though it does not mean it may not be successful), if just seen from the current stage of the “negotiations” it looks pretty appalling.

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Last week was quite the week in Europe.

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U.S. readers may only be picking up the roller coaster in Italian politics via the fluctuations in their pension fund share portfolio values, but it is probably no exaggeration to say European democracy has been tested this week … and the process is far from over.

Italians kicked the process off with March parliamentary elections that ushered in months of wrangling between the two biggest winning parties, the anti-establishment Five Star Movement (or M5S) and the far-right League, formerly known as the Northern League. Both are considered to be the most extremely populist parties Europeans have voted for in decades. When they finally formed a working coalition with an aim to form a government, markets got nervous that many of their campaign promises may actually be put into practice.

Sound familiar?

Well, those fears crystallized when Five Star Movement head Luigi Di Maio announced the appointment of Euroskeptic economist Paolo Savona for finance minister, before the Italian president overruled them (at the behest of Brussels, many believe).

Even if President Sergio Mattarella acted in isolation, his willingness to go against the politically elected representative with the avowed aim of protecting the Euro and the European ideal, is a remarkable case of prioritizing European stability over national democracy. His actions were no doubt attended by sighs of relief in Brussels, Paris and Berlin, where the rise of populist parties in Europe and elsewhere have been met with disdain and derision.

Savona is well known for his anti-Euro views and his proposed appointment spooked markets, which promptly took fright. Investors dumped Italian debt and spreads between Italian and benchmark German rates spiked.

Source: Reuters, Adam Samson/Financial Times

 

Meanwhile, bank shares across Europe were dumped as investors feared Italy could crash out the Euro and banks would be left nursing massive liabilities, despite the fact most debt is held by the European Central Bank (ECB) after months of bond buying under quantitative easing (QE).

The bank share price collapse is what led downfalls in share prices across the world. Yet, after a few days of uncertainty, markets are recovering after M5S indicated it may be willing to reconsider the appointment of Savona. The League is not sounding quite so conciliatory, but the two parties are back in discussion to try to find a solution.

The irony is if Italy is forced back to the polls, the two parties will probably increase their share of the vote. There has been widespread support across Italy for their actions since the March election, but if they increase their share of the vote it will provide an even clearer mandate for an anti-austerity, reflationary, debt-fueled agenda.

Early comments from European politicians — such as Günther Oettinger, Germany’s E.U. commissioner — that upheaval in the markets would exert healthy, pro-European discipline on Italian voters were met with derision across the country, as it was seen as Brussels telling the Italians how to vote. Oettinger’s comments on German television — “My concern and expectation is that the coming weeks will show that developments in Italy’s markets, bonds and economy will become so far-reaching that it might become a signal to voters after all to not vote for populists on the right and left” — were promptly slapped down by more media-sensitive officials, like European Council President Donald Tusk, forcing Oettinger to issue an apology.

Italian President Sergio Mattarella tried to appoint Carlo Cottarelli, a former International Monetary Fund (IMF) official, to form an interim government, but that simply encouraged M5S and the League to get back to the negotiating table to find a solution of their own.

This story has a long way to run.

Italy has lagged behind the rest of Europe’s major economies for the last decade with minimal growth. Voters blame the E.U. — and, in particular Germany — for the trend. Germany is running a persistent current account surplus of 6%, well above E.U. rules, yet is not being held to account.

Italy feels if Germany can break the rules to the detriment of fellow E.U. states, then why cant they? Why should the economy be hobbled by debt limits and austerity when fellow E.U. members flout the rules?

You can see their point.

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In such an atmosphere, the rise of populist parties is understandable, even if their solutions make little economic sense.

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Well, he went and did it, didn’t he?

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Against advice from consumers and pleading from politicians in Europe and the Americas, President Trump went ahead with the imposition of 25% import tariffs on steel and 10% on aluminum from the E.U., Canada and Mexico.

Stock markets dropped on the news and politicians blustered while the biggest loser, U.S. consumers, resigned themselves to paying higher prices for the foreseeable future.

According to the Financial Times, those three economies accounted for 44% of all U.S. steel imports in the first quarter of 2018. U.S. consumers are already paying more for their raw materials than the rest of the world following tariffs announced on other countries earlier in the year, the Financial Times reports.

Source: Financial Times

About the only people not complaining are producers (at least here in Europe).

Speaking to sales offices of European producers, there is firm belief little will change except U.S. consumers will end up paying 25% and 10% more for steel and aluminum, respectively. The U.S. does not produce anywhere near enough finished steel or aluminum to meet its massive domestic demand, and you do not bring new rolling or extrusion mills online in months — it takes years.

So, imports will continue to flow and consumers will just pay more. Admittedly, there will be a short-term blip; U.S. consumers have been buying ahead of the curve. One aluminum mill interviewed by MetalMiner confirmed its normal 3,000 tons of monthly sheet sales has been running at 8,000 tons recently in an effort by consumers to stock up ahead of a possible tariff. That stock will carry over into the summer, but if tariffs are still in place Q3 deliveries will resume as before, just at higher delivered prices.

Meanwhile, Mexico has already hit back with retaliatory tariffs against U.S. products. The Financial Times reports a Mexican minister saying, “Given the tariffs imposed by the US, Mexico will put in place equivalent measures on a range of products including flat steel . . . legs and shoulders of pork, sausages and other food preparations, apples, grapes, blueberries, and various cheeses, among others.” Sen. Patrick Toomey (R-Pa.) pointed out that the tariff on Mexico is particularly bizarre, as the U.S. runs a trade surplus on steel with Mexico.

Although European politicians have howled with fury at the imposition of the tariffs, it has to be said there appears to have been scant progress on talks over the last month aimed at avoiding a crisis.

The U.S., trying to negotiate on a range of bilateral trade terms, has argued that U.S. tariffs on European cars are much lower than E.U. tariffs on American cars – a seemingly unfair situation that as an observer is hard to see how it could be justified.

Never let it be said, though, that logic gets in the way of European Commission President Jean-Claude Junker. After calling the move “protectionism, pure and simple,” he reiterated retaliatory measures listed in a 10-page document published in March, which included Kentucky bourbon and Harley-Davidson motorcycles.

In reality, the E.U. has more to lose than the U.S. in a full-blown trade war. Although Germany’s exports of steel products are in a low single-digit percentage of German steel industry output, the country is a major exporter of automobiles and machine goods. Of all the countries in the E.U., Trump probably has his eyes set on Germany’s massive trade deficit with the rest of the world as much as he does the E.U. as a whole.

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Still, where this goes from here is anyone’s guess. If either side blinks first and shows willingness to negotiate rather than ratchet up the stakes, then there is a chance a trade war can be avoided.

A trade war is not what either side wants, but it is a risk Trump has shown he is willing to take.

What a difference a few days in politics makes.

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Just last week many analysts, including this publication, were optimistically speculating that President Trump’s aggressive application of tariffs to force a major realignment of U.S.-China trade terms was actually paying off. Although the tone and nature of the president’s position shocked politicians and business leaders around the world, raising the specter of a trade war, the howls of protest from Chinese politicians were also matched by indications that inward investment could be relaxed and import tariffs on U.S. products could be reduced in an effort to reach some kind of settlement.

The New York Times, however, reports that as the president’s position on North Korea falls apart, so, too, is progress with China — and the two may not be unrelated.

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