CommentaryMarket Analysis

Normally when supply is constrained prices will rise, but China’s steel market is presently at the mercy of several dynamics.

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On the one hand, Beijing is constraining polluting industries like steel and coke production. Those same policy decisions, however, are hitting industries that consume finished products, such as construction (at least in the industrial northeast, where environmental pollution action has been most active).

Arguably, steel prices would have fallen further as a result of the constraints put upon the construction industry if it were not for the the constraints put on steel production, which has restricted supply. What is difficult to gauge from official figures is quite how much impact restrictions due to environmental measures have caused and what, if any, impact of a relaxation of those restrictions will have.

Average Daily Steel Output Drops in December, Still Up 5.7% for 2017

According to Reuters, China’s average daily steel output fell by 1.9% in December to 2.16 million tons per day from 2.205 million the previous month. Even so, full year output in 2017 still rose 5.7% to 831.73 million tons.

In part, this is due to higher output earlier in the year boosting the annual number, but also because the National Bureau of Statistics has altered what it does and doesn’t include in its numbers. China closed an estimated 140 million tons of illegal induction furnace capacity in the first half of 2015, a sector that has not been included in production numbers because it is not approved.

The sector was significant though, and its loss during 2017 was a significant factor in the strength of rebar prices as conventional blast furnace producers ramped up rebar production and prices to take the place of lost output from these illegal induction furnace producers. Since then, Beijing has been encouraging state mills in the installation of modern electric arc furnaces (EAF), in large part because of their lower environmental impact. It is the growth of these EAF facilities that lifted production in the latter part of the year and contributed to a switch from pig iron to scrap as a raw material source.

Iron Ore Prices Show Volatility

Although China’s iron ore imports rose 5% in 2017, hitting a record of 1.075 billion tons, iron ore prices have show considerable volatility of late as speculators struggle to gauge what demand is going to be like once heating season restrictions are lifted.

Both iron ore and coking coal prices have been sliding in recent days, but the expectation is they will bounce back during the first quarter.

What happens after that remains to be seen.

With steel output restrictions lifted by late March, steel production will almost certainly increase, finished steel prices could weaken and steel mill margins could suffer. Q2 and beyond will depend on the strength of domestic demand, particularly from the construction sector.

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With new iron ore supply continuing to come onstream, it will be interesting to see if miners are able to maintain prices as demand picks up or if current concerns about port stocks prove right and an excess of inventory and supply results in prices falling further.

In an approximately 80-minute speech ranging from jobs and manufacturing to North Korea and Iran, President Donald Trump’s first State of the Union address also touched on issues impacting the metals industry — albeit, perhaps not as directly as one might have expected.

(As a brief aside, according to the American Presidency Project, which tracks the length of State of the Union addresses, Trump’s speech was the third-longest since the speech lengths were tracked beginning with the Johnson administration. Bill Clinton’s State of the Union addresses of 1 hour, 24 minutes and 58 seconds and 1 hour, 28 minutes and 49 seconds are the only addresses longer than Trump’s speech last night.)

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Many in the metals industry were looking for good news regarding infrastructure (including, as we reported this morning, Nucor President and CEO John Ferriola during Tuesday’s quarterly earnings call). On that front, Trump called on Congress to put together a $1.5 trillion plan for infrastructure spending.

“Tonight, I am calling on the Congress to produce a bill that generates at least $1.5 trillion for the new infrastructure investment we need,” Trump said. “Every Federal dollar should be leveraged by partnering with State and local governments and, where appropriate, tapping into private sector investment — to permanently fix the infrastructure deficit.”

He also referred to streamlining the construction permitting process and reclaiming the country’s “building heritage.”

However, for those in the metals industry looking for policy specifics, particularly with respect to trade cases, Trump did not offer much.

For those paying attention to the ongoing Section 232 probes of steel and aluminum imports – of which Chinese excess capacity and state-aided commodities is a focus of much discussion — the president did not refer to those, or any other ongoing trade cases. This isn’t necessarily surprising for a State of the Union address, which are often short on policy specifics or nitty gritty minutiae, a which Section 232, Section 301, and other anti-dumping and countervailable duty investigations could fall under, depending on whom you ask.

Even so, the omission stood out, even as China — along with Russia — was mentioned as a threat.

Trump mentioned China three times: twice during a story about a North Korean defector and another time in a general call for defense spending. (Reuters reported recently that Trump is expected to ask Congress for $716 billion in defense spending for 2019, which would mark a 7% increase from 2018.)`

“As we rebuild America’s strength and confidence at home, we are also restoring our strength and standing abroad,” the president said. “Around the world, we face rogue regimes, terrorist groups, and rivals like China and Russia that challenge our interests, our economy, and our values. In confronting these dangers, we know that weakness is the surest path to conflict, and unmatched power is the surest means of our defense.”

In addition, the word “steel” was only mentioned once in the speech, and that in a metaphorical sense when extolling Americans’ perseverance and the “steel in America’s spine.” Aluminum was not mentioned once during the speech.

While anti-dumping and countervailable duty investigations didn’t get their time in the State of the Union sun, Trump did once again reiterate his stance on what he perceives as bad trade deals — particularly relevant in the shadow of North American Free Trade Agreement (NAFTA) renegotiation talks that concluded Monday in Montreal, capping the sixth round of talks focused on revamping the now 24-year-old trilateral trade deal.

On trade, Trump said the “era of economic surrender is over.”

Trump signed an executive order withdrawing the U.S. from the Trans-Pacific Partnership on his first day in office. He has also consistently attacked NAFTA, which he has called the worst trade deal ever made, citing the loss of American manufacturing and jobs.

“From now on, we expect trading relationships to be fair and to be reciprocal,” Trump said. “We will work to fix bad trade deals and negotiate new ones. And we will protect American workers and American intellectual property, through strong enforcement of our trade rules.”
According to U.S. Census Bureau data through November, the U.S. had a $65.68 billion trade deficit with Mexico last year and a $15.33 billion deficit with Canada.
Scott Paul, president of the Alliance for American Manufacturing, was not impressed with Trump’s presentation on trade and infrastructure.

In general economic indicators, Trump touted job creation figures, saying that since the election (a time frame which of course includes the final months of the Obama administration), “we have created 2.4 million new jobs, including 200,000 new jobs in manufacturing alone.”

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According to the Bureau of Labor Statistics, 2.1 millions jobs were added in the 2017 calendar year, down from 2.2 million in 2016.

We have long since stopped believing official China growth data. If that’s the case, what is the “real” growth rate in China and should we care that the numbers appear to be manipulated?

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Officially, China grew by 6.8% in the final quarter of 2017, taking annual growth to 6.9%. Yet, it is increasingly felt that the National Bureau of Statistics (NBS) numbers are massaged to iron out peaks and troughs from year to year and to support the authorities’ target growth numbers – to make the Party look like it is in total control.

In reality, The Telegraph suggests that 2016 official growth figure of 6.7% was probably overblown, with growth in reality being lower. Following an uptick in activity during 2017, this has resulted in the official figure for last year having to be reduced, as to report growth of more than 7% would have added to a disparity that builds up over time. Inflating poor years has to be balanced by underreporting good years, or eventually the statistics suggest the economy should be twice the size that it clearly is.

Independent assessments of 2017 growth are lower still. The Telegraph quotes Capital Economics, which believes growth to be nearer 6% for 2017, but their models agree that 2017 was better than 2016, saying they estimated GDP growth at 5.1% in 2016.

How this puts projections for 2018 is interesting, as most observers think there was a slowdown in the last three months of 2017, with official figures putting it at 1.6%, while independents, like Pantheon Macroeconomics, are putting it at just 1% for the same period (down sharply from an estimated 1.9% in the third quarter).

The reasons for a slowdown are not hard to see, as two factors are at interplay.

Drive Against Pollution

The first is Beijing’s drive to curb polluting activities, such as construction.

Output growth slowed in steel, cement and glass recently, as the government tried to rein in polluting industries in northern China. These restrictions will be eased at the end of the winter heating season and, as a result, activity is likely to pick up again in Q2.

Weakening Property Market

The property market in particular has weakened in the past six months, The Telegraph observes, noting average residential property prices rose by just 0.2% in December.

This raises a question, if construction activity and, therefore, the supply of new properties was constrained, logic would suggest prices would rise. The fact prices are easing may have more to do with the rising cost of borrowing in China following efforts by Beijing in early 2017 to limit the supply of money and dissuade growth in the shadow banking sector.

Interbank lending costs have risen as a result. If the Fed raises rates during 2018 as expected, global debt costs will rise regardless of currency. The knock-on effect may be that an increase in construction activity is rewarded with a fall in property prices later in the year.

As credit has become less readily available, the article notes, there has been a considerable slowdown in retail sales growth, falling to 9.4% in December from 10.2% in the year to November. A combination of a cooling property market, falling retail sales and an export market facing protectionist headwinds supports the hypothesis that growth in 2018 will be lower than last year.

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The Telegraph article concludes with Capital Economics’ prediction that growth this year could be just 4.5%. It will be interesting to see what quarterly numbers the NBS claims China is achieving as the year unfolds.

Coca Cola’s new lineup of Diet Coke flavors. Source: The Coca-Cola Company Image Library

In two weeks, Diet Coke is introducing four new flavors: Ginger Lime, Feisty Cherry, Zesty Blood Orange and Twisted Mango. They will come in a skinnier silver can, reminiscent of Red Bull’s popular caffeinated hit, and, it is hoped, will reinvigorate Coke’s fortunes by appealing to a younger, millennial buyer, CNN Money reports.

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The soft drinks market has been on the decline. According to the research group Cowen, diet soda sales fell 2% in the last three months of 2017.

The brand leaders, though, are falling faster.

Diet Coke sales fell by 4% and Diet Pepsi by 8%, while sales of the National Beverage Corp.’s LaCroix improved 43% in the sparkling and still flavored water category, as buyers switch not just to water but non-additive, more health-focused drinks. Diet Coke’s new offerings will be sold in slimmer tins, but the 12-ounce volume format remains the same – they will just rattle around irritatingly in your car cup-holder.

The move to slimmer cans is done for more profound reasons than just annoying me on long car journeys. The slimmer shape mimicks the younger image of successful brands like Red Bull — at least, that is Coke’s reasoning — but there may be a further advantage.

The slimmer cans give the impression of containing less fluid and research reported in the Washington Post suggests that may actually boost sales. David Just, a professor of behavioral economics at Cornell University, is quoted as saying their research performed over the years shows that people are incredibly responsive to labels. For example, participants, having been told that the food put in front of them was “double-size,” left 10 times as much food on their plates as those who were told their serving was “regular,” even though both groups were given the exact same amount of food.

The opposite, Just says, happens when servings are labelled as small. If products are marketed as minis, or are presented in a way that suggests they are somehow less, they can actually increase consumption.”

Much will depend, of course, on whether the new flavors find favor with consumers. Anecdotal evidence suggests they may not. Indeed it has to be said the firm’s previous attempts have not been a success, with new variances being withdrawn after just a couple of years.

It’s been a hard slog for reduced and sugar-free versions. Even with the tsunami of bad news about sugar, less than half, or 43%, of Coke sales are made up of Coca-Cola Zero Sugar, Diet Coke or Coca-Cola Life. As such, that raises the question as to how popular these new flavors will be, fancy cans or not.

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For the canmakers, the new, slimmer cans will require an investment in tooling to meet Coke’s volumes but technologically will present no issues, as plenty of products are sold in similarly shaped containers already.

The rise of aluminum in the automotive industry is something we’ve kept tabs on here, as some automakers have opted for the lightweight metal for their models, as opposed to steel.

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Not surprisingly, there are passionate supports of each metal, who will tell you why one is better than the other.

For supporters of aluminum — or, more importantly, automotive brands moving toward aluminum-intensive vehicles — the recent North American International Auto Show in Detroit offered some good news.

Aluminum-intensive vehicles were recognized during the show, which opened Jan. 13 and comes to an end Jan. 28.

The 2018 Lincoln Navigator was named Truck of the Year and the 2018 Honda Accord was named Car of the Year in the North American Car, Utility and Truck of the Year (NACTOY) Awards, which were announced Jan. 15. According to the aluminum Association, the awards marked the second straight year in which an aluminum-intensive vehicles has won a NACTOY award.

According to the Aluminum Association announcement, the 2018 Lincoln Navigator’s all-aluminum body dropped the car’s weight by 200 pounds. The 2018 Honda Accord, meanwhile, is lighter by 110 to 176 pounds, depending on the trim, according to the announcement.

“It’s no wonder Car and Truck of the Year winners innovate with aluminum,” said Heidi Brock, president and CEO of the Aluminum Association, in a prepared statement. “From performance, safety and durability, to fuel economy, battery range and emissions, aluminum delivers in every category consumers demand in new cars and trucks. That’s why recent surveys of automakers confirm aluminum is the fastest growing material, leading the multi-material trend. It’s also why the U.S. aluminum industry invested more than 2.3 billion dollars in domestic automotive capacity and we’re poised to invest further as our customers continue to innovate with aluminum in next generation automobiles.”

Other finalists at the show included:

  • The 2018 Ford Expedition (NACTOY Truck of the Year finalist)
  • 2018 Alfa Romeo Stelvio (NACTOY Utility of the Year finalist)
  • 2018 Honda Odyssey (NACTOY Utility of the Year finalist)
  • 2018 Toyota Camry (NACTOY Car of the Year finalist)
  • 2018 Kia Niro (NACTOY Utility of the Year semi-finalist)
  • 2018 Lexus LC500 (NACTOY Car of the Year semi-finalist)
  • 2018 Hyundai Ionic (NACTOY Car of the Year semi-finalist)
  • 2018 Audi A5 Sportback (NACTOY Car of the Year semi-finalist)

But what does the future hold for aluminum in the automotive industry?

While the metal is lighter than steel, it is more expensive. According to MetalMiner IndX data, LME primary cash aluminum is up 19.6% since this time last year, up to $2,235/metric ton as of Jan. 24.

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If aluminum price increases continue to rise — and outpace those of steel — it bears monitoring whether the allure of aluminum wears off in any way.

Silicon Valley and the modern-day entrepreneurs it has spawned cannot be accused of lacking blue sky thinking.

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Some of their ideas appear whacky and subsequently disappear from the news almost as soon as they are proposed. Others, however, have gone on to become real success stories, challenging our lack of vision and belief.

Take Elon Musk, for example. While he had his supporters for Tesla, there were many more detractors in the early days. Those detractors said he would never get his niche electric car company to a scale able to challenge the incumbents.

Here we are just a few years later and Tesla is worth more than Ford (optimistically in our opinion, but still in the market’s eyes).

SpaceX was ridiculed even more as a rich man’s ego trip, but the firm has achieved more in its few short years – on a much smaller budget — than the lumbering giant that is NASA.

So before we write off the following, think on the above. Elon Musk’s 2013 paper on the future of the Hyperloop (a futuristic, high-speed train running in a vacuum tube) seemed so much hot air back then. It has since been quietly gathering support, and undergoing tests, such that now results suggest that while his original Los Angeles to San Francisco route may not happen anytime soon, other routes and applications could be viable.

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India is often touted as the next China — a similarly sized population is expected to offer vast potential, particularly coming from a low per capita usage of metals, energy and just about everything else.

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India just needs to be freed from bureaucracy and the shackles of its earlier obsession with socialism and it will boom, supporters have been saying for years.

Yet India’s growth has persistently fallen short of expectations, often to the dismay of Western firms investing billions in what they have hoped would be the next big thing.

It’s not that India isn’t growing. At 6.5%, it is almost certainly growing faster than China this year. Despite claims of “on target” 6.5% growth in China, a more realistic measure is probably 4.5%, according to Roger Bootle, chairman of Capital Economics, writing in the Telegraph.

Nevertheless, China has achieved an unprecedented rise in living standards, with perhaps the greatest achievement being the creation of a prosperous middle class numbering in the hundreds of millions.

It is this middle class that has allowed the switch from export-led to domestic consumption — without their combined demand auto sales, white goods and the construction sector (and the list goes on), it would be dead in the water.

India, by comparison, has a paltry middle class.

The top 1% of Indian adults, a rich enclave of just 8 million inhabitants making at least $20,000 a year, equates to roughly Hong Kong in terms of population and average income, The Economist says. The next 9% is akin to Central Europe, in the middle of the global wealth pack.

Even the top 1% would struggle on $20,000 per annum to afford $20,000 for a small BMW or over $1,000 for an iPhone.

The next 40% of India’s population neatly mirrors its combined South Asian poor neighbors, Bangladesh and Pakistan, hardly in the market at all for Western-priced brands. The remaining half-billion or so are on a par with the most destitute bits of Africa, explains a report in The Economist.

So why has India apparently failed where China succeeded?

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Björn Wylezich/Adobe Stock/

Three-month zinc on the London Metal Exchange was up 1.3% at $3,426 a metric ton in official midday trading on Monday, having earlier touched a peak of $3,440 a ton — its highest since August 2007, Reuters reports.

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Like all base metals, zinc was been driven higher by a weak dollar — but that is far from the only driver pushing it to outperform all other base metals so far this year.

Inventories Continue to Fall

LME zinc inventories have fallen for 13 consecutive weeks to their lowest since October 2008. There was a further drop of 10,000 tons to 116,675 tons just late last week.

Meanwhile, Shanghai stocks have declined more than half over the past year, Reuters says, as supply constraints persist. As a result, Treatment and Refining (TC/RC) charges for concentrates and refined metal have fallen as refiners fight for cargoes to process.

A Market in Deficit

The reason physical metal is in short supply is no secret.

The market is in deficit, by 504,000 tons during January to October 2017, compared with a deficit of 202,000 tons recorded in the whole of the previous year, the World Bureau of Metal Statistics reports. Buyers had hoped 500,000 tons of capacity at Glencore’s Lady Loretta mine in Australia would be back onstream by now, having been closed due to low prices in 2015. Although the company promised to restart production in the first half of 2018, so far there have been no deliveries.

Higher prices have encouraged tailings at the previously closed Century mine in Australia to be opened up for processing; but again, significant deliveries are still pending.

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Zinc Could Rise Even More

Meanwhile, speculative positions have grown, betting on further price rises.

That is not without some basis, as robust demand has been constrained by tight supply and with Chinese smelters hit by Beijing’s environmental campaign to close energy-intensive manufacturing activities during the winter heating season. Reuters quotes ING analyst Warren Patterson, who said if economic and manufacturing data remain strong, there is potential for further upside.

The above headline is true, assuming the U.S.’s avowed aim is the health and future of the American steel industry and its workers.

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No one would dispute the idea that the world has too much steelmaking capacity. Many emerging markets and all mature markets are in agreement that excess steelmaking capacity depresses global prices and begats a beggar-thy-neighbor attitude to world trade.

Even taking the elephant in the room out of the assessment, The Economist estimates, by excluding China, global capacity use fell from 86% in 2004 to 69% in 2016, underlining how severe and widespread the problem is.

Source: The Economist

Recent cutbacks in China, recent research from Bank of America Merrill Lynch suggests, mean it is on track to use a full 88% of its capacity in 2018. Steel prices have rallied, mostly due to broad-based rising global growth.

While there are no guarantees that older, less environmentally friendly steel plants closed in the last 12 months will not be replaced by new, more efficient and less-polluting steel plants in the future, recent directives from Beijing suggest it is applying pressure to state governments to limit the permitting of new steel mills.

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Sanjeev Gupta, the industrial buyer of distressed steel, aluminum and coal assets (to name just a few of the areas he has expanded into in recent years), has so far managed an uncanny knack of good timing.

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Buying steel assets just before the global steel market finally lifted even Europe out of the doldrums, and now aluminum. To be fair, Gupta is not new to aluminum.

Gupta’s Liberty Group bought the Lochaber aluminum smelter and hydro-electric power plant from Rio Tinto in 2016 in a $410 million deal when Rio was desperate to shed “non-core” assets and raise cash.

Since then, the aluminum price has risen some 30%. Now, with aluminum on a roll, Gupta is again picking over the carcass of Rio’s aluminum assets, this time putting in a $500 million offer for Europe’s biggest refinery: the Dunkerque aluminum smelter.

Lochaber was only 47,000 tons capacity, but Dunkerque is on an altogether different scale, producing 280,000 tons a year. That disparity makes it a steal with respect to purchase price per ton of capacity compared to Lochaber, and is said to be profitable at current aluminum prices.

For most aluminum producers — unless they are niche, high-purity players or have integrated downstream activities — tend to have larger concerns leveraging economies of scale and sometimes integrating upstream into alumina, and even bauxite mining, to secure their supply chains. It is rumored Gupta may have something of the same objective. He is apparently in talks with Rio for more of its aluminum assets, according to the Financial Times. Rio is also looking to sell a 205,000-ton-per-year Isal aluminum smelter near Reykjavik, Iceland, and its Pacific Aluminum business, which analysts say could fetch more than $2 billion, with Gupta rumored to be interested.

Quite how he has managed to fund his rapid acquisition spree in recent years is the subject of some speculation. With purchases of generally distressed assets in shipping, recycling, banking, commodities trading and energy, there does not appear to be an obvious theme to his empire building beyond being broadly metals-related and presumably cheap.

Turning distressed assets around, though, is a hugely intensive and time-consuming process — and not without considerable risk, as many fail.

Yet so far, Gupta’s vehicles, Liberty Group and Simec under the GFG Alliance holding company, have apparently done rather well.

The success of Dunkerque will be contingent on the French nuclear generator EDF continuing to supply electricity at viable rates. That is probably, for now, a given, since the French apparently are more concerned about maintaining employment of the 600 workers at the plant.