CommentaryMarket Analysis

Readers in North America can be excused for puzzling why Europeans worry overly about the so-called “Eurozone crisis.”

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They seem to come around periodically. There is a great deal of noise and some volatility in the stock markets, but eventually — whether it is Greece, Spain, Portugal, Ireland, or a combination of several economies — the E.U. seems to have muddled through such crises over the last decade.

Even Brexit is confining its impact to the U.K. economy and has largely left the rest of the E.U. unaffected. But Italy’s latest budget proposals hold the potential for serious disruption, not least because it is the Eurozone’s third-largest economy and a founding member of the trade agreement started in the years after World War II — so its impact is proportionately significant.

So, what is the problem this time, you may ask?

Well, Europe has been slow to recover from the financial crisis of 2008. Debt ballooned in many countries and under the constraints of a fixed currency managed to the advantage of rich northern states like Germany, balance of payments deteriorated as the north imposed austerity on the south (or so many southern states saw it).

The rights or wrongs of the Eurozone’s structure aside, countries like Italy have been constrained for the last decade by fiscal rules set in Brussels. The Italian economy has lagged behind the rest of Europe — unemployment is high and growth is low. As the graphs below courtesy of Stratfor illustrate, the populace has had enough.

Earlier this year, they even surprised themselves by voting in a populist coalition on a platform of radical reform and reflation. That is a policy that puts them at loggerheads with Brussels, which has demanded an Italian deficit reduction that should see the deficit grow by just 0.6%, down from an expected 1.6%, to be achieved by increased austerity measures.

Italy’s new government, a coalition of the Five Star Movement and the League, have presented Brussels with a budget that would see the deficit rise to 2.4% next year, three times higher than an E.U.-mandated target and which Barclay’s Bank is quoted as predicting in The Telegraph will likely exceed 3%, even without a global economic downturn next year.

Italian 10-year debt yields have surged as a result, up near 300 points, not quite at the 400 level seen in the crisis of 2011 but a record four-year high. So far they are only talking about the budget, but nothing has been implemented. After years of QE, banks are holding some €387 billion (U.S. $444 billion) of state debt.

As The Telegraph report observes, banks face mark-to-market losses as yields rise. This erodes their capital buffers, forcing them to curtail lending and further crimping growth. Or, they might have to sell some of their bonds, creating pressure for yields to rise higher.

Either action can quickly turn into a self-feeding “doom-loop,” the paper suggests, as the banks and the sovereign state take each other down.

There is not going to be an Italian sovereign default. Although there are reports of capital flight to Switzerland, it is very unlikely there will be a run on Italian banks as there was in Greece.

However, Italy’s sheer size and core membership of the Euro means Brussels and Rome cannot allow the current standoff to escalate out of control.

Like a runaway super tanker, the situation cannot be easily contained like it was in Greece if the markets genuinely take fright.

You have to have some sympathy for Italy. State spending has always played a massive part in keeping a country together, where geography, history and culture constantly try to tear it apart, a report by Stratfor observed.

Reports of riots in Rome over the appalling state of public services underlines the popular will for public investment, regardless of austerity measures demanded by Brussels. So far, the government has a clear popular mandate to ignore Brussels and go for debt-fueled growth.

Brussels, likewise, is equally set against allowing Italy to buck the rules. The two are on a collision course and set against a backdrop of slowing global growth — outside of the U.S., at least — the economics are not in either party’s favor. Global growth or risk appetite are not going to mitigate the impact of an increasingly indebted Italian economy.

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The stage is set for a potential crisis.

We are not there yet, but in an increasingly nervous investment climate, it could prove a factor in a wider global stock market fall and global retrenchment.

Loss-making balance sheets and cost-cutting in — or lax — oversight of health and safety can go hand in hand; they are often examples of poor management.

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The aforementioned also sometimes go hand in hand with state ownership – in both the developed and developing world.

So maybe it should come as little surprise that, according to a Financial Times report, there has been yet another fatal accident at a loss-making, state-owned Indian steel plant.

For foreign buyers of Indian steel, the red flag is loss-making, state-owned manufacturers also have some of the worse reputations of poor quality.

This latest incident is the announcement involving the death of nine workers and injury of 14 following a fire during maintenance at Steel Authority of India Ltd’s (SAIL) Bhilai plant early last week. The Bhilai plant, in the central state of Chhattisgarh, is the largest operation among SAIL’s plants, and is to be expanded from an annual output of 3.7 million to 6.6 million metric tons.

The Financial Times reports Bhilai had already been the site of one of India’s worst recent industrial accidents in 2014, when six people were killed and more than 30 injured by a gas leak. Two years before that, 19 people were killed in an explosion at the Visakhapatnam Steel Plant, another state-controlled company.

Although the private sector in India is making significant strides in terms of both quality, safety and good governance, the state sector continues to lag behind.

Last year, the British Safety Council estimated 48,000 people die annually in occupational accidents in India, often as a result of poor regulatory oversight, the Financial Times reports.

SAIL is not alone among Indian state enterprises with respect to safety issues — but being one the largest makes it also one of the worst.

The firm reported a net loss of Rs 2.8 billion ($37 million) for the year ending in March, its third consecutive annual loss. However, the Financial Times reports accidents have hit state-run companies in other sectors, notably power utility NTPC, where 43 people died from an explosion of a boiler in northern Uttar Pradesh state last year.

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State enterprises are big employers in India. As such, the government is slow to implement rapid change. Those jobs are clearly not without their risks and the lack of reform continues to not only affect profitability, safety and product quality.

GOES Monthly Metals Index (MMI) spot prices took a big drop while large power equipment manufacturers went head to head with the sole U.S. producer of grain-oriented electrical steel (GOES), AK Steel.

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GOES appears more challenging under Section 232 because both producers and manufacturers make the same national security argument. The sole producer of GOES wants tariff protections pitting supplier against customer, yet the power equipment manufacturers make an equally compelling case.

At issue is that the power equipment manufacturers want an exclusion for GOES not currently produced in the U.S. and the sole domestic producer has argued its products provide an “equal” substitute.

Last month, MetalMiner covered the specific Section 232 exemption requests and responses from ABB and Cooper Power. Posco has also made a notable exclusion request, and more recently SPX Transformer Solutions.

In its surrebuttal (a rebuttal to a rebuttal), ABB argued that AK Steel does not produce a substitute for Nippon Steel’s product. Specifically, ABB used the Bureau of Industry and Security (BIS) standard for exclusion requests regarding product substitution, which notes “a substitute product” must meet “quality (e.g., … internal company quality controls or standards) … or testing standards, in order for the U.S. produced steel to be used in that business activity in the United States by that end user” (83 Fed. Reg.46026, 46058).

Whereas AK Steel focused its argument against ABB on the issue of core loss data — suggesting its products meet the equivalent performance standards of Nippon Steel’s product — ABB argued that the actual data from 2016-2018 certified test reports using ASTM A804 test standards did not meet iron loss and core loss requirements. ABB also submitted confidential data not available for public review.

ABB also claims AK Steel does not meet internal quality controls and standards. This point appears significant, as ABB states,“ABB’s transformers are based on proprietary designs that incorporate quality requirements, including burr height, ‘white edge’ and holes, which have significant impacts on the performance of the transformers.” The company goes on to claim that AK’s manufacturing process is “more prone to creating holes than the process employed by Nippon,” and “white edge is an ABB internal measurement of coating adhesions to GOES products,” of which the coatings are important to prevent transformer failures.

More important, ABB claims that 11 of 12 suppliers, with AK as the lone exception, agree to ABB’s quality requirements on these specific parameters.

The argument is analogous to stating that a steak is a steak, whether you are at Peter Luger or Ponderosa. Sorry, folks, but I’m pretty sure that a Peter Luger filet mignon is going to be tastier than Ponderosa’s version of the same cut (with all due respect to Ponderosa).

Meanwhile, Eaton Corp (Cooper Power), although notably with much less detail, made a similar argument: “The AK Laser scribed material if post annealed, loses ALL of the benefits of the laser scribing process, which is to further align the grain structure to a more efficient configuration. The Japanese product that is Chemically or Mechanically etched retains these important properties even after post annealing. The Japanese material is designated as Permanent Domain Refined Electrical Steel.”

SPX and Posco

Meanwhile, SPX imports the following from Posco: “0.23mm thick DR-GOES of Grade 23PHD080 with guaranteed maximum losses of 0.96 W/Kg @ 1.7 kilogauss and 60HZ.” SPX has requested the exclusion for lack of availability of a similar substitute product.

Posco, meanwhile, like ABB, has outlined a series of arguments supporting its exclusion request.

Import Data Supports OEM Claims

MetalMiner has long reported that the lion’s share of GOES imports come from Japan (versus China, the primary target of the Section 232 steel and aluminum tariffs), suggesting that AK’s material may indeed not be a like-for-like substitute product.

A similar pricing-per-ton analysis would also show that Japanese imports are not “dumped” into the U.S:

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Exact GOES Coil Price This Month

The U.S. grain-oriented electrical steel (GOES) coil price fell for the third month in a row, down from $2,763/mt to $2,446/mt. The MMI fell 18 points to 182.

The GOES MMI® collects and weights 1 global grain-oriented electrical steel price point to provide a unique view into price trends over a 30-day period. For more information on the GOES MMI®, how it’s calculated or how your company can use the index, please drop us a note at: info (at) agmetalminer (dot) com.

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A new Cold War — does that sound ridiculous? Does it sound alarmist?

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It would have been a month or more back, but today it is a plausible statement.

A post by Edward Luce in the Financial Times refers to a Bloomberg expose reporting on how China’s People’s Liberation Army has installed secret micro-chips on motherboards that were used to operate big corporate data servers, giving them unprecedented access to American military and technology secrets on an epic scale.

The microchips are said to be smaller than a grain of rice and thinner than the tip of a sharpened pencil, yet could provide backdoor access into the most secret of American technology. We quote Luce when we say, according to Bloomberg, China may have infiltrated U.S. military hardware, including drones, fighter jets, and so on.

It must be said, major retail hardware providers like Apple vehemently denied the existence of such malicious chips, but Bloomberg’s investigation has been going on for three years and begs the old saying — no smoke without fire.

The investigation apparently is still ongoing. But the consequences, coming on top of an escalating trade war and recent military skirmishes in the South China Sea, herald a new superpower rivalry.

There may be some who scoff at the suggestion that China could rival the U.S. as a superpower, but that is to misunderstand the trajectory of history.

China is on the rise, faster in terms of technology than it is even economically.

Take these secret microchips. As Luce points out, the creation and clandestine inclusion of such sophisticated technology is so hard to pull off that it was likened by a professional hacker to getting a unicorn to jump over a rainbow. It would take years, the article suggests and the deepest knowledge of how to manipulate the most cutting-edge technology across the global supply chain, for China to do this — yet, it did.

Roughly 75% of U.S. smartphones and 90% of semiconductors are made in China; it is safe to bet that domination is set to decline, but it can’t happen overnight.

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In a heated and politically charged scenario, it is not unrealistic to think government will mandate or reward firms that reshore technologically sensitive supply chains, with profound implications for what has become a hugely interdependent world.

In recent years China’s steel sector — particularly the large, state-owned steel mills — have benefited from the enforced closure of capacity on environmental grounds during the winter heating season.

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Contrarian as it may at first sound, closure of private mills largely — on the basis they are unregulated  and are supposedly the most polluting steel mills — was a boost to larger competitors.

About 140 million tons of “illegal” production was closed last year, Reuters reports, only for capacity to be further restricted by Beijing’s war on smog during the winter heating season. The forced closure of steel mills in 26 cities around Beijing and Tianjin hit national output, accordig to the report, contributing to a year-on-year contraction in output during November and December last year.

Demand, however, remained buoyant. As a result, prices rose and exports, the relief valve for excess capacity, fell.

Source: Reuters

It should be no surprise that steel mills in the rest of the world all benefited from less competition and, as a result, higher prices (long before America’s 25% steel import tariffs lifted prices further). Indeed, cumulatively, strong domestic demand and state meddling on environmental grounds have allowed China’s steel sector to make good money and focus on the buoyant domestic market for the last two years.

That may be about to change.

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You can’t open a newspaper, of the online or paper variety, without coming across an article on productivity.

Productivity growth has been meager for the last decade. How to achieve productivity levels seen in the latter part of the 20th century and early part of this one has plagued the minds of economists, politicians and business leaders alike.

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Source: Seeking Alpha

You may ask, why should we be bothered?

The only way an economy can afford to pay its workers more next year than last year, inflation aside, is if the business increases its output per unit of input. Broadly speaking everyone has to be producing more for the same amount of work in order to justify higher salaries, whether that is at the level of the company or the economy as a whole. Economic growth is not enough; it needs to be accompanied by productivity growth to achieve a rising standard of living.

The industrial revolution saw an unprecedented increase in productivity enabled by the automation and mechanization in factories of work that had previously been done by hand by artisanal workers. It was widely expected that the information technology revolution, particularly the internet, would deliver much the same increase in worker output.

But while it has undoubtedly revolutionized both businesses and our everyday lives, it has perplexingly failed to deliver the expected increase in productivity.

An article in the Financial Times makes an interesting contribution to the debate, whether you accept its point of view or not. Rana Foroohar this week penned a post entitled “The Productivity Conundrum” which, while light-hearted in tone, makes an intriguing proposition — maybe low productivity growth is not a failure of the system despite IT, but IT is actually part of the problem.

Foroohar quotes research by economist Alan Blinder who, and I quote, “has raised the possibility that high-speed digital technology – email, apps, etc – are actually reducing productivity by taking us away from our work.” Foroohar quotes other studies that suggest the average person touches his or her phone 2,617 times a day, every time potentially taking their attention away from work, not just for the seconds needed to read the message but for the time required to refocus on the original task.

On an anecdotal level, it is commonplace to see shoppers walking around supermarkets checking their phones or on Facebook. How much longer is that shopping trip taking than it would if they focused on the job in hand?

What is the answer?

Well, it’s not do away with iPhones, emails and messaging services.

The reality is we have all become too dependent on them, and while they may get in the way of our efficiency at work they can facilitate many other aspects of our lives.

The choice is not binary. One option many firms are experimenting with is staying offline for periods of the day when addressing a critical task. The focus that reducing distractions brings not only allows us to be more productive but also more creative, allowing us to not just work faster but work better.

I am not sure what the ideal balance would be. In reality, it is likely to be different for different workers depending on your role, but much like a dieter having to exert discipline in the choice of what to eat and when to eat it, I can already see there will be multiple pressures to maintain the current sloppy status quo. That’s why firms creating guidelines for staff is a good idea. Guidelines allows for role- or industry-specific variability to be accommodated, but also provide a framework for individuals adopt — much of the success of weight watchers is down to the shared nature of the endeavor.

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Turn off that iPhone and close down that app for an hour — you never know, but you may actually be more productive (and less stressed) as a result.

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Well, that didn’t go very well, did it?

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After a couple of weeks scurrying around European capitals and intense lobbying directly to E.U. leaders, Britain’s Prime Minster Theresa May received short shrift at an E.U. conference in Salzburg, Austria last week.

May sacrificed a lot internally in the run-up to the conference. She faced intense opposition from her own hard right against her so called Chequers plan (termed thus because it was presented at the prime minister’s grace-and-favor residence Chequers in the summer), she lost two cabinet colleagues who resigned over it and has faced opposition from just about everyone, inside her party and out.

May had hoped it would form the basis of a negotiated exit agreement encompassing a free trade deal on goods but not services, plus much more with the E.U.

The E.U., meanwhile, has problems of its own — granting the U.K. any kind of conciliatory deal would make matters much worse.

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At a recent forum for business leaders, I was surprised the topic of conversation was not Brexit or Donald Trump’s latest tweet, or even cricket, but when the next recession would hit.

That hasn’t been the case for many years now. Since 2009, we have experienced a more or less constant bull market, giving us the longest run of positive growth for a hundred years. Business leaders have been cautiously optimistic growth would continue for the foreseeable future; only recently has the tone changed.

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Not that it has felt quite that joyous — markets have been volatile, particularly commodities, and in Europe government-imposed austerity aimed at balancing excess state spending needed to nurse sick economies back to growth has meant many have felt life has been tough up until the last few years.

But now many in government, industry, academia and even the media are asking the question: when will the next recession hit?

Typically, the media, as here in The Telegraph, are being somewhat more sensationalist about the issue. For example, “The next downturn could rival the Great Depression and wipe $10 trillion off US household assets,” the headline of The Telegraph article reads.

But even so, the article in question makes some sound observations.

Martin Feldstein, president of the U.S. National Bureau of Economic Research and a former chairman of the White House Council of Economic Advisors, was quoted as saying “We have no ability to turn the economy around, fiscal deficits are heading for $1 trillion dollars and the debt ratio is already twice as high as a decade ago, so there is little room for fiscal expansion.”

The worry is that after years of sluggish growth, ultra-low interest rates and the buildup of a massive Federal Reserve balance sheet of assets the world’s major economies lack the fiscal, monetary, and emergency tools to fight the next downturn.

Source: St. Louis Fed

Nor is the U.S. the worst-placed. The economy is still experiencing good levels of growth, the Fed is gradually putting up interest rates (which will allow it to cut later if needed) and the country is blessed with a strong central bank.

But Europe has no fiscal backup, rates are still at record lows and the ECB has committed to holding its reference rate at minus 0.4% until the end of next year, the article states, by which time the end of the cycle could be almost upon us.

Another Telegraph report is suggesting there is a one-in-three chance of a U.S. recession within the next two years, citing the most probable catalyst as the Federal Reserve overtightening monetary policy.

Two economists from the CME Group are quoted as predicting the next recession was unlikely to be caused by mortgage debt or financial panic, as in 2008. Instead, Bluford Putnam and Erik Norland predict the recession will be triggered by U.S. interest rates being raised too high, which will cause trouble in emerging markets and overvalued technology stocks.

Certainly, technology stocks are a concern we all like to ignore when we look at our latest portfolio revaluation. The S&P 500, which is 25% tech stocks, is up 300% since March 2009, while the Nasdaq, which is majority tech stocks, is up 600% — those seem sustainable today based on current earnings, but are they long term?

The stock market, tech stocks included, remains remarkably solid and earnings remain robust such that, at least on current numbers, valuations are not ridiculous.

But economies outside of the U.S. are already showing signs of distress from the modest Fed tightening we have seen so far.

Some emerging-market currencies — like those of Turkey, South Africa and Argentina — already fragile, have taken a pounding this year, dramatically raising local currency costs for dollar-denominated debt.

The biggest gorilla in the room is China, facing a combination of long-term structural issues, such as a shaky shadow banking sector, non-performing debt and a slowing economy due to a trade war with the U.S. that is getting out of control.

The U.K.’s former prime minister Gordon Brown is quoted as saying the world is “in danger of sleepwalking into a future crisis,” adding the next crisis could well start in Asia because of the amount of lending through the shadow banking system.

Unfortunately, the climate of international cooperation is not the same as it was in 2008; today, the focus would be on apportioning blame instead of fixing problems. “Countries have retreated into nationalist silos and that has brought us protectionism and populism. Problems that are global as well as national and local are not being addressed,” Brown is quoted as warning.

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For now there is not much buying organizations can or should be doing. Most expect the next crisis could be 12-24 months away, but the sheer number of parties that are talking about it could herald its arrival by sheer dint of expectation.

The aluminum market is facing much more uncertainty now than it was in February 2018 when Norsk Hydro agreed with Rio Tinto to buy the 205,000-ton-per-year capacity ISAL aluminum smelter, located in Hafnarfjörður, Iceland.

According to the Financial Times, that deal included the balance 53.3% share in the Aluchemie anode plant in the Netherlands that Hydro does not own and a 50% share in the aluminum fluoride plant in Sweden, from Rio Tinto.

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The transaction to acquire Rio’s last remaining aluminum assets in Europe was initially expected to be finalized in the second quarter of 2018 following the surprise agreement by Rio to sell its aluminum Dunkerque smelter in France to Liberty House for U.S. $500 million in June.

The announcement of sanctions on Oleg Deripaska in April this year — and by extension En+ and Rusal, the largest aluminum producer outside of China — has cast some doubts on alumina supplies for European smelters, as Rio sources some of the alumina for its ISAL plant from the Russian company’s Aughinish refinery in Ireland.

But Rio seemed quite confident it could source alumina from elsewhere and Norsk Hydro certainly has enough alumina supply options around the world that raw material supply should not be a major issue.

No, the main reason the firm pulled out seems to be the initial feedback from the E.U. competitions authority, which was raising concerns about market domination reducing competition in Europe if the deal had gone through.

Norsk Hydro makes around 2.1 million tons of primary aluminum a year and ISAL would further consolidate its position as the largest primary supplier in the European market. However, competition authorities may still have had one eye on the Rusal situation.

If, as some are now beginning to question, the sanctions are not lifted in October when the current extension expires, primary metal supply will become very tight in Europe again.

Rusal produced some 3.7 million tons last year according to its annual accounts. While a proportion is consumed domestically, some 0.9 million tons, a significant percentage is exported to the European market, usually under annual supply agreements. If that tonnage is denied the European market due to sanctions, competitions authorities may worry the remaining suppliers will have too much influence to ensure an open and competitive marketplace.

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Fortunately, Rio is making good profits out of its aluminum business, the Financial Times reports — some U.S. $1.58 billion last year — so it is hardly desperate for a sale.

Still, investors were not heartened by the news. Rio’s share price dropped $0.14 on the news, down nearly 16% from its 2018 high of $86.75 in May of this year.

There used to be a time when you were wary of parking your car in an unlit street or side road for fear you may come back to find it jacked up on blocks and all four shiny alloy wheels missing.

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Locking wheel nuts went a long way to alleviating that fear and theft of alloy wheels is mercifully much reduced … only, it would seem, to be replaced by a new worry: theft of your catalytic converter.

According to The Telegraph, thieves are cashing in on six-year highs in prices for the rhodium, palladium and platinum in your car’s catalytic converter — particularly if you own a BMW, Audi or Volkswagen, at least here in the U.K. — the article reports.

Thieves are becoming very discerning, choosing certain models because of their relatively higher precious metal content (such as older Honda Jazz and Accord models) or due to their greater road clearance and easy accessibility (such as the Mitsubishi Shogun SUV).

For reasons of accessibility alone, SUVs are a favorite target because a jack isn’t required to get underneath, speeding up the process and reducing the chance of being seen or heard.

Nor does it take long to do. Apparently, a gang using battery-powered saws can have your motor jacked up or slid under and the requisite parts cut out in around 5 minutes – probably the same nifty team that used to steal your alloy wheels have just found an alternative target.

Rewards are probably similar too, the article suggests. Thieves earn up to £300 (U.S. $400) from your stolen catalytic converter, with the devices often exported to jurisdictions where the traceability of materials sold for scrap is not as rigidly enforced as the U.K.

Catalytic converters have been fitted in the exhaust of the majority of petrol cars manufactured since 1992 and diesel cars since 2001.

According to the British Automobile Association, the metal case of the converter contains a ceramic honeycombed structure that provides a massive surface area across which exhaust gases flow. Precious metals like platinum, palladium and rhodium are coated onto this ceramic structure, exploiting their properties as catalysts with the intention of cleaning the exhaust gases of harmful pollutants.

To extract the precious metals is a complex and potentially toxic process that can only be done in a sophisticated recycling plant. However, as metal prices rise, these platinum-group metals (PGMs) become progressively more valuable as scrap; as such, our vehicles are now said to be more at risk than in the past.

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Beware parking up at a country fair, event or show where the vehicle is left all day among thousands of other vehicles. Apparently, there are vibration-sensitive alarm systems you can have fitted to pick up the vibrations from a saw, and you can get your catalytic converter welded to the vehicle frame to make it harder to remove.

Despite such precautions, thefts are rising, so keep away from those side roads, unlit streets or parking overnight on the front drive, or your car may sound more like a Sherman tank than a limousine next time you go to start it up.