Market Analysis

US hot-rolled coil prices retrace. Source: MetalMiner IndX.

Since November — Coinciding with Donald Trump’s victory — U.S. steel prices have been on a tear.

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However, in February momentum started to cool down. It’s now buyers’ job to determine whether this is a major peak or just a pause within this bull market.

Chinese Steel Capacity Rises in 2016

In February, a report by Greenpeace East Asia and Chinese consultancy Custeel stated that despite China’s high-profile efforts to tackle overcapacity, China’s operating steel capacity increased in 2016. The report says that 73% of the announced cuts in capacity were already idle — in other words the plants were not operating. Only 23 million metric tons of cut capacity involved shutting down production plants that were operating.

Meanwhile, some 49 mmt of capacity that had previously been suspended was restarted, and 12 mmt of new operating capacity came online. That means that China added 37 million metric tons additional operating capacity in 2016. 

Hot-rolled coil prices in China also take a pause. Source: MetalMiner IndX.

This news is bearish for steel prices and it is likely contributing to lower steel prices in February, both in the U.S. and China. Read more

Reuters reported that U.S. stock index futures rose to record intraday highs on Tuesday as oil prices surged and investors assessed earnings from top U.S. retailers.

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The theory is share prices are being driven higher by a strong oil price and retailers who are reporting better than expected store sales. Wal-Mart Stores, Inc., Macy’s, and Home Depot sales are all up on robust consumer demand. If stock prices were supported on consumer confidence alone, we could see an argument for this bull run in share prices to continue.

Stocks are up

Stock prices continue to rise thanks to strong retail sales and oil prices. Source Adobe Stock/Tiagozr.

There is plenty of optimism around. Donald Trump’s much-vaunted infrastructure projects are expected to create significant demand and have an inflationary impact on the economy… when they eventually see the light of day. 2018 At the earliest is our expectation since few are shovel-ready and all will have to get past Congress first. Meanwhile, though, the economy is adding jobs at a steady rate and unemployment is low.

Oil Supply

However, if Reuters is right and shares are being driven higher in part due to the oil price, we have a few concerns. The oil price was driven higher by the Organization of Petroleum Exporting Countries‘ production cap agreement last year, an agreement to which both major OPEC producers and 11 non-OPEC countries like Russia signed up to in an effort to reduce excess production and bring the market into balance by the summer. Read more

The 3-month London Metal Exchange lead price is still climbing. Source: Fastmarkets.com.

Lead has had a pretty wild ride over the past few months. After a big run in 2016, prices sold off in December, offering buyers a great opportunity to buy the metal as prices pulled back.

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Prices are now back near new highs as bulls seem to be taking control again. For reasons we’ll see below, we expect momentum to pick up again on the upside.

Global Lead Refined Production and Usage. Source: MetalMiner IndX.

According to the International Lead and Zinc Study Group, in 2016 refined lead supply exceeded demand by 11,000 metric tons in the global market. Read more

The London Metal Exchange steel scrap contract is coming of age much more rapidly than the old steel billet contract did. Unlike its older sibling, the steel scrap contract has the prospect of becoming a meaningful and valuable tool both for the trade but also for analysts and financial players.

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The LME Ferrous Monthly Update report for February reported there was steady uptake of both scrap and steel rebar contracts last year and that there was  a surge of activity in January, for both February dates and out to September of this year. LME Steel Scrap and LME Steel Rebar both traded record volumes last month. LME Steel Scrap traded the equivalent of 262,450 metric tons composed of almost 2,500 individual trades, the LME reports.

Source London Metal Exchange

As volume and liquidity builds, the contract will become more representative of real market prices and as a result increasingly relevant as a viable tool. One measure of liquidity is the narrowing of bid/offer spreads. In a non-liquid market buyers and sellers are harder to find and spreads tend to be wider, but as volume has built market makers have been able to narrow the spreads reducing trading costs and increasing the attractiveness of the contract for hedging. Read more

Source: MetalMiner IndX

Zinc hit a record shortage in 2016. According to the International Lead and Zinc Study Group, zinc registered a deficit of 286,000 metric tons last year. Global usage of refined zinc metal rose 3.6% while supply remained pretty much flat thanks to a number of mine shutdowns.

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The tightening in zinc’s raw material segment accelerated last year thanks to the closure of big mines such as Century, Lisheen and Glencore‘s suspension of 500,000 mt of annual mine capacity. These closures have impacted the supply of mine concentrates drastically and, for the first time, we are seeing an impact in the refined metal market.

In February, Korea Zinc Co. announced it will reduce its refined zinc output by 7.7% (or 50,000 mt) this year. The company attributed its decision to tight supplies of mined concentrate and the accompanying reduction in treatment charges, which have plummeted to multiyear lows.

Prices at Multiyear Highs

Zinc is trading near multiyear highs. Source: MetalMiner analysis of Fastmarkets.com data.

As a result of this narrative of supply shortfall, zinc is trading at the highest levels in more than eight years. Bulls have been in such a powerful position that prices have barely retraced during this run.

Will China Cut Output This Year?

Outside of China, mine supply of zinc fell by 10% last year. However, production increased inside China. In 2017 investors will be closely monitoring China’s numbers. Although output rose, imports slumped by 38% last year. This, combined with falling treatment charges, suggests that a raw material shortfall is building in China as well. China must get serious about controlling industrial metals output to solve its pollution problems.

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The conclusion: it’s only a matter of time before Chinese producers are forced to cut refined zinc output.

The 3-Month LME aluminum price soars. Source: Fastmarkets.com.

Aluminum prices hit $1,900 per metric ton this week. Aluminum has surged 13% so far this year.

China Proposes Supply Cuts to Fight Pollution

We already predicted at the beginning of January that China’s supply would be the most important price driver to watch this year.

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In February, a Chinese government document proposed that about a third of aluminum capacity in the provinces of Shandong, Henan, Hebei and Shanxi be shut down over the winter months. If implemented, they would be some of the most radical steps so far to tackle air quality in the country of 1 billion’s most polluted cities. Read more

Stock markets in China are up nearly 10% this year, outpacing a 4% gain in the S&P 500.

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President Donald Trump’s election victory in November raised worries that his administration would pursue more aggressive policies toward Asia’s biggest economy. On the campaign trail, Trump had threatened to increase tariffs on Chinese exports and label the country a currency manipulator.

FXI China shares attempt to breakout. Source: MetalMiner analysis of @stockcharts.com data.

While these threats haven’t materialized yet, fund managers have focused on healthier Chinese corporate earnings and stable economic data, rather than worrying about protectionism.

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When it comes to providing stimulus to meet growth targets, you can’t bet against China. But when it comes to cutting output, things can get obscure… literally.

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new report by Greenpeace East Asia and Chinese consultancy Custeel says that despite China’s high-profile efforts to tackle overcapacity, China’s operating steel capacity increased in 2016. The report states that 73% of the announced cuts in capacity were already idle — in other words the plants were not operating. Only 23 million metric tons of cut capacity involved shutting down production plants that were operating.

Meanwhile, some 49 mmt of capacity that had previously been suspended was restarted, and 12 mmt of new operating capacity came online. That means that China added 37 million metric tons additional operating capacity in 2016. 

Production Up, Prices Up

Chinese Hot-rolled coil price climbs. Source: MetalMiner IndX.

After falling in 2015, Chinese crude steel output is now rising again at a healthy clip — it was up 4% on the year in the fourth quarter. Meanwhile, hot-rolled coil prices in China rose near 70% for the year. Despite resilient output, demand growth has been much more significant. As a result, Chinese steel exports have fallen double digits for four consecutive months.

Can Just Promises Sustain Rising Prices?

Sentiment in the steel industry is also bullish thanks to expectations of lower output this year. In January, China unleashed its boldest reform plan so far for its bloated steel sector, saying it will eliminate all production of low-quality steel products by the end of June.

Eliminating excess steel capacity and restructuring the industry has enormous environmental significance because the steel industry is the second-largest emitter of air pollution in China. This is another reason to believe Beijing will strengthen its supply-side reforms this year.

However, according to the report most of the capacity elimination target set for the 2016-2020 period has, technically, already been achieved in 2016, meaning that capacity elimination in 2017-2020 will be much more modest unless targets are increased. Meanwhile, a 21 mmt capacity increase is still in the pipeline from new projects, and there is at least 42 mmt of existing idle capacity that could be used to fulfill the capacity elimination targets.

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These numbers give us reasons to doubt on what China can deliver this year. China is now under pressure to demonstrate progress on capacity cuts. But financial and legal incentives to keep marginal firms running will cause regulators to struggle to enforce capacity cuts. Chinese steel mills are so hard to get rid of as they are often a key source of local tax revenue and employment.

What This Means For Metal Buyers

The sustainability of the ongoing rising trend in steel prices will much depend on China. Buyers will need to keep a close eye on how much growth can China deliver and how much of the promised production cuts will actually materialize this year. The problem is that growth without controlling steel out will only translate into severe air pollution.

We warned last month that the mostly small losses the prices our MetalMiner IndX experienced were caused by investors taking profits.

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Our suspicions were confirmed when almost all of our sub-indexes had big price rebounds this month. The Automotive MMI jumped 12.2% Raw Steels 8% and Aluminum 6%. Even our Stainless Steel MMI only dropped 1.7% and has taken off since February 1 as nickel supply is even more in question now with both the Philippines and Indonesia’s raw ore exports in question.

The bull market is on for the entire industrial metals complex. Last month’s pause was necessary for markets to digest gains but the strong positive sentiment for both manufacturing and construction shows no signs of ebbing in the U.S. and Chinese markets.

Last year, investors were wondering whether copper was worth more than $6,000 per metric ton or not.

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Late in 2016, prices were struggling to overcome this psychological level, but things are shaping up for 2017 to be a hot year for copper production, which could translate into a hot year for the copper price.

Upside momentum for copper prices picked up on supply disruptions. Copper rises above $6,000 per metric ton. Source: MetalMiner analysis of FastMarkets.com data.

Escondida Stops Production

Chile’s massive Escondida mine’s processing plants completely stopped supplying refined copper to markets on Thursday as no miners arrived for morning work. The mine produced around 1 million mt of copper last year, or 5% of global production.  Read more