Market Analysis

This is the second post of a two part series. You can read the first post here.

Source: Credit Suisse and Brook Hunt

Copper demand in all parts of the world is expected to rise in 2011-13 but growth rates will be highest and overall demand greatest in China as this graph illustrates.

So if demand is forecast to rise at these levels is mine supply able to support it? No major mines are due to come on stream over this period but at a conference held in August, Credit Suisse concluded most mine development would come in the smaller 50-200 ktpa range which makes the supply market much more sensitive to prices. Continued high prices will support ongoing small mine start ups, but a softening in prices could undermine a significant number of projects for which finance is often more precarious. Continued high prices will also support copper scrap markets, which will help to support supplies particularly for China, a big scrap importer, but also for smelters in Europe which have already increased scrap intake to try and offset a scarcity of concentrate this year.

Not everyone is so bullish on prices however. HSBC, typically more conservative than some, sees the copper market in 2010 as having been in balance and is expecting prices to ease back from current levels by year end. As the bank points out, copper has never averaged more than $8000 per ton for more than 5-6 weeks and an annual spot average that high would require spot prices at record levels, which could cause demand destruction. What does the financial services industry say in their small print past performance is no indication of future returns meaning just because it did or didn’t happen in the past is no reason to say it will or will not happen in the future. HSBC realistically makes the point that 2010 demand was a cyclical recovery to the 2009 recession and that a large part of western world demand has been re-stocking. Price strength has been a combination of investment funds taking a view on future demand and limited supply, supported by falling exchange inventories and the simultaneous weakening in the US dollar resulting in a flight to commodities as a hedge against further dollar weakness. How much more money is there chasing the same holy grail?

Which brings us to conundrum that is the copper market in 2011. Clearly demand is strong and is likely to stay in growth mode although with western supply chain re-stocking now well underway and Chinese growth solid but lower than in 2009/10 not at the rate of the last year. Mine and concentrate supply is constrained but probably sufficient with increased scrap supply. The question is how much of the bullish growth picture and constrained supply position is already factored into current prices?  The world’s major money managers appear to be betting the run has further to go, investing in copper miners only makes sense if you feel prices will remain solid in the longer term. Blackrock, the world’s largest global investment fund, is overweight in only two metals sectors copper and iron ore according to a Reuters report in Mineweb. We have underestimated the China influence on rather too many occasions over the last two years and would be hesitant to do so again but we struggle to see further upside to current prices of $8300-8500 per metric ton, let alone Credit Suisse’s $4/lb or $8800+, but with further dollar weakness possible, the risk seems more on the upside than on the down-side.

–Stuart Burns

Reuters reported some bullish comments emanating from an industry conference in Ningbo China this week. Taking the long view, a director at the Ministry of Industry and Information Technology predicted a 25% rise in Chinese copper consumption by 2015 from 2010 demand forecasts. Zhang Fengkui at the Ministry’s Non-Ferrous Metals department said consumption would rise to 8.5 million tons from current levels estimated by Antaike, a state backed analyst, at 6.8 million tons. Consumption this year has been held back in the second half by power cuts imposed as part of Beijing’s drive to meet power consumption and emission targets, consumption that is expected to be made up in the first quarter of next year when controls are relaxed. For Zhang Fengkui to specifically identify power, car and home appliances as the main drivers of increasing demand suggest the state has factored in significant growth into these sectors as part of its new five year plan starting in January.

Analysts differ as to the underlying state of the copper market. All agree that demand growth in OECD markets has been mixed with western European re-stocking strongly in H1 2010.

Source: HSBC and Brook Hunt

North America and Western Europe combined make up only 26% of global consumption against 62% from China and Asia, never mind the rest. So if Asia grows 5% it’s much more significant than OECD demand rising 5%, explaining why predictions of China’s growth are so noteworthy.

Indeed the two drivers this year have been the behavior of the LME and perceptions of the supply-demand balance particularly as it relates to China. First, the LME. Credit Suisse sees the draw down in LME stocks as evidence of physical demand exceeding supply, that is of the market being in deficit.

Source: Credit Suisse, LME, SHFE, Comex

As this chart shows inventory not just on the LME but Comex and the SHFE has fallen since the start of the year and in Credit Suisse’s opinion has been in deficit all year with the normal summer seasonal slow down that would historically manifest itself in rising stocks not occurring   in 2010. Indeed after a slowdown in September, draw downs have picked up again since, supporting prices in Q4.

We will continue with our analysis in a follow-up post.

–Stuart Burns

Purchasing Manager indexes are always closely followed but none more than those for China when looked at in reference to the commodities markets. The belief is a positive China PMI reading is bullish for metals and other commodities. But is that right? Well a note this week by Standard Bank to investors provided a very useful chart mapping the PMI over twelve month cycles year over year as reproduced here. As we can see the PMI and underlying economic activity follow the same seasonal cycle every year. Interestingly though in previous years, October has been lower than September but this year October has continued to rise possibly because the summer trough was lower than in previous years, with the obvious exception of the crash of 2008.

China’s October PMI came in at 54.7 higher than an expected 53.8 and followed two months of rising readings in August and September. Ironically China’s has been rising again just as Europe and the US has been falling, although all remain in positive territory.

The bank contends that all the base metals follow a good correlation to the Chinese PMI with aluminum followed by copper holding the closest correlation. In reality, the relationship is to the underlying conditions that drive both the PMI and the metal price/demand figures.

Source: LME

These graphs from the LME show the bank may have a point. The first is aluminum and the second copper, covering the last twelve months.

Source: LME

Prices dipped sharply in February as indeed did the PMI the month before, but then rose in late Q1/early Q2 before falling again during the summer. The bank suggests the highest correlation is with a 3 month lag so the current rise in the PMI could be supportive of price rises for aluminum and copper in Q4. With several other sources predicting the resumption in price increases in Q1 2011 the current level may prove to be a good time to be fixing forward contracts at prevailing levels.

–Stuart Burns

As part of a new effort to more routinely cover both ferrous and non-ferrous scrap markets, we turn to some recent data that could have a profound impact on how analysts look at overall steel prices. Though dated August 12, 2010, Recycling Today reports that, “a new report by the firm Global Industry Analysts Inc. forecasts the global ferrous scrap market to reach 631.5 million tons by 2015. The research group notes that the figure is expected to be driven by the rise in steel production following a lull in steel industry operations due to the global recession. Ferrous scrap plays a significant role in the raw material cost calculation steel buyers often use to help determine the direction of steel prices. The Bureau of Labor statistics believes EAF production makes up “well over half of all steel production in the US. But industry participants believe that number is now north of 60% of the total market.

To clarify, steel scrap also represents a key cost factor in integrated steel-making, though not as large a percentage of the overall cost as for electric arc production. So let’s break down the numbers a bit further to analyze how scrap prices impact steel prices. According to our own cost breakdown analyses available in our Price Perspectives (our next steel edition will come out this month), the overall scrap cost factors relating to the production of one of steel are as follows:

Integrated Production Using $300 as an average scrap cost (using HMS as the ballpark form) we calculate that for integrated mills, scrap makes up about 9% of the costs to produce one ton of steel.

Electric Arc Furnace Production Again, (using HMS scrap and technically we should be using a mixed ratio of shredded and HMS), we calculate that for the electric arc furnace producers, scrap makes up about 71% of the costs to produce one ton of steel.

So when we see reports suggesting that scrap markets will continue to grow and many developing nations have much less scrap supply (e.g. China, even Turkey), we should not find ourselves surprised that ferrous scrap prices will maintain an upward price trajectory. When we examine the latest ISRI broadsheet data, we can see the index shows positive price momentum:

Source: ISRI and Bureau of Labor Statistics

And though we witnessed a few short-term dips in ferrous scrap prices for November, the long-term fundamentals appear bullish, particularly when one factors in large overseas purchases from countries such as Turkey (read our earlier analysis on Turkish scrap markets).

So though many analysts remain slightly bearish on steel prices at least in the short term, scrap-pricing volatility creates enough uncertainty that we don’t see any near term Ëœdrop-off-a-cliff’ steel pricing. In fact, the underlying scrap markets will largely support steel prices going forward.

Disagree with our analysis our numbers? Drop us a line or leave a comment.

–Lisa Reisman

Success in securing steel import restrictions has encouraged the United Steelworkers and a number of producers to push for similar measures against Chinese aluminum extrusions. Coming fast on the heals of US countervailing duties announced in August ranging from 8.18% to 137.65%, the US Department of Commerce announced last week that they would set preliminary anti-dumping duties on imports of aluminum extrusions imported from China. The duties have been set at 59.31%.

The action was initiated and funded by the United Steelworkers and Aluminum Extrusions Fair Trade Committee in March and had the active support of a group of U.S. producers a Reuters article says, including William L Bonnell Co, Hydro Aluminum North America, Kaiser Aluminum Corp and Sapa Extrusions Inc,  The US producers complained that Chinese imports undercut their market and depressed prices pointing to an increase in imports from that country from $306.8m in 2008 to $513.6m in 2009, a 67% surge according to a Global Times article. Another article quotes the WSJ as saying in 2007 China controlled just 8% of the U.S. aluminum extrusion market, a share that jumped to 20% last year. Over that same time, the WSJ says, prices of Chinese imports of aluminum extrusions have fallen 30 to 50%, figures that could be a little misleading. For a start if the US extrusions market is worth some $3.57bn then $500m is 14% not 20%, but arguably it could mean 20% of a particular sector.

Source: LME

Second, all aluminum prices have dropped from 2007 to 2009 due to the fall in the underlying price of aluminum ingot as the chart above shows.

Nevertheless it is almost certainly a valid point that Chinese imports at a time of relatively low domestic mill utilization will only have been able to compete on price and as such will have had to undercut domestic mills in order to grow market share even though a proportion of the increase from 2008 to 2009 will again be solely due to the rise in the ingot price over the time frame discussed, 2008-9. What is interesting is that as with similar announcements made recently on steel, currency is now being accepted and used as an appropriate example of subsidy. As we have argued for some time, the Chinese are clearly rigging the system by keeping their currency artificially low, just as Britain did in the 1650’s, the US did in the 1800’s, and as Japan and South Korea did in the latter part of the last century. In one form or another, all mercantilist states have implemented protectionist measures in the development stages of their economies. The twin problems for China are that first the country makes up such a significant part of global output that such actions cause severe trade distortions and second that in this century we (including China) have all signed up to WTO rules that make such actions illegal. While economists may argue about what is a realistic level for the Renminbi against the US dollar, none would argue that it should be higher than it is now.

These recent duty decisions will not stop imports from other countries but arguably China is one of the lowest priced and as such domestic US extrusion prices should rise in coming months helping those extruders that have found themselves under pressure. Now that the US Department of Commerce is de-facto accepting that China is manipulating its currency, you have to wonder how much longer it can pursue this policy of hypocrisy in implementing duties on the basis of currency manipulation on the one hand but failing to call China a currency manipulator on the other.

–Stuart Burns

This is the second of a two part series. You can read the first post here.

Although zinc does share alloying applications with copper in brass and bronze making, by far the largest use is in galvanizing. In Europe and the US galvanized steel in the construction industries has remained in the doldrums since before the financial crisis. Consumer goods sales have picked up in 2010 over 2009 but are still below 2007 levels. Only in autos have sales improved and although not back to previous peaks, autos offer a relatively steady market in spite of the demise of clunker programs. However auto sales in Germany have eased recently and with austerity measures about to be introduced in the UK auto sales are set to fall there too so the outlook in Europe is not strong. In emerging markets however cars sales are growing robustly. Although infrastructure and construction spending may slow from the dizzy rates of H2 2009 and H1 2010 in China they will continue to grow, as will activity in India, other parts of Asia, Brazil and even Russia. Credit Suisse notes a high correlation between auto production and zinc consumption so JD Powers’ projection that auto production capacity in China could reach 31 million vehicles by 2015 promises strong ongoing demand for galvanized steel and hence zinc. Both banks expect both refined metal supply and demand to rise as this table shows.

Source: Data drawn from CS, Brook Hunt and HSBC

Where the banks differ is in the level of demand, Credit Suisse being consistently more bullish in the years ahead and projecting a greater deficit by 2013. If refining capacity is restricted as current trends and plans suggest, and demand continues to rise in Asia and with some lag in developed markets then Credit Suisse’ scenario of a deficit in refined zinc supply would logically lead to a tight supply market and higher prices. If however HSBC’s scenario of continued excess mining capacity and sufficient refining capacity is proved to be closer to reality then the more likely result is a continued growth in exchange inventory levels and only moderate advance in prices.

China’s car growth is unlikely to be linear, all markets go through periods of surge and consolidation. In spite of continued investment in new car production in China, the market is over ripe for consolidation and this will be encouraged by Beijing who is looking to encourage fewer globally sized national champions. There is even the risk of over capacity and a bubble in auto production capacity but either way current growth rates of 40+% are unlikely to continue. So demand growth is likely to moderate in China. The question is will this be before demand picks up with any degree of momentum in developed markets?

Nor on the other hand can we see long-term zinc refining remaining in deficit in China. If prices remain around current levels and zinc refining remains profitable, power targets or no we would expect to see new more energy efficient and less environmentally damaging capacity being added. Nor is Beijing going to prevent investment if the alternative is imported refined metal. So metal price not withstanding we would expect China’s refining deficit, if it appears, to be temporary.

Given that our expectation is prices will remain above $2200 per ton but below $2650/ton in 2011, that’s a pretty wide band but the market has been extremely volatile and the announcement of further smelter closures or introduction of a physically backed zinc ETF, while not expected in the short term, could have significant impact on the market. For the next 6-9 months though watch emerging market demand, steel and auto production. It will likely be some time before western markets activities make a significant dent on the zinc market again.

–Stuart Burns

The zinc market isn’t copper and yet along with most base metals, zinc has risen strongly in recent weeks due to dollar weakness and a return to risk led among the metals by the tight and booming copper market. All the base metals have looked a little frothy in the short term. There is a lot of money chasing hedges against further dollar weakness and an enduring belief in the emerging market bull run continuing for the foreseeable future. But in reality what does the future have in store for zinc? We review some of the leading banks opinions and mix in some analysis of our own.

A reduction in LME inventories could lead us to assume the zinc market is getting tighter while at the same time zinc smelters are being closed in China to meet environmental and power consumption targets as part of the 11th Five Year plan suggesting the market is going to be squeezed for supplies. It is reasonable to suggest under those circumstances that the recent strength in the zinc price is less froth and more solid foundation so we thought a more thorough review was in order to see what is really going on and where the market may be leading in the years ahead.

LME inventory levels as we have seen with aluminum can be a bit of a red herring. It is probable that a portion of the zinc coming off the LME is heading back into inventory but off warrant in lower priced storage. A few players have control of a significant portion of zinc market inventory and as such their actions can have a misleading impact on headlines.

It is may be not surprising that even the large banks cannot agree on what the forward supply demand balance will look like. HSBC in a recent Global Metals & Mining Review noted that several major mines, notably Brunswick, Antamina and Century, between them worth nearly 1m tons of capacity will gradually run down during the first half of this decade. Yet at the same time, they note there are a number of sizable new projects planned for development during the same time period and unlike say iron ore, zinc mines have shorter development periods. As such the bank concludes there will not be any shortage of concentrates to the market. In addition, unlike many other metals, China has its own resources equivalent to some 30% of global supply meaning it will not make demands on global supplies in the way it has with say copper or iron ore.

Credit Suisse, on the other hand, focuses on the refining market and in its Commodities Quarterly draws on Brook Hunt research into Chinese smelter capacity to support a growing tightness in refined zinc supply. The research firm is expecting a cut in Chinese refining capacity of 400k tons per annum for each of the next five years. Apparently China has a three-year plan to close 400 kt of obsolete zinc smelter capacity starting with a list of 53 smelters with a nominal capacity of 294kt of zinc to be closed by the start of Q4. Possibly as a result, zinc refinery capacity utilization has increased slightly from 87% to 89%, but it still below the historical average of 95%.

We will continue our analysis of the zinc market in a follow-up post.

–Stuart Burns

As we continue to develop our coverage of the steel industry, we find ourselves struck by the number of enigmas we encounter in our research. For example, about ten days ago, my colleague Stuart wrote a two part series examining the steel industry from a US and UK perspective. In that second post, Stuart rattled off a number of countries that export an excessive amount of steel tonnage when compared to the size and demand for steel within those local markets, “according to the ISSB, the former Soviet states of Russia, Ukraine and Kazakhstan collectively import 3 million metric tons, internally trade just 8 million metric tons but export a whopping 49 million metric tons. Though Stuart’s post did not mention Turkey specifically, Turkey clearly exports a significant amount of steel in proportion to its own local demand. Consider the following data from the World Steel Association:

Source: World Steel Association

US steel demand, typically in the 100+ ton range, has slipped to between 58 million metric tons in 2009, due to the economy whereas Turkey’s production reached 25 million metric tons despite the fact that Turkey has only one quarter the population as the US. According to H. Metin Surmen from Traxys Europe S.A (a raw materials trading company), “ Turkey has always been a steel producing country which has produced more than its consumes. Turkey has to export its production and manage its product range wisely.

Now let’s turn to the method of steel production.

Turkey produces steel using both EAF and BOF production methods but clearly EAF production methods have increased as a percentage of overall steel production:

Source: World Steel Association

Examining Turkey’s exports, we’ll let you draw your own conclusions:

Source: World Steel Association

It is no surprise to see how Turkey’s purchases of scrap (most of it coming from the United States) drives scrap prices on the world market. Although ferrous scrap prices have declined this month by $25-34/gross ton for obsolete grades and $55/ton for Chicago bushelings, according to ISRI, fresh Turkish scrap buying may drive US scrap prices higher.

And though steel price momentum appears to be moving in a downward direction (and many analysts have revised their forecasts lower as we will we with our fourth quarter price perspective), Turkish scrap purchases do impact domestic scrap price levels. If we see some Q4 scrap purchases from Turkey, we suspect the scrap numbers to increase domestically lending some support (although perhaps limited support) to steel prices here. Stay tuned.

–Lisa Reisman

Lead, along with zinc have not been as much in the news of late and while prices rose this month along with the whole base metals complex on a weaker dollar, the heavy metal has been very much in the shade of copper and tin. News late this week of a Chinese smelter closure gave a boost to prices and something of a shock to the market as record Chinese production numbers in September were announced around the same time. The smelter in question is Zhongjin Lingnan’s Shaoguan lead and zinc smelter in Guangdong province according to a Standard Bank note to clients, and although details appear uncertain the belief is the smelter has been closed due to excessive levels of thallium – a highly toxic metal – in the Beijing River. The smelter has a capacity of around 270 ktpy of zinc and 115 ktpy of lead, accounting for around 5.5% and 3% of Chinese production respectively according to Leon Westgate at Standard Bank.

At the same time, Reuters is quoting data from the National Bureau of Statistics that state lead production reached 421,000 tons in September, up 4.2% on the previous record in August and 19.3% from the same month a year last year. Chinese year to date output is over 3 million tons, up 4.5% over the same period in 2009. The increased production is due to improved concentrate supplies and smelters coming back after maintenance close-downs and refurbishments extending capacity.

So what does this increased production mean for the global lead market? Can we expect prices to fall as a result of improved supply? Well first, although China is the world’s largest lead producer, accounting for over 40% of global production according to Credit Suisse and Brook Hunt, it has not been a lead exporter since about 2008 and is unlikely to be with Beijing’s focus on energy use and environmental impact. By the application of export taxes and similar incentives, Beijing will ensure China remains neutral or a small net importer of refined metal. China is however a major importer of concentrate, imports of which have suddenly surged again after several months of decline while Chinese consumers run down stocks.

There is some softening in the demand outlook for refined lead however. 80% of lead is used in the battery industry and 57% in autos. China’s growth in vehicle production has been slowing since April and Credit Suisse notes utilization rates at e-bike manufacturers has fallen since the beginning of this year. Auto manufacture in OECD markets has remained more robust than many expected when stimulus support was removed but still cannot be said to be strong. Stimulus support for car buyers has just been withdrawn in China and evidence in Europe suggests this will result in a sharp slowdown in vehicle sales. Replacement battery sales will continue and increasingly become a major component of the market as those cars and e-bikes require replacements.

Lead concentrate supply is a mixed picture. In China, mine supply has surprised on the upside this year but over the medium term production could decline as the government seeks to consolidate the highly fragmented industry for environmental, safety and energy consumption reasons. Globally supply is more than adequate at the moment but towards the middle of the decade large mines in Australia and Canada will be at the end of their lives and at present there is nothing to take their place.

Source: Credit Suisse

The following table taken from Credit Suisse data summarizes the current and go forward position for consumption, refined lead balance, stocks (LME) and price. We include the reference to the LME in brackets because producers and consumers also hold significant inventory. Last year for example when the LME averaged some 147kt, producers held an estimated 135kt and consumers a further 106kt. But it is fair to say if either got seriously out of balance with the other the LME would be the bell-weather displaying the underlying state of the market.

There is considerable uncertainty about many of these estimates. Domestic Chinese mine production has a significant +/- to it, as does demand from automotive and e-bike batteries. There could well be a softening in demand in Q4, 2010 and Q1, 2011 as demand eases in China and western markets remain flat. Current prices probably already factor in much of the upside for the first half of 2011 but as H2 2011 unfolds, a growing tightness should unleash further speculative buying that will be needed to justify mine expansion in the years ahead.

–Stuart Burns

MetalMiner is pleased to welcome our newest commentator, Taras Berezowsky.

China steel prices appear to be on an upswing at third quarter’s end, but going into Q4, there is still much uncertainty about exactly where prices will be by the end of 2010.

Based on MetalMiner’s latest IndX, as of October 1, most metal types experienced a slight increase [see below]. For example, rebar was up nearly 8 percent from September 1.

Source: MetalMiner IndX(SM)

The slight increases do not necessarily indicate that prices in China, and by extension, much of Asia, are less affected than those in the U.S. As MetalMiner makes clear in its Q3 report, “the US market does have more price protection for raw materials than either Asian or European steel markets.

Though US steel price momentum remains uncertain, China may head toward a slightly different trajectory. News lately has focused on China’s crackdown on oversupply. By shutting down several mills entirely (though temporarily), and decreasing steel production overall by 70 percent, the move was seen as necessary to spur future demand in the Asian market. Now, according to sources, production looks to be restarting.

The Steel Index reports that spot iron ore prices reached $151/ton for 62% Fe fines. Prices have increased 11.5% over the past four weeks.

In a recent Reuters article, Manolo Serapio, Jr., writes that [Australian bank] ANZ said reports that China may be easing power curbs on steel mills “sets the scene for a boost in positive sentiment¦

Raw materials prices, especially iron ore, will no doubt be the primary drivers for increased steel prices. However, China, the biggest iron ore buyer in the world, will encounter market volatility here, as evidenced by the recent iron ore conference in Dalian.

Ian Christmas, the World Steel Association’s director general, quoted by Reuters at a news conference in Tokyo, sees uncertainty here as well. “There is no doubt a very short-term volatility in steel prices coming from raw material prices gives us and customers some issues, he said.

Global steel demand may just be the most important indicator. Demand is set to rise 13.1 percent to 1.27 billion tons this year, higher than an earlier forecast of 8.4 percent growth, according to the Oct. 4 Reuters report. Even Ukraine, the world’s eighth-largest steel producer, has seen sizable increases in crude steel output this year, with 33.5 million tons projected for 2010.

“We are in a transitional period: emerging economies like China, India, Latin American countries and Russia are bolstering their shares in steel output and consumption while demand in developed economies remains in the doldrums,” said Hajime Bada, president of the world’s No. 5 steelmaker, JFE Holdings Inc.

As long as demand in nations such as India stay strong, domestic consumption remains hearty the IMF projects 10.5 percent growth in 2011 and the real estate market is kept under control, China’s steel prices should stay steady.

–Taras Berezowsky

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