Market Analysis

Back in early October we published a post entitled: The Case For Steel Price Increases Weakens. We hesitated slightly about calling any outright price declines for several reasons. Ironically, only a month later, we now have multiple mills announcing price increases. AK Steel, will raise base prices for new HRC orders by $30/ton and CRC and coated products by $40/ton effective immediately according to BusinessWeek.   Severstal according to its own website, also raised prices for HRC, CRC and galvanized products by $40/ton effective immediately for shipments through end-December (the company has also announced price increases for January shipments). Finally, Nucor also announced price increases last week, according to Platts “a minimum $30/short ton increase in the base prices of its hot-rolled coil, cold-rolled coil and galvanized products.

In our post of October 4, we called out four conditions that would drive steel prices higher. These drivers include the following:

  • Raw material costs to remain high and volatile
  • Domestic producers must continue to closely monitor production rates. At the time we suggested that though the mills were carefully monitoring production, we felt that with the addition of ThyssenKrupp to the mix late in 2010, producers may have less success in monitoring production rates.
  • An improvement in order books from mills. At the time we said we don’t see a lot of support for that based on recent earnings guidance from several producers.
  • Finally, rising steel prices require strong demand from key manufacturing sectors

So where do we stand today on November 9?

Raw material costs do indeed remain volatile and have moved up in recent weeks. Whether one examines iron ore fines (now up to $157.20/dry metric ton for 62% Fe fines or $126.2/dry metric ton for 58% fines) according to The Steel Index or scrap prices according to October 28 data released by SteelBenchmarker, (shredded scrap is at $334/metric ton, No 1 HMS at $304/metric ton and busheling scrap at $377/metric ton) raw materials have crept up from September and early October numbers.   As for coking coal, my colleague Stuart reported recently these prices will likely increase after this quarter. Score 1 for rising steel raw material costs.

Turning to domestic production, we know from the AISI that steel capacity utilization rates through November 6 dropped to 66.8%, only 5.3% higher than the same time period during 2009. Score 1 for domestic producers holding the line on utilization.

In terms of order books from mills the only evidence we have of rising order books involves lead times. Looking at data from The Steel Index we see a mixed bag on lead times. Lead times appear to have extended for HRC, CRC and HDG but appear to have shortened for plate and rebar. Generally speaking, longer lead times suggest larger order books. Score .5 points for lead times supporting price increases.

Last, we turn to demand from large steel-buying OEMs. We find this a challenging metric to gauge. On the one hand, we saw some better automotive numbers out of October and anecdotally distributors point to very low customer inventories (signaling some re-stocking may appear in the near-term) but the anemic economic recovery and lousy construction markets will continue to put pressure on demand. Score .5 points from key steel buying sectors.

What do our signals tell us? We may see some continued price strength through the end of Q4 but after re-stocking, we’ll need some cheery economic news to sustain the upward price momentum.

Perhaps we can solicit some thoughts from MetalMiner readers via the MetalMiner Steel Market Pulse series (see survey below). We will publish results on Friday.

[survey_fly]

–Lisa Reisman

Will we see aluminum prices suffer because of oversupply issues? Several analysts are saying no, and Harbor Aluminum’s recent conclusions on the topic point otherwise.

Sucden Financial recently released their quarterly base metals report, with a spotlight on aluminum, copper and tin activity. Brenda Sullivan, Sucden’s head of research, spoke with Reuters Insider reporters and underlined that both aluminum and copper are bucking their longer-term downtrends and moving upwards.

Aluminum and copper have both seen historic price increases in the wake of the Fed’s decision to buy up treasuries to the tune of $600 billion over the next several months. The aluminum cash price hit a high around $2,500 before the weekend.

Source: LME

Sucden is forecasting Q4 prices for aluminum to remain in the $2,000-$2,500 range.

Whether this remains a sustainable trend remains to be seen. Volatility has been higher, with spreads tightening, much of it due to supply-side issues. One reason aluminum’s price rise may be short-lived (or, at the very least, illogical) is that warehouse stockpiles are larger than producers would like them to be.   According to an article in Aluminum Investing News, “the amount of aluminum stored in warehouses has climbed to a 32-year high.   In the past year alone aluminum stocks have risen 25 percent, paradoxically futures prices are up 67 percent. Between 2000 and 2009, aluminum demand grew 38 percent, compared to 20 percent across other metals. However, supply has outpaced demand by 6 million tons since 2007, said William Adams, an analyst for basemetals.com.

Going back into the world of ETFs for a moment, Steve Hardcastle, head of client services at JPMorgan Commodity ETF Services, seems to share the view of aluminum perhaps not making the most sense in the ETF market. “The aluminum fundamentals are by no means bullish,” he said in a Reuters report. “I cannot see that aluminum would be a particularly attractive investment for the ETC client base. It would be a very welcome introduction of somewhere else to park this surplus aluminum.”

But with global demand still pulsing (as opposed to domestic demand here in the US, what with the residential construction sector still sluggish) it may be hard to downplay the notion that aluminum prices have room to rise. In contrast to the above views, which downplay aluminum’s potential increases, Harbor Aluminum’s recent outlook seems more a rosy one.

Although we cannot republish these findings in detail, we can report that Harbor expects the developed world to do better than feared, and tightness in the scrap market and the launch of the new ETFs to buoy aluminum demand.

–Taras Berezowsky

For more information on Harbor Aluminum’s research and reports, click here.

Uranium is a metal we do not cover very often but as a material with a key role in power generation and an active spot market it deserves periodic review. Interestingly the market has been moving up. Just last month a Bloomberg article called out advice from Macquarie Group of significant risk of higher prices in the event of supply disruptions. At the time, uranium prices were $4548/lb but since then and even though there have not been any supply disruptions Industrial Fuels & Power reported prices are now at US$ 53.50/lb and annual sales volumes up a third over 2009.

The US tends to look at nuclear power as a sunset industry because reactor construction ceased after the Three Mile Island incident but in some parts of the world, massive nuclear programs are underway, seen as a way to limit carbon emissions and environmental damage from coal. Credit Suisse reports China has 24 reactors under construction about half of which were started in just the last 12 months. China’s target for installed nuclear capacity is 70GWe by 2020 and with only 11 reactors providing 8.6GWe at present, the program will require around 60 new builds. According to the World Nuclear Association such build rates are not unprecedented. During the 1980’s, the world was adding one new nuclear reactor every 17 days, including 47 in the US, 42 in France and 18 in Japan.

Source: Credit Suisse and WNA

In spite of planned reactor new builds of course a number of those old reactors are now coming to the end of their life and as in the UK will be replaced later this decade. To some extent closures will mitigate new builds so that the sum of new capacity added each year will drop as the decade goes on. Even so total nuclear generating capacity is estimated by Credit Suisse as likely to rise from the current level of 373 GWe to approximately 425 GWe by 2014 and 495 GWe by 2020, representing annual growth of about 3%.

Nevertheless UxC, a nuclear industry consultant, and CS estimate prices will rise next year to average $55/lb in H1 and US$60/lb in H2, before powering on to $70/lb in 2012 and 2013. Reactor closures will not begin to significantly feature in removing demand until the second half of the decade by which time mine expansions in Kazakhstan should increase supply and bring prices down slightly the bank says. However, doubts still exist as to the cost model for as yet undeveloped resources around the world and with emerging nations increasingly turning to nuclear power a long-term price of at least $60/lb is expected on solid demand.

–Stuart Burns

A lot of things have been going wrong in the marketplace for Rolls Royce. Their share price fell a bit more than 5 percent today on the LSE in the aftermath of Qantas grounding their half-dozen Airbus A380s. But stock price seems a more near-term hiccup as opposed to the potentially systemic failings of their jet engines. The malfunction may came down to a rather small but not insignificant metal part upon which the propeller is mounted: the rotating spline.

Splines are defined simply as a series of grooves that fit into a shaft to transfer torque:

Source: Perry Technology Corporation

The real issue at hand in the Qantas accident may be the wear and tear noticed on the splines. Aviation Week reported that an airworthiness directive had been issued for Rolls’ Trent 900 engine back in January by the European Aviation Safety Agency.

“As the shaft-to-coupling spline interface provides the means of controlling the turbine axial setting, the wear through of the splines would permit the IP turbine to move rearward¦This rearward movement “would enable contact with static turbine components and would result in loss of engine performance with potential for in-flight shut down, oil migration and oil fire below the [low-pressure] turbine discs prior to sufficient indication resulting in loss of [low-pressure] turbine disc integrity, the article explained.

Clearly, metal factors into the airline industry, in several industrial metals that we cover play crucial roles. Jet engines are made from various alloys of steel, stainless steel, nickel, aluminum and titanium. In fact, according to Rolls Royce’s Web site, the fan containment system in their engines is the first to be manufactured from titanium and does not need the additional Kevlar wrap (which has become more common than the alternative, fiberglass), making it a lighter and smaller system.

In recent years, there has been a significant rise in the demand for titanium and titanium alloys. The price of commercially pure titanium (CP) has risen sharply since 2003, from $15.00 per lb to $50.00 per lb., according to All Metals & Forge Group.  The price remains up as we head into 2011.

Source: InfoMine.com

But Rolls has been under fire for the performance of a number of their latest products. On Aviation Week’s Things With Wings blog, Robert Wall reported that Rolls has experienced several setbacks with their Trent 1000 engine, among other things.

To put this into context, Rolls is the world’s second-largest jet engine manufacturer, and the majority of Airbus’s A380 line uses the Trent series engine.  (The company supplies to Lufthansa and Singapore Airlines as well.) If engine manufacturers like Rolls continue to experience trouble with their products, what could it mean from a design and development perspective using metals? Only time will tell, and we’ll keep an eye on it.

–Taras Berezowsky

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

MM: We have come out saying large parts of this sector appear to be in a “ bubble” yet in your report you state (and we would agree), “Investors have limited experience and knowledge of the technology minerals fundamentals to date as this is a complex new area.” First, do you agree the sector is a bubble (yes/no and why/why not) and second, can you explain some of the specifics (e.g. fundamentals) that you feel investors are lacking?

E&Y: From a company share price perspective, yes the market is probably a little frothy. There does appear to be a lot of hype in the market but not from a metal pricing perspective. Let’s face it, because the politics of rare earth metals specifically the disputes between China and Japan and leaders such as Angela Merkel and Hillary Clinton getting involved, the political agenda is creating the sentiment we are seeing in the market. This may be driving the stock prices of many of these companies. There are quite a few big projects specifically Molycorp, Lynas, Great Western, and one more in Australia coming on stream soon. The question is this – are the valuations of the companies in the sector too high at the moment? It’s possible.

The reality is that the pricing of rare earth metals, increased China demand, and supply chain bottlenecks with few processing plants for rare earths have led not only to an extraction problem but also a refining problem this point is not often made. Skilled labor has disappeared from this portion of the supply chain.

In terms of what investors are lacking, we definitely see confusion over the Rare Earths terminology and what it means. There is a big divide between light and heavy rare earths and confusion over how these metals are used in terms of end industries and their respective future demand.

MM: Do you think China back in the Ëœ70’s when Deng Xiaping famously said, “The Middle East has oil but China has rare earths specifically intended to drop the prices of these metals in the US to effectively take out the US domestic industry?

E&Y: No, we don’t believe China had a sinister point of view or intent to lower prices to sell into the US. They have a different way to operate in terms of profits but they were likely more motivated to create jobs domestically.

MM: You advocate for a number of steps that the EC should take to remain (or become) competitive with regard to REEs. To what extent do you feel the US is doing or is not doing the same series of recommendations?

E&Y: 13% of the world’s rare earth reserves are in the US and the US used to have the expertise to run the supply chain as well. Between the US and Europe, the US is likely better positioned than Europe in terms of reserves. In terms of recycling rare earth metals, Europe may have a greater emphasis than American companies. In the UK, today for example , if you want a replacement mobile phone, the mobile operator is likely to ask you to turn in your old one before you get the replacement, this was not the case 18 months ago, although I am not 100% sure that they can recycle it but there is a change in attitude. In the US, the focus is to keep phones out of landfills, but without those specific rules and regulations. Read more

Though the rare earth field is awash with news and constant media exposure, we recently came across a well-written report examining the European market. The report, published by Ernst & Young, entitled “Material Risk Access to Technology Minerals, discusses many points typically not covered in the now very public rare earth metal discourse. We caught up with Michel Nestour, Director in the Mining and Metals Practice based out of the UK (and author of the study) as well as Andy Miller who leads the Americas Mining and Metals practice for some additional insight into some of the key findings in the report.

MM: Can you give us some background information on the E&Y metals practice?

E&Y: As a practice, we serve 25 of the top 30 mining and metals companies. We perform external audits, tax, advisory and transactional work that includes due diligence, operational M&A and strategy. There are 1000 professionals in the metals and mining practice including mining engineers, mineral process specialists and geologists (Michel came from Corus). We have a global center in Australia, and major operations in the key mining hubs such as the US, Brazil, China, South Africa and Russia. We focus on both mining and metals (upstream and downstream). We also work for some players in the rare earth sector.

MM: You mention in the study that Korean companies are able to take equity positions in rare earth metal companies in China. Though there have been some news reports on specific investments, this factor is not widely known. Are other countries able to do the same and if so which ones and if not, why not?

E&Y: As was reported in the China Daily in June of this year, Posco has taken a 60% ownership stake in a Chinese mining company. This was a way to get access to the export quotas set by the Chinese. Essentially, you want to be near the actual extraction as well as to the refining, fabrication, etc. near raw materials. In addition, Glencore announced it was looking at a rare earths mine in the USA which is currently owned by a private business, Wings Enterprises Inc. In Baotou, a high-tech zone in inner Mongolia, we understand that there are French companies and some outsiders are trying to locate themselves there. In addition, we understand a sideline meeting of the 10-nation association of South East Asian nations (ASEAN) summit in the Vietnamese Capital Hanoi between the Chinese w/ the Japanese and South Korean counterparts on the subject of rare earth metals had been canceled last week.

MM: You cite from an EC report, three minerals that should experience the largest demand growth – gallium, indium and germanium. And we know these metals are by-products of bauxite, zinc, lead and copper. Little is made of this particular issue. How do you see the “rare earth crisis” affecting these three metals? It seems as though the supply chain story here is quite a bit different from the heavy REEs. What are your thoughts?

E&Y: Gallium, indium and germanium are not Rare Earths as they are not part of the 17 elements comprising the Rare Earths.   But they could potentially be considered “Rare Metals.   If you look at these three minerals they are by-products and subject to the supply/demand scenarios for the underlying metals. This drives the larger miners and drives those metals. According to Metals Insider, in China, there is an export quota for example for Indium of 233 tons in 2010 (expectations are that this will be the same in 2011, according to the Chinese commerce ministry). You are asking us whether a large diversified miner will make the investment to refine more of that by-product if demand for the gallium, indium and germanium increase. We do not think so as these products are just credited to cost of sales and the diversified miners generally would rather produce the copper, tin, lead, or zinc.

The large miners look at this sector but the interest is pretty limited it’s just too small for them. If there is nominal investment, they’ll add it. Generally if it doesn’t make economical sense, it becomes a tailings pond.

The second post to this series will appear later today.

–Lisa Reisman

It seems the gold rush is slowly working its way up again.

With an already weak dollar, QE2 around the corner and the price of gold at around $1350 per ounce”and few signs of letting up”certain market watchers and product providers are pointing to these factors as the main reason to invest in gold and other precious-metal securities.

Indeed, if QE2 goes through, many analysts say that gold prices will spike sharply.

One of the liveliest (and certainly lesser-known, at least in some U.S. markets) ways to invest in precious metals is with commodity ETFs. Now, one of the world’s leading promoters and issuers of these funds, ETF Securities (ETFS), is making a run on U.S. markets. More on ETFS’s performance can be found here.

On Nov. 2, at a precious metals briefing in Chicago, ETFS made their bid to prove to Chicago investors the global importance and potential value of investing in precious metals “baskets”bundles of precious metals securities”in this economy.

“At $1300 an ounce, is the price of gold really expensive? No, it’s not! said David Hightower, president and co-founder of The Hightower Report and a speaker at the briefing. “Just shows that times are changing.

In his view, gold’s market price should match the cost of production. By inducing another round of quantitative easing, Hightower later said, the Fed is extending the gold market for the future.

But what do commodity ETFs mean for metals buyers? In terms of gold and silver, probably not much. However, as far as platinum and palladium prices go”and even more importantly, base metals such as copper and aluminum”key developments are on the horizon.

After already introducing physically backed gold ETFs in the U.S. (traded on NYSE Arca), ETFS is set to introduce base metals baskets soon. When MetalMiner asked Nicholas Brooks, Head of Investment Research and Strategy at ETFS, when to expect an announcement on physically-backed base metal baskets, he kept mum.

As we look to watch metals such as copper and aluminum trade on ETFs, the biggest concern is when, not if, inflation will hit. The implications for buyers may be huge.

With Bernanke playing with QE fire the second time this decade, folks such as Hightower see no way around it. “In my 30 years of experience, he said, “I have not seen such a loaded macroeconomic setup for inflation, and politicians think they can stop this.

Regardless, it behooves investors and metals buyers to be educated on commodity ETFs so that they not only are aware of the risks, but of the potential rewards. Firms such as ETF Securities want to spread the word to buyers that the terms “commodity and “ETF, when used side-by-side, will no longer sound as opposite as oil and water.

–Taras Berezowsky

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

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