Market Analysis

We don’t really want to beat the whole ‘base metals ETF’ thing to death much more than the next guy (rare earths coverage, anyone?), but it seems fitting to do sort of a “wrap-up post on how last Friday’s opening of copper, tin and nickel ETPs by ETF Securities went. At least, we can gauge analysts’ reactions to the opening and their expectations for the 2011 aluminum, zinc and lead offerings.

Can the initial trading activity and sentiment tell us anything about the health of future base metal stocks and supply? With a couple trading days behind us, leaving the dust to settle a bit, here are some indicators and viewpoints on where prices especially those for copper are headed.

As a partial answer to a question I posed in my last post on this topic, Deutsche Bank said back in October that physically backed copper ETPs could hold 300,000 to 400,000 metric tons of metal, according to a Reuters article. “That compares with stocks of about 350,000 tonnes in London Metal Exchange warehouses now, the article continued. Meaning, the amount tied up in ETFs will about equal what’s now available, exacerbating the supply tightness rather than alleviating it.

“The next couple of weeks will be very interesting to see what the level of interest is, said David Wilson, analyst at Societe Generale, quoted in the article. “You do wonder if investors may wait until the bigger players’ products are launched. Two of those bigger players are JP Morgan and Black Rock Asset Management, whose ETP launches are reportedly in the works.

Copper is clearly hotter right now than the other two base metals. The nickel ETP was unchanged from the open, and the tin ETP was left untraded on Friday, according to Reuters. In a Q&A published by Reuters’ Metals Insider, Luvata’s head of metals for Europe and Asia, Ian Scarlett, expressed concern for copper especially. “We’re in a period in which availability is challenged, he said. “Anything that ties up physical metal and restricts end users from using copper is unhealthy.

Kevin Norrish, the managing director of commodities research at Barclays Capital, provides a helpful line of reasoning from the investors’ viewpoint in a Financial Times article:

“In current copper market conditions, investors get a return boost from the futures market as it has gone into backwardation, meaning new contracts cost less than expiring contracts. Investors buying into the physically backed product will not enjoy that uplift. It is a contradiction at the heart of the new products that their existence could lead to tighter market conditions, resulting in ongoing backwardation, to the benefit of investors in futures, Norrish says. On the other hand, if spot market prices go down, and futures markets go into contango (new contracts cost more than expiring ones), investors in physical products will still lose out because the cost of warehousing will go up (because the fee is per ton of metal).

Ultimately, Norrish says in the article: “You can’t argue that physical market investment doesn’t have an impact on price.

–Taras Berezowsky

There appears to be no respite in sight for global steel producers. While demand is recovering, raw material prices have risen and according to Credit Suisse – early and major players in the iron ore market – raw material prices are set to rise further. In a research report for investors, Credit Suisse outlined their reasons why they see the spot price moving decisively higher in 2011-12, potentially rivaling the previous highs seen in early 2008 and mid-2010.

Source: Bloomberg

Following a mid-year slump, Chinese steel production has recovered and is forecast to rise further in 2011 just as the slow recovery in Europe and North America gradually drives higher output in developed markets.

Source: Bloomberg

Part of the mid-year dip was due to over-production resulting in excess stocks, but Reuters puts Beijing’s campaign to meet 2010 energy efficiency targets (which resulted in reduced power supply to major industrial users) as the main contributory cause.

China in particular and Asia in general are the main drivers of the iron ore price because of their dominant position in the seaborne iron ore trade, yet China is not totally reliant on imported ore. The trend, though, appears to be that domestic grades have been falling; the bank estimates that compared to Australian and Brazilian 62% Fe content and Indian ore at 55-62% many domestic Chinese sources average no more than 30% and some are at 12%. Combined with rising wages, this has put the marginal cost of production for Chinese iron ore around US $150 per ton for 62% Fe equivalent.

As an alternative to the Big Two of Brazil and Australia, India has traditionally been a significant No. 3 supplier, but volumes are down this year following the Indian state of Karnataka’s ban on exports in late July, followed by a longer-than-usual monsoon hindering production and export shipments. At the same time, the domestic Indian market is consuming ever more of the domestic produced iron ore, a trend that will continue for the next decade or more.

Source: Bloomberg/Credit Suisse

Combined, these factors have pushed up prices in the spot market where much of India’s exports are sold.

The bank sees global steel production rising, saying seasonally adjusted production rose 3.5 percent in October. Supporting this view, Reuters said production was up in November by a further 2.4 percent over October and, quoting CISA, estimated production for the year would be up 8.2 percent over 2009. Credit Suisse expects both Brazil and Australia to remain supply constrained in 2011 such that while exports of iron ore may rise, it will be at a slower rate than steel production. In addition, the cost of production in both China and India is heading in only one direction, further limiting the opportunity for lower-cost material to replace Brazilian or Australian sources even if supply was sufficient, which it clearly appears not to be. In conclusion, the bank expects 62% Fe CFR iron ore prices to peak in Q1 at US $175 per ton before easing to $165 in Q2 and $150 for the second half of the year – China’s marginal cost of production effectively putting a floor under the spot price.

–Stuart Burns

After years of fruitless negotiations with other stainless steel producers, ArcelorMittal has decided to abandon attempts at a negotiated industry rationalization and has spun out their stainless division in a 1 for 20 rights issue to existing shareholders. In the words of a Bloomberg article, the industry, at least in Europe, has been beset with overcapacity and rising costs, producers have been losing money for years and ArcelorMittal’s decision follows that of competitor ThyssenKrupp AG, who abandoned plans for consolidation last year when it couldn’t get a favorable valuation.

As carbon steel mills return to profit, stainless mills are only just turning a corner. ArcelorMittal’s Inox stainless division, with plants in Belgium and Brazil, produced 1.59 million metric tons of steel in the first nine months of this year, resulting sales of $4.18 billion, or 6.8 percent of ArcelorMittal’s total revenue. The division reported a $219 million operating profit in the period. Last year, it posted a $172 million operating loss and lost $119 on every ton it produced. ThyssenKrupp’s stainless unit posted a 946 million euro ($1.2 billion) loss last year, the biggest among its divisions.

The problem for the stainless industry is its rising raw material costs cannot be passed on to consumers due to chronic over-capacity, which results in the mill firstly having to absorb cost increases and secondly unable to amortize its fixed costs over its full capacity. The market is ripe for consolidation, but if it cannot be done by negotiation it will have to be done by takeover and closure. One challenge is that of antitrust. According to a Reuters article, the largest global stainless producer Acerinox has an 11 percent market share in Europe versus 23 percent for Outokumpu. ThyssenKrupp, Germany’s biggest steelmaker, is also the biggest stainless steel player in Europe with 31 percent of the market, making it unlikely the company would be allowed to take on ArcelorMittal’s 22 percent. Acerinox looks the most likely, but they may struggle to find funding.

If not a European, then how about one of the rising stars of Asia? China’s mills, though a growing force in global steel production, are hardly household names, but China’s Taiyuan Iron & Steel Group Co. (said by Bloomberg to be the largest maker of stainless steel by 2009 output) is a possibility. Or Posco of South Korea, or maybe Taiwan’s Yieh United Steel Corp? In truth, though, who would want Inox? The “new company is valued at $2.8 billion but carries $1 billion of net debt. It is barely breaking even and operates in a market with far too much capacity. The probability is ArcelorMittal will have to nurse it along for a while longer before some form of consensus can be reached with European regulators, or shareholders will vote with their feet.

–Stuart Burns

I hope I am not alone in being hugely encouraged by a headline in the Financial Times stating “Xstrata steps up spending plans. It was not the fact that the miner was increasing spending, which comes as no surprise with metal prices back to near record highs; it was the fact they were increasing capital expenditure on their internal portfolio instead of the dubious spending sprees we have seen miners engage in over recent years, like the ludicrous prices paid for acquisitions like Alcan by Rio Tinto that left the latter on the verge of bankruptcy when the markets turned. Rio buying Alcan did not yield one ton more metal for the world, but Xstrata’s increase on capex from US $4.5 billion for 2011 and 2012 to $6.8 billion will result in increased metal availability in the years to come.

“Years to come” is, of course, the problem. Part of the reason we have record prices now for metals like copper is a result of under-investment in the 1990s and 2000s during times of low commodity prices (or when miners’ focus was on easy expansion by acquisition). Now the copper market is in deficit and, according to an FT article, is bracing itself for a 500,000 ton deficit next year — and that is before the impact of ETF Securities’ new physically backed copper, nickel and tin funds starting this Friday. Part of copper’s surge above $9,000 per ton this week is due to the expectation that ETFS’ copper fund will prove popular and, as a result, tie up LME physical metal that would otherwise be available for consumption.

A Telegraph article this week by Rowena Mason adds more detail to Xstrata’s focus on organic growth, saying the miner is the world’s biggest exporter of coal and the extra spend will primarily be on coal, copper and nickel projects. The firm singled out the Ravensworth North coal mine in Australia as the target of a $1.3 billion expansion plan. This mine is scheduled to start producing 8 million tons of coal from 2012. It is currently expanding about 20 mines across the globe and had already increased its capital expenditure program by $5 billion in August.

Nor is Xstrata alone: Rio Tinto is raising capital expenditure on internal assets from US $7 billion this year to US $11 billion next year, and like Xstrata expects to keep an elevated level of investment for some years to come. Even though miners are increasing spending now, this will not equate to increased metal availability for many years to come, in some cases up to 10-15 years into the future — such is the long term nature of major mining projects. So while it is encouraging to see miners commit hard cash to developing in-ground resources, it won’t save us in the short term from higher metal prices if the impending impact of continued emerging market demand collides with increased financial investment vehicles such as ETFs driving another bubble.

–Stuart Burns

Is there any metal or, indeed, commodity in which China is not making the running — where China’s rising demand is not creating a wholly new dynamic in the global supply market? After some thought, one might have ventured uranium, that metal long dependent on the established generating markets of the old order Russia, France, Japan, the US and, more recently, South Korea. But apparently even the uranium market is rapidly changing. According to an FT article, China is aiming to generate 5 percent of its electricity from nuclear power by 2020, in the process quadrupling its uranium consumption to 50 million-60 million pounds a year, according to UxC forecasts.

Source: UxC

That compares with annual global demand of about 190 million pounds today and has seen the Chinese embark on an ambitious and aggressive buying spree at prices some 30 percent over current spot and twice spot prices of a year ago, tying up long-term supply offtake agreements and joint ventures. With minimal domestic production, just 2 million pounds this year, China’s imports have been equivalent to 20-25 percent of global uranium consumption and yet reactor building is still in its early stages with 23 reactors under construction but 120 planned, according to another article.

Ralph Profiti, analyst at Credit Suisse in Toronto, believes China is getting ahead of other consumers and, as with copper and non-ferrous metals, is building up a strategic stockpile before the Americans, Japan or Korea need to do their restocking.

If that is so, the US is particularly vulnerable. The country has over 100 nuclear reactors generating nearly 20 percent of the country’s electrical energy, but the US imports over 80 percent of its uranium supply. If uranium supply goes the way of other commodities, the US could increasingly be a hostage to the fortunes of an increasingly limited supply base as spot prices are driven higher and sources are tied up under long-term supply agreements. Which may explain why US authorities were so willing to pass approval for a Russian state-owned mining company, ARMZ, part of Rosatom power group, to control up to half of US uranium output by the middle of the decade.   The FT this week reported ARMZ has been approved by the Committee on Foreign Investment in the US, the government agency that vets foreign takeovers of US companies for possible national security implications. In November, the US Nuclear Regulatory Commission, which controls the ownership and operation of nuclear power facilities, also gave their go-ahead for ARMZ to take a 51 percent stake in Uranium One. The firm owns resources in Wyoming and plans under ARMZ’s control to ramp up production to between 2 and 4 million pounds by 2015 against a total US production today of about 4 million pounds.

Interestingly, the changing supply landscape has not escaped the investment community. BlackRock, said to be one of the largest investors in commodities, is said to be bullish on uranium, and an exchange-traded fund launched by Global X Funds has increased its holdings to $70 million in just three weeks since launch.

–Stuart Burns

That was the title of a recent webinar presented by the CME Group and Platts, and when the speakers finally addressed the question, the answer seemed to be, well, it already is.

“A picture is worth a thousand words, said Joe Innace, Platts chief editor of Steel Markets Daily, as he showed a graph plotting the Platts IODEX to Comex copper. For most part, the copper pricing pattern has been leading that of iron ore. After running a correlation, from June 2008 to November 24th of this year, Innace found the correlation to be 87 percent. “I believe that’s quite striking, he said, concluding, “Maybe iron ore already is the next copper.

Source: Platts

This may not necessarily be news to our readers MetalMiner has been following copper’s movement for some time now but it simply reiterates the importance of iron ore prices affecting steel demand and pricing in Q1 of 2011. Things are looking up for steel and copper next year. The FT reported that ThyssenKrupp is forecasting a year of double digit revenue and profit growth in 2011. In terms of copper, Reuters reported the same day that Threadneedle Asset Management expects a bumper year for copper in 2011 “as strong emerging market demand outweighs sluggish consumption in the developed world. Copper hit a record $8,966 per metric ton earlier this month.

Emerging market demand clearly colored the majority of the CME/Platts presentation, and showed what buyers can expect price-wise next year. Vale, for example, takes Platts’s IODEX values from this September to November to set their ore prices for 2011. Innace pointed out that the Sept.-Nov. values were up 9 percent from June-August. Both Vale and Rio Tinto are expected to raise fines by significant percentages on a number of products.

Source: Platts

Steel prices are obviously dependent on more than just ore prices; a whole basket of raw materials, seaborne freight and logistics also ties in. Other drivers considered were Black sea prices, Brent crude oil prices (which feed stock for other petroleum derivatives), the convergence between US HRC prices, China prices and FOB Black Sea prices last month, and the tight tit-for-tat moves between iron ore and US ferrous scrap prices.

Ultimately, the conclusion was surprise the volatility in iron ore is here to stay. With new product offerings, the industry will be allowed to manage their price and hedge against credit and risk issues, said Paul Shellman of CME Group. Supply and demand is up to markets, he said, but volatility won’t change.

–Taras Berezowsky

China’s ferro-alloys production has been hit by the same energy restrictions that curtailed aluminum production in the third and fourth quarters this year. A Metal-Pages report states the government had ordered many ferro-alloys producers to shut down in the last few months to meet its energy saving targets. However, the National Development and Reform Commission, the country’s top planning body, said the targets for the period of “11th Five-Year Plan have been achieved in advance. “This could be a sign that power rationing on the ferro-alloys industry will be eased in the following months, said an industry source.

A Bloomberg report suggests Chinese stainless steel production may rise 13 percent next year and Alloy Metals & Steel Market Research is predicting a 4.8 percent increase globally. Worldwide stainless steel production in 2009 was only 2.4 percent and crude steel 97.6 percent of total steel production, according to industry analyst Heinz Pariser. Analysts expect stainless steel demand to recover faster than that for crude steel, where government spending and construction activity have stalled. Demand trends for stainless steel are different from crude steel. Stainless steel is used extensively in consumer-related applications like cutlery, sinks and household appliances, while crude steel’s biggest customers are in infrastructure and construction. Even so, crude steel production is likely to rise on resurgent manufacturing activity in northern Europe and the USA; even if China’s growth rates cool, they will remain positive.

Ferro-alloy prices are generally expected to be supported not just by demand but by rising power costs. Thermal coal prices have been rising and are expected to rise further next year as we wrote recently, and even on current coal prices, some major producers like South Africa are facing rising costs. South Africa’s state power producer Eskom was allowed 25 percent tariff hikes in 2010, 2011 and 2012 by the regulator in February, and the utility has also warned of potential power outages from next year, until the first new large-scale generation plants come on stream. South African power is no longer cheaper than Russia’s or Ukraine’s and is 30 percent more expensive than even in Colorado.

Steel and stainless steel producers alike are caught between the proverbial rock and a hard place, with rising raw material costs but insufficient capacity utilization to raise prices for finished steel.

–Stuart Burns

We’re seeing some mixed messages again in bulk freight shipping prices as November has drawn to a close.

The Baltic Dry Index is down for a third straight session, declining 25 points to 2,145, according to a recent Bloomberg article. The index, long analyzed as an indicator of global economic growth and production, has undergone a rather steady decline during most of November, after hitting a 2010 low on Aug. 9. When last updated on Nov. 26, the index was down 1.4 percent.

Source: Bloomberg

However, this time, the surplus of ships is growing at a much higher rate proportional to the prices of iron ore and steel, which are also rising, driving the prices to rent bulk-carrying freighters lower. Rent prices for capesize ships those too large to sail through the Panama Canal, instead having to swoop around Cape Horn or the Cape of Good Hope dropped 16 percent over four days. (According to estimates by Clarkson Plc quoted in the Bloomberg article, iron ore will go up 6.1 percent, while the capesize fleet is looking to rise by 24 percent.)

Loyal MetalMiner readers will know that this has happened before, as we reported last July, mostly due to the vessel surplus rather than a dip in Chinese/Asian demand. The same holds true today: rebar prices in China have increased, and Chinese output remains strong. China’s PMI rose to 57.4 this past October, while the LEI rose to 150.8, both 2010 highs.

This time, it looks as though the oversupply trend will continue to hold. Alexandros Prokopakis, general manager of Mamidoil-Jetoil SA, mentioned in an interview with Hellenic Shipping News Worldwide that he doesn’t see an end to low tanker freight rates until 2012. “Of course the oversupply will continue to be a crucial factor. I have a very negative feeling for 2011 but I want to believe that mid 2012 onwards things will start to improve, he said. In terms of adding vessels to his fleet, Prokopakis added that he doesn’t think this is a good time to buy, despite attractive prices.

So does the decline in the BDI automatically spell doom for healthy overseas demand? Not necessarily. But we will have to wait for the vessel surplus from recent fleet expansion and the corresponding demand to even out until then, we can expect many more BDI ups and downs.

–Taras Berezowsky

Silver may not match gold as an inflation-hedging investment vehicle in many professionals’ eyes, but it has certainly proved popular with the general public and smaller investors. The Silver Institute reported on its Web site this week that the US American Eagle Silver Bullion coin program has already posted another record year with a month to go.   As of Nov. 24, the date of the press release, over 32 million of the US Mint’s 1-ounce coins had been sold, easily exceeding last year’s record of 28 million coins sold. Should the current pace continue, the Institute believes sales will surpass 35 million coins by year’s end.

Source: The Silver Institute

As this graph illustrates, sales of American Eagle Silver Bullion coins increased by 223 percent over the past five years as investors have taken a liking to holding a physical asset as a store of value separate from deposits or equities. According to the Coin Update News blog site, the US Mint was so overloaded with orders between Nov. 19 and 21 that the website collapsed and several thousand orders were lost.

Minting of silver coins is expected to rise by some 23 percent globally this year to an all-time high. A Bloomberg article reports that Royal Canadian Mint sales of silver Maple Leaf bullion are up 50 percent over those for 2009.

Likewise, the Perth Mint, which currently refines all of the gold mined in Australia, says it expects to sell 50 percent more of its Koala bullion coins this year than last, according to the Gold & Silver Blog.

The recent move towards silver investment comes as the price of silver has been outperforming gold. For the year to date, silver has risen by about 57 percent, while gold has gained about 25 percent. Investor demand this year could top 210 million ounces according to an FT article, representing almost a quarter of the total supply of the metal. Even the Austrian Mint is reporting doubling demand after producing silver Vienna Philharmonic coins at a record pace this year.

Expectations among some quarters, notably Philip Klapwijk, executive chairman of GFMS, are that silver prices will be even higher next year. But as with any trend, the secret is getting in at the bottom and off at the top — assuming you are looking to make some financial gain out of it. After so much movement and after the loss of uplift due to the buy-sell spread — approximately 10 percent — the opportunities now must be somewhat limited for investors recently attracted to the market. A few, such as Mr. Klapwijk, expect the silver price to exceed $30 an ounce next year. But by enough to be worth the risk of a price retreat or even to overcome the buy-sell spread? That’s another matter.

–Stuart Burns

The “Rare Earth Metal Scare, if we can agree to call it that, has lit a fire under some Japanese global corporations when it comes to securing raw material supply. The Ëœalleged’ rare earth export ban from China has put at least two Asian countries in high gear to kick-start a full-blown global sourcing strategy. The fire started when the Canadian Embassy in Tokyo received a request from the Japanese government in November, to conduct a seminar introducing Japanese trading firms and OEMs to Canadian junior rare earth mining firms. The meetings took place earlier this month. We spoke to a source that told us the trading houses had called the consulate up to 10 times per day inquiring about what metals each of the junior miners have available. Several Canadian mining companies participated (Avalon, Commerce Resources, Pele Mountain, Rare Earth Metals, Rock Tech Lithium, Stans Energy   and Harp Capital) and 65 Japanese companies attended, including Mitsubishi, Marubeni, Toyota, Mitsui, Hitachi, Sumitomo and The Japan Steel Works (JSW), to name a few — with just two weeks notice. Three hundred Japanese firms remained on the waiting lists to meet with the mining firms.

This activity comes on top of a recent Japanese government announcement of a $1.3 billion fund to help Japanese firms secure supplies from abroad. The fund encourages typically risk-averse trading houses and end users to find promising properties to make joint venture agreements to secure long term supply, according to Ron MacDonald, a former MP of the Canadian Parliament, now Senior Counsel Global Markets on behalf of Commerce Resources. Specifically, the $1.3 billion fund will go toward four key programs. The first involves reducing use and creating better economics around the use of the metal involved. The second involves programs toward research and development. The third program examines recycling technologies and initiatives and finally the fourth allows for direct investment in firms such as the ones based in Canada. Coordinated by JOGMEC (Japan Oil Gas Metals National Corporation), the organization will have “significant influence in cutting up these resources, according to MacDonald. Part of JOGMEC’s strategy involves early stage investment. Much of the discussions focused on the heavy rare earth metals and the percentages of heavies within each mine’s reserves.

MacDonald, in an interview with MetalMiner, discussed some of the challenges for Canadian mining firms as well as the Japanese mindset when it comes to investing in early stage companies. He suggested that Canadian firms should “get outside their comfort zone. Canadian firms look for funding from closed sources and private placements, but according to MacDonald, “their business is now truly global the pressure is global and the miners need to become more savvy about the international marketplace as that will drive the investment into production. He added that he felt a lot of these companies will have some difficulty moving in that direction.

MacDonald also offered specific advice to the Canadian government. “You have to represent the broad industry of Canada and make sure there is a level playing field to keep Canadian miners competitive, he said. MacDonald went on to say, “we need to be critically aware of what is going on in the US, particularly NAFTA where additional collaboration between the Canadian and US government via the US Restart program can make it easier for American firms to easily invest in Canada. Finally, with regard to down-stream processing that MacDonald characterized as a “difficult and thorny issue, he called on governments to partner with industry and develop cross-boarder strategies in which the US also participates.

From a Japanese perspective, MacDonald believes companies have historically invested too late in the process, after many firms have established long-term agreements as well as made investments. JOGMEC has encouraged Japanese firms to move more quickly and shore up supply and mitigate risk.

The Koreans have also taken a proactive role in shoring up long-term supply. Traditionally they have accepted the higher risk of early investments, particularly in light of supply shortages.

If the Chinese have reminded us all about one lesson regarding the supply of rare earth metals, it is this it almost never makes sense to rely on a “sole source (or in this case, a sole country) without having at least one other viable option available. How long will it take for American firms to take as proactive a stance as Japan and Korea? If you know of US firms aggressively seeking out long term supply, drop us a line…

–Lisa Reisman

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