Commerzbank: Correction before further price rises
Base metal prices have risen sharply in the last few months and easily outperformed energy sources and precious metals – despite numerous geopolitical trouble spots recently. Positive economic data has been a contributing factor. That said, the price rallies have also been speculatively driven and we therefore see short-term correction potential. Once the correction is over, we expect higher prices again that could be fundamentally justified in the medium and long term, Commerzbank said in a report.
Base metals trading on the LME have staged a price rally since mid June. The London Metals Exchange Index (LMEX) has risen by 8.6% to 3,316 points at the peak, marking its highest level since March 2013. Compared to its low in March of this year, the LMEX has actually climbed 13.5%. We believe the reasons for this latest rise in the price of base metals were brighter economic indicators and a noticeable tightening of the supply and demand situation on copper, nickel, zinc and lead markets. Moreover, a large volume of speculative money has flown into the commodities market lately. This and the breakthrough of key chart-technical thresholds have strengthened the price rally but also cast doubts on its sustainability. Consequently, correction potential has built up as the sharp gains occurred within a very short period of time. However, in fundamental terms, higher prices could be justified for nearly all metals in the medium to long term.
Positive economic data in China should have an impact especially. In the second quarter, China’s economy expanded by 7.5%, year-on-year, which is somewhat more than market participants had expected. In June, China’s Prime Minister Li Keqiang said in rather unusually clear terms that he would not accept economic growth of below 7.5% this year. As the average annual growth rate in the first half of the year was 7%, a rate of 8% now has to be achieved in the second half to reach this target. Given the low level of sovereign debt, the moderate inflation rate and the investment plans, the government and central bank do have the scope for this. However, a noticeable downturn on the housing market could quash the government’s plans. On the other hand, if this can be avoided and the growth plans realized, this should be reflected in a robust demand for metals and support prices accordingly over the year.
As the base metal sector is not presenting itself as a homogeneous entity at present and different forces are currently working on the metal markets, we take a closer look at the individual base metals in the following and also review the current situation on the iron ore market.
COPPER
Within six weeks since mid June, the price of copper has climbed by 9% or about $600 a ton. However, the sharp price slump in March still gives a negative performance of 3% overall since the start of the year. In our view, it is also questionable whether the last price rise is sustainable as it was largely speculatively driven. This is shown by the CFTC statistics on the market positioning of speculative financial investors. This group of investors repositioned itself completely in the four weeks up to 15 July. Net long positions on the reporting day were at their highest level ever, at 48,900 contracts. This was due to a strong increase of bets on rising prices, which are at a record level. Four weeks before, the majority of speculative financial investors was still betting on falling prices. In the case of profit taking, this would mean correction potential.
In fundamental terms, the situation on the global copper market is rather tight at present, suggesting higher prices. The International Copper Study Group (ICSG) estimates a seasonably-adjusted supply deficit of 381,000 tones fir the first four months. This compares with a supply surplus of 258,000 tons a year ago. While the supply has been expanded by 5.5% on the year, in the review period, global demand has risen at an even sharper rate of about 15%. This is mainly attributable to China, where apparent copper demand has surged by 31% on last year’s low level and is reflected in much higher imports. But demand has picked up beyond China too – for example in the EU (+11%) and Japan (+15%). Consequently, global copper demand has a broader basis again. For China, by far the world’s largest copper consumer, high growth rates are also expected for the full year. Chile’s state-owned Copper Commission stated in its report published at the beginning of the month that China’s copper demand will pick up by 10% this year, which is more than double the rate estimated three months ago.
On the other hand, there are some question marks attached to the planned expansion of supply in the medium to long term. While the “Oyu Tolgoi” mine in Mongolia was commissioned last year and supply has also been expanded in Chile and Peru, the world’s two largest copper producers, the next problems appear to be emerging. Fresh tensions are rising in Mongolia between the mine operator and the government after the tax authorities demanded large-scale back payments. This could slow down the planned expansion of the mine. Furthermore, industry sources report that Codelco, the world’s largest copper producer from Chile, is having difficulties in financing its billion-heavy investment programme to increase supply in the next few years.
On the other hand, on a short-term perspective more supply could enter the market from Indonesia, where “Grasberg”, the world’s second largest copper mine, is located. A mineral ore export ban was imposed there in mid January and no copper concentrate has left the country since. After months of negotiations, Freeport-McMoRan, the operator of the “Grasberg” mine, has been granted government approval to export copper concentrate again. Exports should resume in August and Freeport estimates that it could export over 750,000 tons by the end of the year. In return, the company undertakes to pay higher royalties and an export tax and to build a smelter in the country. Mining production has also been reduced by the interruption of exports but high stocks have been built up in the past few months and more material should therefore enter the market very soon, which should ease the supply and demand situation on the global copper market somewhat. That said, Indonesia has not yet reached an agreement with the country’s second largest international mining company, Newmont Mining, operator of the “Batu Hijau” mine, and the government is even threatening to withdraw its licence. If the trend of the first months of the year continues and the global copper market therefore remains tight, this suggests higher copper prices up to year end in our view. Copper should then be trading at $7,400 a ton.
ALUMINUM
The world is still upside down on the global aluminum market. Despite continued high aluminum production, the price is still rising on the LME and recently reached its highest level in seventeen months at over $2,000 a ton. A glance at the global production rates shows that the market is not tight on paper. According to data of the International Aluminum Institute (IAI), 4.303 million tons of aluminum was produced in June, which was only a good 2% less than the record high in March. China especially has increased its output and is meanwhile producing almost 2 million tons of aluminum a month. The country thus accounts for over 45% of global aluminum production. New smelters have been commissioned in the northwestern provinces especially as land is cheap there and energy is subsidized. The state-owned research institute Antaike estimates that China could produce even almost 28 million tons of aluminum in 2014.
Smelting capacities at the end of the year are estimated at 35 million tons. Aluminum production in China is being kept alive artificially through subsidies as SMM data shows continued losses for over a year now. However, the rise of aluminum prices has meant that these losses have been reduced considerably and currently lie at around 200 RMB a ton (a good $30 a ton) according to SMM, compared to losses of over 1,800 RMB a ton in March. High production rates in China are overcompensating for reductions elsewhere. According to data from RUSAL, the world’s largest aluminum producer, production capacities of 1.2 million tons were shut down worldwide last year. A further 1-1.5 million tons outside China should follow this year. Even so, we do not believe that this will be enough to bring the oversupplied aluminum market for some years now into balance, especially as the last price rally and the high physical premiums evidently lead to temporarily closed smelters being recommissioned. Last year, supply outstripped demand by 1.1 million tons according to data of the World Bureau of Metal Statistics (WBMS). This was the seventh annual surplus in succession.
Demand has been looking very robust for some time and is likely to pick up this year by 5-7%. Besides the construction sector and the packaging industry, the transport sector is playing an increasing role, with aluminum being used more and more in the automobile industry on account of its light weight. The largest US aluminum producer, Alcoa, recently confirmed its demand forecast of +7%. The reduction of aluminum stocks at LME warehouses – stocks have dropped below the 5-million-ton mark again for the first time since September 2012 – is not solely due to higher real demand in our view though. While some cancelled warrants are likely to have been serviced, these are still at virtually record level at 2.88 million tons. This means that the bulk of stocks are still not available to the market. This is also clear from the waiting times for shipments of aluminum: In Vlissingen and Detroit, the warehouses with the highest aluminum stocks in the LME system, the waiting times were 774 and 681 days respectively at the end of June.
Supply on the market is therefore still being artificially tightened by large-scale financial transactions, reflected in physical premiums – a factor that is particularly important for aluminum at the moment. In all key consumer countries and regions, (virtually) record high premiums have to be paid on the exchange traded price of aluminum at present. The premium on the LME price in Europe according to data from Platts is $360-380 a ton (duty unpaid) and 440-$450 a ton (duty paid). In the US, the premium is 20 US cents per pound (corresponding to around $440 per ton) while consumers in Japan also have to pay premiums of over $400 per ton. Low interest rates coupled with the steepness of the forward curve and the retention of existing LME warehousing practices at least for now are making financial transactions still attractive. A trend reversal in premiums or catalysts for such change are not in sight at the moment and we believe premiums should remain high in the foreseeable future.
From a fundamental perspective, the current level of aluminum prices is not justifiable in our opinion. Given high production rates, a lower price would probably be more appropriate. However, the artificial tightening of supply and current momentum speak against a sharp price fall. We see the price of aluminum at $1,925 per ton at the end of 2014.
NICKEL
The nickel price has overshadowed the performance of all other metal prices so far this year. Rising above $21,600 per ton at one point, though this was largely speculatively driven, nickel has registered a gain of over 50%. After the due correction, the price has meanwhile settled between 18,000 and 20,000 USD per ton, which still leaves a gain of 36%.
As already said previously, the strong price rally was attributable to supply outages. Indonesia, the world’s largest nickel mine producer, introduced a mineral ore export ban on January 12th. Despite recurrent trade deficits, this ban has also been strictly implemented so far, resulting in the country exporting hardly any nickel ores since then. China is the main buyer and imported only about 40,000 tons of nickel ores a month from Indonesia in May and June, compared to over 6 million tons in January. That said, Indonesia’s energy and mineral resources ministry recently granted two local mining companies permission to export iron ore and lead and zinc concentrate upon payment of a 20% export tax. This has led to speculation among market players that ore exports could soon resume for nickel as well. The declared winner of the presidential election in late July, Joko Widodo, would like to meet mining companies to resolve the dispute on mining policy. This could mean improved export conditions for companies that have undertaken to build smelters in the country, though whether this will ultimately lead to higher nickel ore exports is questionable.
The export ban has also contributed to a significant reduction this year of the high oversupply on the global nickel market – this was almost 173,000 tons in 2013 according to data of the International Nickel Study Group (INSG). The INSG recently reported an oversupply of 15,000 tons for the first five months of 2014, compared to four times as much in the same period of the year before. That said, nickel ore stocks in China have evidently not been reduced as much as had been expected a few months ago. Japan’s largest nickel producer Sumitomo Metal Mining estimates stocks at somewhat more than 20 million tons, compared to 25 million tons at the end of 2013. A part of lacking nickel ore imports from Indonesia is compensated by higher imports from the Philippines. This means that nickel pig iron production in China is likewise not declining at such a sharp rate as originally expected. According to Sumitomo, 430,000 tons of NPI is to be produced this year, while last year the figures stretched up to 500,000 tons, depending on the source.
Consequently, more supply would be available to the global nickel market again. Nickel stocks in LME warehouses are at record level at any case, at about 316,000 tons. And in contrast to aluminum, waiting times for shipments are not being artificially extended by financial transactions. Cancelled warrants have likewise been reduced in recent months, which points to lower demand.
The future trend of nickel prices should largely depend on whether (more) supply enters the market again from Indonesia. That said, supply should remain limited in the near term at least, which is likely to support the price. In the case of higher exports again, the price of nickel should retreat in the medium to long term. We expect to see the price of nickel at $18,000 per ton at the end of the year.
Base metal prices have risen sharply in the last few months and easily outperformed energy sources and precious metals – despite numerous geopolitical trouble spots recently. Positive economic data has been a contributing factor. That said, the price rallies have also been speculatively driven and we therefore see short-term correction potential. Once the correction is over, we expect higher prices again that could be fundamentally justified in the medium and long term, Commerzbank said in a report.
