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Base Metal Commentary

By: Natalie Scott-Gray, Senior Metals Demand Analyst, EMEA and Asia region

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Base Metals Close the Week on a Positive Note; Driven by Supply Concerns, Although Anxiety in the Chinese Market is Set to Remain
 
Natalie Scott-Gray
Senior Metals Analyst
natalie.scott-gray@stonex.com
The base metal suite is on track to end the week up by 0.5%, driven by gains in tin (which lifted to its highest level on record in morning trading) and aluminium, on the back of renewed supply concerns. However, with the talk of tapering in the United States firmly set on the horizon over the next six months, and indeed rising concerns over China’s economy from the risk of rising commodity prices, electricity supply tightness and the impact that Evergrande’s possible restructuring has played, it appears we could be in for a bumpy ride to year-end. 
 
LME BASE METAL 3M INDEX (W/W CHG)
Source: Bloomberg 
 
 
LME 3M BASE METAL PRICE PERFORMANCE (W/W CHG)
Source: Bloomberg
 

FOCUS ON CHINA 

Evergrande – Government Restructuring Ahead?
The base metal suite recorded its best daily performance since 18th May 2020 on Wednesday (jumping 2.7%), following the announcement from Evergrande’s main unit that it would make the coupon payment on its domestic bonds (totalling 232M yuan or $35.8M). Evergrande is not only China’s second largest property developer, but is also the world’s most heavily indebted developer (with liabilities amounting to $300Bn), and concerns of a possible default this week impacted not just the domestic market, but global markets as fears grew that this could be the beginning of systemic risk. However, given that the company was due to make a further bond interest payment of $83.5M (this time an offshore payment) yesterday (24th September), yet there has been no announcement, we suspect that this may be due to a possible ongoing Government-led restructuring, rather than outright default. Evergrande also faces a third upcoming coupon payment on its seven-year USD bonds due 29th September for $47.5M (please note the company has a 30-day grace period before any failure to pay officially results in a default). Overall, the future of Evergrande and indeed the wider property sector in China, which has come under strain following tightening regulation (resulting in double digit declines in home sales over the summer months), is set to remain uncertain, creating negative headwinds for base metals heavily utilised in construction such as copper and aluminium.  

 
SCI 300 & CSI 300 REAL ESTATE INDEX
Source: Bloomberg
 
Power Restrictions Remain in the Headlines 
The combination of China’s Dual Control of Energy Consumption programme (to rein in emissions) and fundamental tightness in thermal coal supplies (particularly due to global supply bottlenecks and China’s ban on Australian imports), is likely to result in further production cuts from Chinese base metal smelters in the weeks ahead. Indeed, 21st Century Business reported this morning that up to ten provinces are now facing power rationing and production suspensions. As it stands, base metals most at risk remain aluminium, while zinc smelters are forecast to face limited disruptions, with copper smelters (who front loaded in H1), facing longer maintenance periods to year-end. Meanwhile, this week we heard from the Chinese State Council and National and Development Reform Commission, who vowed to study and solve issues over the last year, ranging from power limits, rising raw material costs and freight rates, with the State Council ensuring future stability in commodity prices and supply in power and gas ahead of the winter. However, the markets appear not to have taken much notice. 
 
 
CHINESE IMPORTS OF THERMAL COAL
 
Source: Bloomberg
 

SNAPSHOT UPDATE ON FOMC SEPTEMBER MEETING 

While the Minutes for the latest September FOMC meeting will not be released for three weeks yet, yesterday we got an insight into the current stance of the Federal Reserve, given the release of updated economic projections over 2021-2024, in conjunction to a press statement from the Chairman, Jerome Powell. 

Economic Projections – Key Highlights: 
-    GDP growth projections for this year were lowered to 5.9% from 7.0% in June, likely based on recent weak economic data driven by the spread of the delta variant of COVID-19. However, GDP projections for 2022 were raised from June’s projections to 3.8% from 3.3%. 
-    Both PCE Inflation and core PCE inflation were revised significantly higher in September’s meeting from June; based on higher producer gate prices which have soared on the back of ongoing supply chain disruptions (we forecast disruptions will continue well into H1 2022). However, what should be noted is that it appears the Federal Reserve continues to see inflation as transitionary, given the outlook for inflation by 2022. 
-    Projections for unemployment this year have risen, coming in at a median expectation of 4.8% from 4.0% in June. 

This news for aluminium comes on the back of a six week stretch, in which aluminium has continued to buck the general trend of the base metal suite, having jumped 12% over the period, versus a rise of just 0.4% for the suite (excluding tin). This is due to the largest aluminium producer in the world, China, undergoing a supply squeeze, with production being hampered from flooding, power shortages, supply bottlenecks as a result of the COVID-19 delta variant, in addition to China’s pledge towards decarbonisation targets. Based on a Antaike presentation last week, it is believed as much as 2.331Mt of aluminium output has been lost so far this year in the country, which (based on 2020 Chinese output figures), amounts to 5.9%. Looking ahead, the Government’s continued efforts to keep commodity prices in check and avoid inflation being passed on from producer prices down to the consumer, have seen the announcement of the release of a third batch of aluminium into the market (via open auction) from its state reserves (please note this is on the back of the release of 140,000t of the metal in two open auctions in July). In addition to this the CNMC (which is responsible for ~ 70% of domestic production) conducted a meeting last week, in which it vowed to maintain price stability and ensure the supply of aluminium. The realisation that more production cuts are likely ahead, especially on the back of emission led drivers, is hampering their efforts. Indeed, it is forecast that on a global basis, aluminium is set to shift into a deficit this year on the back of reduced Chinese output and increased demand outside China.

 
 
SUMMARY OF FOMC ECONOMIC PROJECTIONS (SEPTEMBER VERSUS JUNE) 
 
Source: FederalReserve.gov
 
SUMMARY OF FOMC ECONOMIC PROJECTIONS (2021-2024)
 
Source: FederalReserve.gov
 
FEDERAL RESERVE DOT PLOT - JUNE 
 
Source: FederalReserve.gov
 
FEDERAL RESERVE DOT PLOT - SEPTEMBER
 
 
 
Please note: The dot plot is a collection of projections for the midpoint range for the federal funds rate, provided by the Federal Reserve’s seven Governors of the Board (in Washington) and twelve regional banks Presidents. Source: FederalReserve.gov
 
-    The federal funds target rate has remained unaltered since the last FOMC meeting for 2021. However, where focus should be given is to the dot plot. Indeed for 2022, two more members (since June’s meeting), moved their projections to a rate hike in 2022 (from seven in June), bringing the total vote to an even split, with nine members predicting no rate hike will occur, versus nine that forecast that at least one will. If we dig into these numbers further, of the nine members that forecast a rate hike, three see at least two rate hikes occurring (from two previously). Meanwhile, looking to 2023, there are now nine members who forecast at least one rate hike will occur to a level above 1% (this is up from five in June). 
However, perhaps something to keep in mind here, is that not only were these economic projections most likely voted on pre-Evergrande crisis (which could suggest we may have had a slightly more dovish tone if they had been after). But next year, the voting members of the FOMC will rotate, and as it stands, we are expecting several more hawkish members to be participating in the vote from this year.
Jerome Powell Press Conference – Key Highlights 
-    Mr. Powell alluded that “if progress continues broadly as expected”, then the tapering process could start “soon”, leaving the door open with respect to a tapering timeline, although it is still largely expected that tapering will occur this year. However, he did mention during the Q&A that he expected the tapering process to be complete “around the middle of 2022”. Based on BBG forecasts, given the current level of asset purchases at $120 a month, a rough reduction of $15Bn could occur monthly, if this target were to be met starting in November. 
 
On a final note, something of interest to watch in this sector of the market for a longer-term outlook will be developments over China’s new electricity pricing policy, which is set to begin in 2023. Here the NDRC announced last week that it will improve electricity pricing for the aluminium industry with the classification standard lowering to 13,450kWh/t (from 13,650kWh/t) by 2023 and then 13,300 by 2025. As part of the move, all current preferential power treatment to aluminium smelters will have to stop effective immediately, while the use of renewable energy, excluding hydropower, if higher than 15% of total consumption, will result in a smaller rise in tariffs. Interestingly, rumours in the market at present have suggested that China is likely to announce at the UN Climate Change Summit in November, plans to almost double its current solar and wind energy output, which if confirmed, would support the industry change. This certainly supports our view that the aluminium market is likely to remain in tight balance over the medium term. 
 
 
 
 
 
 
 
 
 
 
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