Base Metal Commentary
By: Natalie Scott-Gray, Senior Metals Demand Analyst, EMEA and Asia region
Despite The First Signs of Economic Recovery in China Emerging, Inflationary Pressures Continue to Build in the West Capping Another Week of Gains – The Question Now Remains – Have We Hit the Bottom Yet?
The base metal index is on track to reverse gains made last week as building inflationary pressures in the west and uncertainty over the timing of China’s recovery weigh on sentiment. In today’s commentary we will explore these key themes and the developments over the last month, while asking the all-important question – have we hit the bottom yet?
BBG BASE METAL INDEX 3M (W/W CHANGE)
Source: Bloomberg
BBG BASE METAL INDEX 3M PRICE PERFORMANCE
Source: Bloomberg
Rising US CPI Catches the Market Off Guard
The headline CPI M/M figure for August reversed expectations of a decline and jumped 0.1% (after holding steady in July), while core CPI doubled growth expectations at 0.6% from 0.3% the previous month. These latest figures have displayed inflationary pressures are broad based and have added to concerns that the Federal Reserve will remain in the hawkish camp for the time being. Indeed, markets are now anticipating a 33% chance of a 100-basis point rise in the 20-21st September FOMC meeting. Please note, the dominance of the U.S. dollar over much of this year (particularly since May), has been a key driver behind price moves, with this week, no exception.
U.S. DOLLAR VERSUS LME 3M COPPER (Intraday)
Source: Bloomberg
U.S. DOLLAR CORRELATION TO LME 3M COPPER YTD
Source: Bloomberg
U.S. IMPLIED OVERNIGHT RATE – 16th SEPTEMBER
Source: Bloomberg
U.S. IMPLIED OVERNIGHT RATE – 31st SEPTEMBER
Source: Bloomberg
Chinese Domestic Demand to Remain in the Spotlight
With the outlook for external demand (ex-China) at risk of weakening in the months ahead, on the back of faster than anticipated tightening of monetary policy amid still increasing inflationary pressures, focus for an improved demand outlook have fallen to China (and the timing of a recovery in domestic demand). However, despite the release of improved economic readings for August (this morning – 16th September), headlines surrounding the pull back of financing to major Chinese metal trading companies has muddied the waters. Indeed, JP Morgan Chase & Co and ICBC Standard Bank Plc are reportedly cutting back on financing to companies such as Maike Metals International Ltd, with credit lines being frozen or reduced. While the longevity of this pull back is unknown (with financial stresses in the country stemming from COVID-19 flare up, weakness in the property sector, fraudulent reporting of metal inventories and nickel’s short squeeze in March), it has only added to headwinds facing China’s future imports (which are already under pressure from a depreciating yuan).
YUAN VERSUS THE U.S. DOLLAR
Source: Bloomberg
CHINESE IMPORT & EXPORTS
Source: Bloomberg
China’s Latest August Readings Could Signal a Turning Point
Despite key headwinds within China, the latest readings out this morning (16th September), are displaying a modest lift in activity in the country and could be suggestive of the beginning of a recovery. Indeed, on a YTD Y/Y basis, industrial production, retail sales and Fixed Asset Investment (FAI) jumped above market expectations, with retail sales recording growth for the first time since March this year. While these readings indicate that policy action taken (such as stimulus spending on infrastructure and tax subsidies on goods such as cars) is starting to trickle into the economy (with the unemployment rate falling for a fourth month), the outlook for the property sector (which makes up 20% of GDP), remains in the red. Indeed, new home prices sank 0.3% from a 0.1% decline in July, while property investment and property sales YTD declined by 7.4% (from 6.4%) and 30.3% from 31.4%. Meanwhile, if we turn to where we are with current COVID-19 spreads, at the end of August, it was reported that China had recorded its broadest outbreak on record (with all mainland provinces have reported cases over the previous ten days), resulting in the Government stepping up travel restrictions. However, as it stands now, restrictions are being eased on the back of locally transmitted cases having fallen to just 126 (on 15th September), its lowest level since early August. Looking ahead, despite having heard from the Director of WHO (on 15th September) stating that that the end of COVID-19 was “in sight”, we do not expect China to remove its zero-tolerance stance until at least the end of October (post the Communist Party meeting, in which President Jinping is looking for a third term).
INDUSTRIAL PRODUCTION, RETAIL SALES, FIXED-ASSET & PROPERTY INVESTMENT (YTD)
Source: Bloomberg
INDUSTRIAL PRODUCTION & RETAIL SALES (M/M Change)
Source: Bloomberg
CHINESE DOMESTIC OUTPUT FIGURES
Source: Bloomberg
Looking at the breakdown of production output by commodity, further positive readings were released for August, with M/M gains for aluminium, 10 non-ferrous metals and steel, with all three of these sectors now on track to record a Y/Y jump for 2022 as a whole. Please note, the Y/Y lift for crude steel in August marks the first gain this year, which comes just as China enters in peak construction season. Meanwhile, despite ongoing power rationing in Yunnan (which is responsible for 13% of China’s total aluminium capacity), resulting in run rates being reduced by up to 30% in September (based on SMM data), domestic output is on track to record a record high in 2022.
Our View
As we look towards the end of the year, we forecast that base metal prices are likely to bottom out in Q3, before finding moderate support from restocking within China and increasing supply risks for high energy intensive metals in Europe (as tensions escalate between Russia and Ukraine over energy security). However, macro headwinds will remain dominate in the form of tightening monetary policy and its impact on global economic growth, further spreads of COVID-19 and uncertainty over geopolitical tensions between the United States, China and Taiwan.
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