By: Natalie Scott-Gray, Senior Metals Demand Analyst, EMEA and Asia region
Base metals continue (as they have done over the last 18 months) to be driven predominantly by macro forces, with the health of the global economy, U.S. dollar and outlook for Chinese recovery at the heart of price direction.
• The U.S. Dollar Versus the Base Metal Index
The base metal index has held a building negative correlation to the U.S. dollar since May 2022; however, over the last month, the weakness within the suite appears to be taking its cues from the outlook on China and growing risks within the U.S. economy.
• Market Concentration Moves Away from Fed and on to Looming U.S. Debt Ceiling
Following comments from Chairman Jerome Powell in the May FOMC meeting, in which he stated that any forward guidance surrounding rate hikes, pauses or cuts would be postponed until June, market concentration has shifted towards the outlook for the Government debt ceiling (especially after Treasury Secretary Janet Yellen stated that the risk of default could arise as early as 1st June). While President Biden and House Speaker Kevin McCarthy have been in talks with state aides over the last several weeks, little progress has been made, with President Biden’s most recent comment (on 14th May), leaving market optimism luke-warm, “I think (negotiations) are moving along, hard to tell”. Please note, President Biden and McCarthy will resume in person talks today (16th May).
• Chinese Recovery Far Behind Market Expectations
In our view, the key driver behind demand growth for base metals this year is set to arise from a recovery in economic performance within China, especially given the surprise dropping of zero-tolerance to COVID-19 in early January. However, with the vast majority of economic readings released for the first four months of the year, markets have been left disappointed.
In our view, there are three main sectors that we are concentrating on when it comes to tracking the health of China’s recovery for base metals, and those are:
1. Outlook for the Export Market
2. The Health of the Property Market
3. Domestic Consumption
1. Outlook for the Export Market
Historically, exports have been a key pillar of strength for the Chinese economy; however, with the impact of higher interest rates set to take full effect in H2 in the west, and falling demand from Southeast Asian nations of late, we forecast that exports will be largely muted this year. In addition, please note, over the last two months, exports to Russia have hit record highs, which may further add to geopolitical tensions between the U.S. and China.
2. The Health of the Property Market
Targeted policy action taken by the Government to support property developers over the last six months is starting to bear fruit, with residential property sales recording a third consecutive month of gains, after having been in the red over the entirety of 2022 on strict legislation polices and low confidence. As a result, residential property prices similarly have started to tick up since February, while infrastructure projects have benefited from improving investment (in the form of Fixed Asset Investment). However, the deep-rooted problems associated with the property market can’t be solved overnight, especially when it comes to restoring confidence, and as a result, property investment recorded a 12 month of decline in April, with the reading falling below market expectations at -6.2% YTD Y/Y. We do not expect a meaningful recovery in the property market (which contributes to one-fifth of GDP growth) until later this year or into 2024.
3. Domestic Consumption
China announced in its annual Two Sessions meetings, that domestic consumption would be a particular focus point for growth this year; however, when it comes to base metal demand, it appears to be solely base metal supply that has benefited from the reopening of the country, with little signs of physical demand recovery.
• Domestic production for ten non-ferrous metals jumped to its highest level on record in March 2023 (with refined copper at an all-time high). Based on data from SMM, aluminium and copper output in March rose to 90% and 91% of total capacity. Based on the latest April data, production of these ten non-ferrous metals is up 10.8% on a YTD Y/Y basis.
• Base metal SHFE stocks remain in double (if not triple) digit levels since the start of the year, highlighting season demand weakness.
• Domestic imports of base metals remain in negative territory on a YTD basis.
• The only April manufacturing PMI reading in expansionary territory was the sub-index for production.
• Chinese headline CPI has been decelerating since the start of the year on lower domestic demand, with April CPI falling to 0.1%, its lowest level since February 2021.
The technical view for the base metal index has grown increasingly bearish since mid-April, with the 50DMA having crossed over the 100DMA to the downside. As it stands now, the next testing point will be to see whether the 50DMA will cross over the 200DMA, which if traversed would signal a death cross. In the absence of a strong trend (with the ADX reading below 25), the index is likely to remain within its long-standing sideways trending channel, although a potential overbought reading on the RSI tracker could provide short-term relief.
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