Over the week to Friday October 16, the world’s base metal producers, consumers and traders converged on London for the annual LME dinner and surrounding events (including Macquarie’s own well-attended conference on the Monday). Contrary to the fears of a year earlier, China turned its economic policies on their head from a tightening bias at mid-2008 to a loosening bias by year’s end, stimulating one of the strongest demand recoveries ever witnessed in that country. Data released over the week to Friday on exports (recovering steadily), construction (booming) and bank loans (still strong and ahead of expectations) suggest that Chinese real consumption for 2009 and 2010 will continue to be revised upwards by analysts in the coming months.
“In addition to stimulating real consumption growth,” Macquarie Research continues, “the Chinese also did two really clever things. First, they (almost) instantly shut their high-cost marginal supply and replaced it with cheaper imports (aluminium, zinc and nickel stand out in this regard). Second, they took advantage of the fact that for a while they were the only buyers and decided to build inventories of base metals for future use at what turned out to be bargain prices. This was both government-sponsored buying and private speculative buyers (often by cash buyers rather than that using cheap and readily available bank credit). In addition, a good part of the extra buying was normal consumer restocking in an economic recovery.
“What dominated discussion though the week was speculation about how big the Chinese stocks were and what Chinese buyers plan to do with their accumulated stocks. We were shocked at the overestimation of these stock levels by many non-Chinese market participants and analysts. This suggested to us that many forecasting organisations and market participants are blind as to the extent of the construction boom, consumer spending boom and export recovery currently under way in China and the extent of the real consumption recovery.
“We are astounded that some are still touting 7% YoY growth in Chinese real copper consumption for 2009, for example (implying a 1.1-1.2 Mt stock build this year), when the available evidence suggests that 20-25% is likely (especially when allowing for the sharp fall in secondary copper availability this year). Similarly, those forecasting sub-10% growth in zinc and nickel consumption end up talking of 150,000 t plus nickel and up to 1 Mt zinc stock build in China.
“Our sense is that the speculative stock holding assumed by many are in reality 50% or more lower. In addition, there are no signs of these stocks being sold (in fact, we believe that the holders are looking for higher prices, are willing to wait a long while for that to happen and may well buy more into any price weakness).
“Non-Chinese world demand has experienced one of the largest slowdowns of the past century from the fourth quarter of 2009. There have been signs of a recovery in recent months, and most economic lead indicators are pointing upwards; however, the magnitude and duration of the recovery remain highly uncertain. In this light, the state of non-Chinese demand was the subject of prolonged discussion.
“We end the week with a similar uncertainty to entering the week (unfortunately). The signals are still very mixed, with reports from Japan being positive (much better orders), from the US being weak (no signs of recovery yet) and from Europe being mixed. In copper, European orders fell in September but now seem to be recovering in October, but there is still no clear-cut trend. Nickel demand looks likely to fall in the short run (following strong QoQ rises in the second and third quarters of this year), as orders have fallen in its main end use (the stainless steel market).
“Certainly, the substantial destocking cycle among consumers appears to be ending, and we expect the call on production to rise even if real consumption remains flat. The question is, will this be enough? Our sense remains that the demand recovery outside China will be slow and could disappoint in the short run (within the next month or so) but then may well surprise on the upside in late 2009 and early 2010 (history suggest this is likely from the lead indicator information we currently have). We believe that Chinese demand may well continue to surprise on the upside (witness this week‟s strong data on September copper imports).
“The other questions will involve the pace and level of the supply response. In copper, where the market remains tight, a considerable number of labour contracts have to be renewed between now and the end of the year, and the supply risks remain to the downside – the Spence strike, the Batu Hijau wall failure and the problems at Olympic Dam confirm this.
“For copper, the consensus was bullish on the fundamental outlook over the medium to long term; however, there was a lack of conviction on the price outlook in the short term (with price risks perceived to be weighted slightly to the downside from here). Indeed, most LME week participants appear to be still waiting for the elusive pullback in copper, to buy/accumulate (a bullish signal).
“Overall, there has been little/no information that has dented our bullish copper view – we still believe that an end to destocking outside China and minimal supply growth should see copper move into balance over the next three to six months.
“Also important in LME week were presentations on copper by Brook Hunt, the influential consulting company, which pointed to ongoing large concentrate shortfalls and market tightness out to 2015 and beyond (in contrast with their more bearish views on zinc, lead, nickel and aluminium).
“In aluminium, the statement that “75% of stocks are not available to the market” due to financing agreements will be subject to a lot of scrutiny and debate – certainly, if prices are driven up by non-availability of material, plenty more idle capacity would become ‘available’ if producers reopen idle capacity and sell forward to lock in a profit. The general view on aluminium was cautiously pessimistic – the caution arose from the bullish comments by influential traders and producers around the likely continued non-availability of stocks. Our view remains that aluminium has limited downside due to cost pressures but limited upside due to plenty of restart capacity (especially in China).
“Zinc and lead were widely debated with no consensus. The bears tended to be very bearish based on expected surges in global mine production in China and elsewhere in 2H09 and 2010 – Brook Hunt called for a 1.5 Mt 2010 surplus if supply continued its current projected course. Others were less convinced that supply could grow so much and were more bullish on demand, and this could help keep prices near current (relatively high) levels.
“In nickel, there are plenty of bears, and there is 200,000 t-plus of idle capacity at the moment that could reappear soon (especially if the Vale Inco Canadian strike ends). There was worry over the potential impact of Chinese nickel pig iron production (where costs are assessed in the wide $5-8/lb range) and over a potential sharp fall in Chinese import demand (already happening). The bulls stated that consumer and producer stocks are chronically low, that Chinese stocks will stay off the market, that Vale Inco will stay on strike for a long time and that stainless steel production could rise strongly in 1H10. The short-term bulls could have a case, but the longer term still looks weaker (with restarts and new projects). There was intense debate, however, on new projects, with most agreeing that perhaps half of the current projects out here (exceeding 400,000 t/y by 2014) could either fail to deliver or experience major delays.
“Another bull factor for commodities generally that was widely discussed was the expected ongoing weakening of the US dollar. Historically, this has been a significant support factor, as it boosts the production costs in countries where costs are not linked to US dollars. In his presentation at Macquarie’s LME Seminar in London on Monday, Macquarie’s Chief Economist, Richard Gibbs, noted that the commoditisation of the US dollar is likely to be a theme that continues to be played out over the coming year.