By James Williams – Within the S&P GSCI Enhanced Commodity Index, industrial metals returned -4.7 per cent through early June 2012. Whilst not exactly exciting, the space at least held up stronger than energy, which was down 11.1 per cent. Widespread deleveraging and a move to net speculative short positioning in response to continued fears in the eurozone have caused some analysts to revise down their short-term forecasts, with Goldman Sachs, for example, reducing its three-month forecast for copper from USD9,000/mt to USD8,000/mt.
As the Goldman Sachs team wrote in their Commodity Watch report on 11 June 2012, despite reducing their near-term forecasts their base case is still for solid upside on a three-month basis in aluminium (+11 per cent) and copper (+10 per cent). The house view is even more positive for Q4 2012 and is based on the macroeconomic assumption that the US will engage in QE3, Europe will develop a sufficient policy response and China will loosen its monetary policy.
Goldman’s average price forecast for aluminium and copper in Q4 is USD2,400/mt and USD9,000 respectively.
Despite weak macro data, the micro fundamentals for copper have been resilient in 2012. On the one hand ex-China demand has softened (particularly in Europe), but on the other hand demand for social housing construction projects in China has supported consumption levels.
What’s more, because mine supply has been coming in lower than expected, the copper market has been in deficit since April; globally, inventories in copper have been declining on a seasonally-adjusted basis.
Wrote the Goldman Sachs commodities research team: “In our view, the strength in apparent refined copper demand in China so far in 2012 reflects strong property sector completion growth, with both residential completions and social housing completions growth likely contributing to robust copper offtake from the construction sector.
“As social housing completions are not projected to peak until 1H13, this dynamic will likely support Chinese copper and aluminium consumption through at least the end of 2012.”
Daniel Brebner (pictured) is Head of Metals Research at Deutsche Bank. Expanding on the macroeconomic view shared by Goldman Sachs, Brebner thinks that based on global physical fundamentals “prices are likely higher than they should be”, due to the expectations of further monetary easing by China, the US and Europe in Q3. “These expectations have risen over the past quarter as economic indicators globally have deteriorated. This has lent an element of support to the base metals complex in our view,” Brebner.
Brebner confirms that Deutsche Bank’s Q4 average price forecasts across the base metals complex are: copper, USD8,200/t; aluminium, USD2,100; nickel, USD19,000/t, and zinc, USD2,000/t.
This is a more conservative forecast for copper compared to Goldman’s. On the supply side Brebner says that copper continues to disappoint. It should improve over the next several years but there remains a “high probability of further disappointment” that the growth rate could be considerably lower.
Demand remains a key variable and forms the basis for Brebner’s outlook: “While we believe that European inventories are at very low levels, we also believe that inventories in China are the opposite; stocks of copper are elevated and equally importantly that stocks of semi-finished and finished products are also very high.
“Therefore we expect that if Chinese growth begins to recover in the second half of 2012 it may take some time for the copper market in China to tighten sufficiently to push imports higher.”
Sanjay Saraf, Director of Metals Research at GFMS – a Thomson Reuters firm - has the same Q4 price forecast for copper as Brebner at USD8,200/t and thinks that copper has scope to outpace the other base metals “if we see Chinese demand coming back rapidly”.
“In general, miners are finding it difficult to add more copper to the market. Supply tightness for copper is keeping it buoyed. If you look at copper relative to its costs of production it has a greater cushion to its cost curve than for the other metals and that’s partly because of this ongoing supply tightness.”
Some market analysts think copper prices could fall to USD5,000/t in 2013 and although Saraf thinks it quite unlikely, it nevertheless depends on the macroeconomic climate that develops. “If you see continued fall in global GDP growth, a China hard landing and a potential eurozone break up then that sort of price level is certainly within the realms of possibility.
“We still expect to see copper prices in excess of USD7000/t next year, and probably higher than USD8000/t. That’s based on the assumption of more quantitative easing taking place, and in China we’ve already seen a couple of interest rate cuts.”
Aluminium prices – which have fallen from USD2,151/mt to USD1,885/mt through June – now represent good short-medium term risk reward with Goldman Sachs’s trade recommendation being long September 2012 aluminium USD2,150/mt calls at a premium of USD18.8/mt.
“With minimal to no growth in output likely at current prices (even from supposedly low cost areas such as Xinjiang and Gansu in China), any significant growth in aluminium consumption would result in aluminium tightening and prices moving higher,” wrote the research team.
Saraf is not quite as bullish about aluminium’s upside potential given that it has a large stock overhang: around five million tonnes in LME warehouses alone. “A lot of aluminium is tied up in financing deals. That’s keeping availability in the market restricted which isn’t supporting market price so much as supporting premiums, but is nonetheless providing some support to prices. As long as the aluminium forward curve remains in contango and interest rates remain low then stocks will likely remain tied up,” explains Saraf.
The GFMS house forecast for aluminium in Q4 2012 is USD2,075/mt. Both Saraf and Brebner are therefore predicting a more modest bounce compared to Goldman’s forecast of USD2,400/mt. “We believe that aluminium prices will bottom in the current quarter and gradually recover into 2013,” confirms Brebner.
“As well as the Chinese government lowering power tariffs in order to support the domestic aluminium industry, actions have also been taken by the Indonesian government to ban exports of metal ores. This has taken the market by surprise and could have important positive consequences for the nickel and aluminium markets going forward.”
Aluminium prices on average are probably the ones that have fallen furthest below their marginal costs of production. Because of this, Saraf thinks that the downside risk for aluminium is relatively limited, noting that producer results are already showing that margins are being squeezed.
“The restricted availability of the stock could mean that if we started to see some increase in demand consumers might scramble for stock and create a short-term price rally on the back of that. But in terms of a sustained fundamentally-led price rise in aluminium, we’re not so sure of that,” comments Saraf.
Aluminium’s large stock overhang means that further production cutbacks are needed before prices start to recover. Interestingly, as Brebner alludes to above, even though producers like Alcoa in Europe are already beginning to do this, the regional government in Henan Province, China recently introduced power price subsidies to prevent further cutbacks after levels were cut by 700,000 tonnes.
The Goldman Sachs team does not think that such a stock overhang will hinder price recovery in aluminium, pointing to the fact that it traded up to USD2,800/mt in early 2011 with similar overcapacity and stock levels to that seen today.
As for nickel and zinc, the former metal has been dogged by a lot of new projects coming on stream. This has led to a market in surplus. Factor in weak Chinese demand and, unsurprisingly, the price outlook doesn’t look great. Goldman Sachs have an average price forecast of USD18,600/mt for nickel and USD2,200/mt. Saraf, meanwhile, forecasts USD17,750/mt for nickel and USD1,960/mt for zinc. Current prices for nickel and zinc are USD16,603 and USD1,855/mt.
“On the demand side, with the market for stainless steel not being that strong, that has certainly affected the market for nickel. Also, we are starting to see some new High Pressure Acid Leach projects coming on, which in the past have suffered from production problems. We are also continuing to see strong nickel pig iron production in China,” observes Saraf.
A weak demand outlook also applies to zinc and in a similar trend to aluminium, stocks have risen this year but the fact that they are getting tied up in financing deals will tighten immediate availability. “A slow down in the auto market is affecting demand as well, so we expect demand for zinc to remain relatively weak.
“People have talked about some of the big mines closing down as they reach the end of their life, but it might be another couple of years before we see those closures biting into the zinc market,” says Saraf.
Looking ahead into 2013, Deutsche Bank’s Brebner believes that further monetary expansion will improve conditions in base metals: “We remain worried, however, that the spectre of deflation could once again emerge to put renewed and possibly more forceful downward pressure on the complex in late 2013.”