Market Report: Metals Industry Overview

METALS INDUSTRY OVERVIEW>>GLOBAL>>

Robin Bhar, Metals Analyst with Credit Agricole CIB

There is a lot of confusion within the commodity markets. Not just metals but all commodity and financial markets have been undermined by what is happening in Europe with the debt crisis occurring in several countries.

Perhaps it’s a bit overdone, but the market fears that the global recovery will be stopped in its tracks by what’s happening in Europe. There are fears that the contagion will spread to other parts of the world and reverse the recovery. Many people in Europe have remarked about how the sub-prime crisis in America spread globally, and how this could be similar in spreading like wildfire. That’s the worst case scenario of which people are fearful.

On top of that, we have some more negative data out of the U.S. economy—such as weaker housing starts and employment data—that’s an added concern. Thirdly, there are concerns that China will try to engineer more of a slowdown in its economy because it is growing fast and could still be inflationary. Thus, they’re trying to engineer a soft landing.

Another factor is that we’re heading into the slow summer period in the northern hemisphere, where there is normally a drop-off in physical demand and buying activity for metals. That could cause pricing to stay fairly weak or at best to track sideways in the third quarter.

There are a couple of other things to note, which I don’t think will alter the picture drastically but that are probably important developments. China has signaled that it will adopt a more flexible currency regime. There was a feeling of euphoria initially because a stronger Chinese currency can help to rebound growth and make imports of metals cheaper in Chinese currency terms. China is also a high-cost producer of metals like aluminium and zinc, and there is a feeling that if the currency does appreciate, that will raise the costs of production further for aluminium, zinc and nickel. There is a feeling this could lead to production cutbacks or rationalization.

A Chinese revaluation is generally considered positive for the metals markets. But the Chinese authorities have signaled that they don’t want the currency to appreciate strongly, unlike what we saw in July of 2005 when there was one-off increase of about 5% against the U.S dollar. This time they are seeking a more gradual, slow climb in the currency.

So we’ll have to wait to see what the change will be in the currency values. The announcement could have been timed to deflect criticism ahead of the G20 meeting. The Chinese have said what they will do; now we’ll see if they do it.

Another major development that may prove important is that EU leaders have agreed to stress-test the European banks and publish the results sometime in the second half of July. This will be important in increasing market transparency. It will indicate which are the strong banks and which are the weak banks. It is hoped that, much as in the U.S. , if there are some weak banks then government funds from the respective national governments will provide funding to repair the balance sheets of those banks.

If this is well received by the markets, it could mark a turning point in the economy, much like it did in the U.S. After those stress tests in the U.S., suspect banks returned to health relatively quickly. And I would argue today that U.S. banks are healthier than they were two years ago.

In Europe, it could mark a turning point and dispel some of the fears. It’s easy for these fears to circulate because there is not much public data to circulate about the debt the banks are holding and the ability of those banks to withstand shocks such as the one in Greece. I think it’s an important landmark in financial markets—but I don’t think we’re going know much until the end of July.

So there are concerns about global growth but also these important developments--such as the Chinese currency revaluation if it takes place and the bank stress testing when it’s published and if it’s well received by the markets—that could cause a market turnaround and a turnaround in the fairly weak metals prices we have at the moment.

Otherwise, without all these macroeconomic concerns, the fundamentals for metals are pretty good. Demand has rebounded strongly from year-ago levels. There is a bit of weakness because of the onset of the summer months. Exchange inventories are falling steadily.

There are some supply constraints emerging. Treatment charges for spot copper concentrate are very low, so the smelters are having to keep processing fees at a very low level to secure concentrate purchases. That will restrain copper production going forward. And the copper scrap markets are still relatively tight because manufacturing has been in recession. The slow recovery has meant that scrap availability for copper, aluminium and nickel has tightened up appreciably compared to, say, six months ago.

It means that consumers of metals may have to resort to purchasing primary metal for their consumption needs. That’s been very much noted in the market. Even with the copper price up to $6,000 or thereabout, scrap is still tight. Falling prices have also caused some scrap dealers to hold onto material for now.

The fact that metal prices have dropped 15 to 20 percent since earlier in the year has more to do with the fears of lack of economic growth rather than the actual fundamentals of the metals. We don’t yet know whether these fears that have undermined metal prices will come to fruition.

Robin Bhar can be contacted at robin.bhar@ca-cib.com.