Wednesday, March 16, 2016

Industrial Metals: Bull Market or Dead Cat Bounce?

After a disastrous year in 2015, industrial metals started off on the right foot in 2016. Indeed, every single base metal is up in price on the year-to-date.
But, is this price rally just another dead cat bounce or the start of new bull market? and, what factors do we need to watch for more clues?

Sharp Rallies Are Usual in Bear Markets

Industrial Metals: Bull Market or Dead Cat Bounce?
Since the commodity bear market started in the spring of 2011, we’ve had several price rallies in industrial metals (see the graph above), that made some people think that a new bull market was underway. It wasn’t. Sharp price rallies are not unusual in bear markets and, although base metals are showing strength, we need more evidence before confirming that this won’t be another bounce followed by further declines like we’ve seen before.

Crude Oil and Base Metals Move Simultaneously

The main driver causing metal prices to rally this quarter is the oil price recovery that’s been happening since February. Lower fuel prices have compounded the longest commodity slump in a generation as oil is also key input in the cost of producing industrial commodities.
Oil prices rally since February
Moreover, oil is an asset closely followed by commodity investors. Falling oil prices make investors move away from commodities and, of course, industrial metals. Finally, the latest recovery in oil prices has caused oil-exporting countries such as Russia and Canada to strengthen their currencies against the US dollar. Therefore, higher oil prices contributed to a weaker dollar these past few weeks as we’ll explain soon.

As we just reported in our latest MMI, Saudi Arabia and other powerful OPEC members are reportedly discussing how to boost oil prices to $50 per barrel. Despite reports of a Russia and Saudi Arabia-approved production freeze, however, other non-OPEC nations such as Iraq still have not committed to cutting their own oil production. New production from Iran has entered the market at a much lower pace than most expected, but there is also good reason to believe Iran will ramp up production gradually as it deals with the nuances of re-entering global oil trading.
Similarly to what we see in base metals, it’s not possible to know if this oil price rally is sustainable or not. What is true is that we’ve seen oil prices bouncing in previous years, only to then see them slump so we need more evidence to believe oil prices will continue to rise. What oil prices do from now will have a huge impacts on metal prices.

Did the US Dollar Bull Market Just End?

US dollar index moving sideways for over a year

Base metals as commodities move in opposite directions to the dollar. In Q4 of 2015, a rising US dollar contributed to the slump in base metals. However, some factors have made the dollar weaken this quarter, helping push metal prices up.
As explained above, a recovery in oil prices contributed to a weaker dollar this quarter. Also, the Euro is gaining against the dollar after the European Central Bank recently announced that it probably won’t lower interest rates more.
The dollar index (shows the performance of the dollar against a basket of currencies) has traded within main support and resistance levels (red lines in chart above) for over a year. The dollar might be topping, but it’s to early to say that. We would to see if the index breaks below support levels to call for the end of the dollar’s bull market. If that happened, we would be more inclined to call a sustainable rebound in metal prices.

China: No Signs of Rebound

Shanghai stock market composite index

Another big factor that affects the price performance of industrial metals is China. For a sustainable rally in industrial metals we’d like to see a recovery in China, but we haven’t seen that yet. That could change but, so far, it makes the rally in base metal prices a bit suspicious. Investors’ sentiment on China hasn’t become bullish yet, at least we see that reflected in the performance of China’s stock market, which is hovering near the lows recorded in January.
Chinese February imports hit a new 6 year low

Fundamentally we don’t see signs of a turnaround, either. Indeed, if anything fundamentals are signaling more choppiness ahead. Recently, China reported a large drop in exports since the beginning of the financial crisis, with February exports down 25% year over year, confirming weak global demand which will likely be a drag on China’s economic growth in 2016. Even more worrisome for commodities might be the slump in imports. China’s imports in February fell to the lowest levels in six years, confirming weak demand in China.

Is it Now a Good Time to Buy Forward?

Well, that depends on what type of buyer you are. If you are a bottom picker then you are probably tempted to buy large quantities at these low prices. However, picking bottoms is easier said than done and it’s hardly ever a good strategy.

Zinc seen as best metal pick

Zinc seen as best metal pick
Supply cuts by major global producers and bright demand prospects support the bullish trend
Global markets were battered brutally in January, the worst since the financial crisis in 2008.
Circuit breaker mechanism, which was introduced in January to cushion the Chinese equity markets from excessive volatility, ironically spurred panic and hurt global market sentiments. Amidst such gloom, the only metal which stood the test of time was zinc, thanks to the supply tightening measures by major producers.
Mines closure
Australia’s giant Century mine and Ireland’s Lisheen mine ultimately called it off earlier this year after proposing output cuts in 2014. Mining company MMG exported its final shipment of zinc concentrate from Karumba, marking the end of production at Century Mine, one of the world’s largest zinc and lead deposits.
Another major support came from Switzerland-based mining and trading giant Glencore’s decision to mothball around 500,000 tonnes per year of mining capacity, mostly in Australia and Peru, apart from Europe’s biggest zinc producer Nyrstar’s suspension of its 50,000-tonne-per-year Middle Tennessee mines.
This is in addition to Glencore’s announcement in October 2015 that it will cut 500,000 tonnes of annual zinc production, equivalent to around four per cent of global supply.
Furthermore, Horsehead Holding Corp, a large US zinc producer, which has been operating for around 150 years, filed for Chapter 11 bankruptcy on February 2, hurt by slump in metals prices and a shortage of cash.
Owing to such aggressive supply reductions, Treatment Charges (TCs) or fees paid by miners to smelters to process raw material into metal has tumbled to around $125 a tonne from $220 a few months ago.
Higher imports
The closure of major zinc mines has reduced supply, resulting in lower treatment fees charged by smelters.
This shows that the concentrate is not as readily available as last year but imports show a positive trend as steel mills gear up for the Chinese production of galvanised steel products.
Recent data released by the General Administration of Customs showed refined imports of zinc soared by 150 per cent in January.
Zinc imports surged by 440 per cent in December 2015 after shipments nearly quadrupled in November and almost tripled in October. Taking tightening measures into consideration, Mitsui Mining & Smelting Co., Japan’s top zinc supplier, stated that zinc market balance is likely to shift to deficit of 440,000 tonnes, the most in more than a decade and prices likely to surge by about a third in 2016.
Strong demand
Along with supply constraints, demand prospects too brightened as Chinese car sales were up 9 per cent year-on-year in January after rising 13.4 per cent in the fourth quarter of 2015 from the corresponding period of last year. Global automotive market is a large component of demand for zinc and numbers show the industry remains robust.
Overall, output cuts and anticipation of higher deficit in 2016 place the grayish white metal in a win-win situation.
Hence, we expect zinc prices to trend higher from a two-month perspective and LME zinc (CMP: $1,808) prices can possibly head higher towards $2,000/tonne while MCX zinc (CMP: ₹121.35) prices may surge towards ₹140/kg as rupee depreciation towards 70-mark will also be a supporting factor.

Tuesday, March 15, 2016

The LME aluminium mystery

The LME aluminium mystery
While aluminium inventories appear high on paper, the market is quite tight
How can a market be burdened with millions of tonnes of excess stock and at the same time be prone to almost continuous tightness?
This is the conundrum posed by the aluminium contract traded on the London Metal Exchange. (LME). LME front-month spreads have just passed through another period of extreme turbulence.
At its most acute, on February 29, the cost of borrowing metal for the three weeks to the March prompt date flexed out to $29 per tonne. The cost of borrowing for a single day, known in the London market as ‘tom-next,’ reached almost $8.5 per tonne on March 3.
The benchmark cash-to-three-months period has so far this year spent twice as much time in backwardation as in contango.
Yet this is a market defined by massive legacy inventory. Most of it is ‘hidden’ in off-market storage — some say this is not less than 10 million tonnes.
Something’s not quite right. Maybe it’s the fact that for many months now someone has been holding much of the LME inventory and using that position to exert pressure on shorts rolling their positions forward. But that in itself is a sign of a more fundamental problem with the LME aluminium contract.
Last time, it was the disconnect between LME price and physical premiums. This time it’s the disconnect between nearby and forward spreads. There’s a worrying possibility that the LME’s solution to the first problem, attacking the persistent load-out queues in its delivery system, is now creating a new problem.
Who’s got the metal?

As of the close of business Tuesday one entity was holding between 50 and 80 per cent of all the ‘live’ stock in the LME system. That would make the position somewhere between 1.43 and 2.29 million tonnes.
This is not news to anyone trading the LME aluminium market. That dominant position holder has been there for many months, albeit with a fluctuating amount of metal at any one time. This sort of long position requires very deep pockets.
And our ‘mystery long’ is not breaking any LME rules. The LME doesn’t prohibit such big positions but it does put limits on their potential abuse. In this case, such a massive holder of metal must lend to shorts at a prescribed rate. Moreover, the LME’s compliance department will have been in regular contact with this buyer.
Money out, stocks out

It is also becoming easier to squeeze the LME aluminium contract’s nearby dates. Firstly, the withdrawal of investment money from commodities by passive index investors, has reduced the amount of lending generated by funds rolling their long positions forward.
Secondly, the amount of underlying stock liquidity in the LME warehouse system has been steadily declining. ‘Live’ tonnage, meaning that which isn’t earmarked for physical withdrawal, hit a seven-year low of 1.63 million tonnes in December.
This year has seen that figure rebound to a current 2.87 million tonnes as previously cancelled metal has been re-warranted.
Distressed shorts have delivered fresh units into the system too. But not all of that headline figure on stocks is available for settlement of LME positions. Some of it is locked up in long-term financing deals.
The outlook is for LME stocks to continue declining over the medium term. This is where the LME’s increasingly draconian anti-queue rules are having an effect.
Accelerating outflows

Even while new aluminium units are arriving, ever increasing amounts are leaving. The daily load-out rate at Vlissingen, the location of the longest queue, has just accelerated from 3,000 to 4,000 tonnes per day.
That’s because Pacorini, the warehouse operator that ‘owns’ the queue at the Dutch port, is complying with the LME’s new elevated load-out rules.
The Vlissingen outflow will accelerate again from next month when another new rule, limiting the rent on queue-locked metal, kicks in. Most, if not all of this metal, is headed for off-market storage, which is considerably cheaper than LME storage. Warehouse rental is the single-biggest cost for metal financiers, who seek to make a return on the difference between short- and long-dated futures.
Stock financing is a core function of any commodity market. Consider the implications of it not being there and 10 million-plus tonnes of aluminium swamping the physical market.
Vicious circle?

But this financing function is creating a potentially vicious circle in the LME aluminium market right now. Those looking to move stocks out of the LME system will be rewarded with ever faster load-out.
The promise of faster outflow leaves the aluminium contract even more vulnerable to the sort of dominant-position pressures seen over the last couple of months. Unless the dominant long gives up, it’s difficult to see how this cycle is going to be broken. And even if the current buyer (long) does cash in, another one could just as easily play the same game, given the continuing migration of inventory from LME to off-market storage.
Aluminium looks set to continue to be plagued by LME delivery issues, just a whole different set of issues to last time. It would be deeply ironic if the solution to the previous abnormality is the cause of the new one. - Reuters


Sunday, March 6, 2016

The Reason For Copper's Dramatic Surge: Chinese Copper Inventories Hit Record

Two weeks ago we reported that one month after China created a record $520 billion in total credit (TSF), through February 18 Chinese banks had followed through with another CNY2 trillion according to MarketNews, meaning that in the first two months of the year China will have created a gargantuan $1 trillion in new credit between loans and unregulated shadow banking issues.
The Reason For Copper's Dramatic Surge: Chinese Copper Inventories Hit Record

A question that emerged is what China is spending all this newly created money on. One answer emerged overnight when Bloomberg reported that after tumbling in the first half of 2015, copper inventories at the Shanghai Futures Exchange had been steadily rising, and in the most recent week soared by 11% to an all time high of 305,106 tons.
At the same time reserves at the London Metals Exchange declined for 11 days to the lowest level in more than a year, in other words China is shifting idle inventory from Point A to Point B.
The Reason For Copper's Dramatic Surge: Chinese Copper Inventories Hit Record
Bloomberg adds that as a result of this massive spending spree, inventories tracked by the Shanghai Futures Exchange are higher than stockpiles monitored by the London Metal Exchange for the first time in a more than a decade.
This explains two things:
  • for all talk of reform, China is once again building a bubble in excess capacity and stockpiling surplus commodities, which will likely last as long as China floods the economy with newly created bank loans;
  • The recent surge in the price of copper, which has been a direct function of China's recent massive restocking
The Reason For Copper's Dramatic Surge: Chinese Copper Inventories Hit Record

Most importantly, this means that the world is now back to the "old regime" China, where it was stockpiling massive amounts of inventory as only possible the "use of capital" of trillions in new money created, which of course is precisely the "regime" that created the hard landing scenario that China finds itself in at this very moment.
And so, can kicked. The only question is for how long.

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