Commodities | Feb 08 2012
– Surge in LME cancelled warrants supporting base metal prices
– Sluggish base metal demand could see short-term price retracement
– China the key to manganese demand
– Citi remains positive on bulk commodity outlook
By Chris Shaw
While shifting macro sentiment has been the predominant driver of the strong start to the year for base metal prices, Barclays Capital notes a surge in LME-cancelled warrant levels as a proportion of total stocks held in LME warehouses has also been supportive.
Barclays points out cancelled warrants now stand at an average of 15% of total LME stocks for base metals. This compares very favourably to a five-year average of just less than 5.0% and implies significant amounts of inventories are going to be withdrawn from LME warehouses in the short-term.
The key according to Barclays is to what degree this cancelling of warrants is being driven by real demand, as this would suggest a tightening of market fundamentals. Such a tightening would be supportive for prices.
Barclays suggests the most fundamentally-driven increases in cancelled warrants have occurred in the tin and lead markets, where in both cases the Chinese market is tight, import arbitrage is open and most of the increase in cancellations has been at Asian warehouses.
In contrast, aluminium has been the metal where the key driver of warrant cancellations has been tactical rather than demand based. This reflects the fact the aluminium market remains in a modest surplus position.
For Barclays, differentiating the drivers behind the rise in cancelled warrants remains critical, but given the highly synchronised levels across the base metals complex so far this year, Barclays analysts see the increases as a bullish signal.
Macquarie is a little more cautious on the base metal price outlook, suggesting still sluggish demand conditions make a retracement in prices in the shorter-term more likely as such a move would match market fundamentals.
Current fundamentals include high inventory levels across the six main LME metals, Macquarie noting there is a lack of any aggressive restocking measures on the part of physical market participants at present, with the exception of the tin market.
The degree of base metal relative price outperformance compared to other commodities has surprised Macquarie, given risks remain high in the current environment. The main driver appears to have been increased backing of China via financial markets, with short-covering also playing a part.
But with Chinese demand likely to be quiet entering its New Year period, recent gains appear to Macquarie to have been a case of too much too soon. For copper, Macquarie suggests prices may need trade back to around US$8,000 per tonne to bid up the market, this as manufacturing output continues to run ahead of consumption.
In the aluminium, lead and zinc markets, where mild surpluses are in place, the strong price gains now give Chinese smelters no incentive to cut output. This is causing stocks to build, leading Macquarie to suggest another trip back into the cost curve will be needed to brings these markets back into equilibrium.
Still on copper, Citi notes the supply picture in China is less tight than had been assumed, as inventories have risen steadily, cancelled warrants have been mainly in the US and not in Asia and scrap copper supply has also become less tight.
These factors suggest to Citi some near-term pressure on Chinese copper imports is likely in coming months. Such pressure should also put some pressure on prices for the metal. Copper prices are unlikely to collapse however, as Citi notes traders have not yet been forced to export copper back to the international market.
Also in China, Macquarie expects a continuation of that country's position as the main driver of global manganese demand. Since the middle of 2010 manganese prices have declined, not due to weak demand but thanks to oversupply out of South Africa, the world's largest supplier.
Manganese ore is used in the production of manganese ferroalloys for the steel industry, so demand has risen significantly as global steel output has increased over the past decade. Manganese is primarily used as an alloying agent and to fix residual sulphur originating from primary iron making raw materials and ferrous scrap. While manganese demand has increased, Macquarie notes the intensity of manganese use in steelmaking has also risen, this due to a change in the mix of steels produced.
With China the world's largest steel producer it is also the world's largest consumer of manganese ore and ferroalloys. Given a depleted domestic ore base, China is increasingly becoming reliant on imports of manganese units, as reflected by imports hitting a record level in 2011.
While the market is currently well supplied with manganese ore, which limits the short-term price outlook, Macquarie suggests longer-term questions about the sourcing of medium to high-grade ores should be supportive for manganese prices.
This is because such ores are necessary inputs in the production of certain manganese alloys, which in turn are necessary inputs in the production of certain steel grades. While China has for some time been using manganese ferroalloys differently to reduce any reliance on medium to high-grade manganese ores, Macquarie suggests a continuation of this trend will become increasingly difficult.
Turning to the bulk materials, Citi remains positive on the outlook for the sector over the course of the coming year. Iron ore is the broker's key pick, reflecting an expected rebound in Chinese steel production and limited growth in iron ore supply. This should deliver a strong rally in prices in the second quarter of 2012.
A major risk to this outcome is the Chinese property sector, this given a shaky credit market and oversupply concerns. But on the flipside, Citi expects Indian exports of iron ore will remain subdued.
Metallurgical coal prices are near to a bottom in the view of Citi, with the return of Japanese and Chinese steelmakers likely to provide this market with some support. A repeat of last year's price movements would require further severe supply side disruption in Australia in particular, while Citi suggests Japan offers the greatest risk if reconstruction efforts fail to deliver some incremental growth in demand.
Emerging Asian markets should support thermal coal demand at above trend rates of growth for the foreseeable future, according to Citi. This should see markets remain in deficit, especially given expected weak supply growth thanks to ongoing infrastructure bottlenecks. Short-term there are some questions though, as Citi notes a structural disconnect in India is likely to cap prices for the next three to six months.
In terms of price forecasts, Citi expects hard coking coal contract prices of US$256 per tonne this year and US$248 per tonne in 2013, while semi-soft price forecasts stand at US$173 per tonne and US$168 per tonne respectively. Thermal benchmark forecasts are for average annual prices of US$125 per tonne in 2012 and US$134 per tonne in 2013.
In the iron ore market, Citi is forecasting average Asian prices of US$241 per DMTu in 2012 and US$213 per tonne in 2013 for lump and US$219 per tonne and US$194 per tonne respectively for fines.
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