Commodities | Mar 18 2014
-Tight credit behind selling
-Copper needs industrial rebound
-Iron ore, copper buying opportunity
-Oil and gas capex moving onshore
By Eva Brocklehurst
The recent selling in copper and iron ore originated from tight credit conditions in China. That's Morgan Stanley's understanding. Beijing is suspected of targeting those speculators that use commodities as collateral in the shadow banking network, a channel used to evade capital controls and credit policies.
Hence we have seen a rapid unwinding of copper inventory financing. It's not a new phenomenon but Chinese officials have implemented a number of reforms to limit these "carry" trades. Morgan Stanley notes two recent changes which are likely to limit copper inventory financing in the future. The first forces the investor to hold copper used for collateral "onshore" as opposed to in bonded warehouses that are free from tax and tariffs. The second change, announced just days ago, is a widening of the Chinese renminbi trading band against the US dollar in the interbank market. This is expected to help deter carry trade speculators, as larger fluctuations in the band increase the volatility, and thus the risk.
In the case of iron ore, Morgan Stanley thinks it was a "buyer's strike" that pushed the price down recently, as high inventory, slower steel production growth and tight working capital forced the mills to refrain from spot purchases. The analysts do not yet see compelling evidence the fundamentals are changing in China's consumption patterns. Morgan Stanley believes this presents a buying opportunity in the metals.
Deutsche Bank thinks the recent selling of copper has been driven by speculators trying to anticipate the unwinding of the financing deals, rather than the actual unwinding. The broker does not expect a complete end to this type of trade but thinks bearish sentiment may persist because of an absence of real copper demand and any meaningful pick up in industrial activity in China. Still, the GDP target of 7.5% set out by the Chinese government is supportive of industrial materials demand. The broker thinks value could start to emerge if copper prices move back to US$6,000/tonne.
Iron ore is less attractive as a financing vehicle because of high storage costs but its use in import financing has garnered momentum. Deutsche Bank sees this as a function of elevated pressure on the liquidity of steel mills. This type of financing is more vulnerable to unwinding as iron ore positions are typically unhedged. The analysts think iron ore prices could go below US$100/t because of elevated port inventory, steel inventory and soft industrial demand. This has a flow-on effect in that a sustained decline in iron ore prices may result in lower Chinese production, as such a price is below marginal cost for producers. This means higher iron ore imports should ensue once inventory levels normalise.
JP Morgan has collected 2014 upstream data on capital expenditure for the global oil and gas sector. Aggregate capex is up just 4.4% so far compared with actual spending in 2013. The broker suspects 2014 may become a year characterised by zero overall upstream capex growth, the first time since 2009. The broker also suspects that the international oil companies are looking to achieve more while spending less and this represents a challenge to the services companies, which are capex rather than operating expenditure dependent. This is particularly the case for those that are focused on offshore fields. Capex cuts are manifesting more in offshore drilling, as JP Morgan notes North American upstream onshore trends remain robust.
While investors may have discarded "peak oil" theories because of the surge in shale oil the broker thinks they could now consider the implications of a near-term peak in capex and how that may relate to onshore growth and offshore decline.
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