Commodities | Jul 03 2009
By Chris Shaw
Fortis Bank has not been a believer in the recent rally in commodity prices as while the analysts accepts economic data from China in recent months have been positive they haven’t been strong enough to bring about an end to the global recession.
This is especially the case given in the group’s view economic data out of China are massaged by the government to achieve its goals, rather than being an accurate reflection of the state of the economy. As a result, Fortis analysts suggest the trend in the data is as important as the data itself, with the news here encouraging as growth will still be positive even while the rest of the world struggles.
But how this has occured is something of a puzzle in the group’s view given the downturn has seen China’s export markets crumble, crude oil prices are again moving higher and there is little sign yet of a recovery in regions such as the US, Europe and Japan. Much of the growth can be attributed to the government’s stimulus package as it has helped ease credit markets and supported growth generally and lending in particular, which has had a trickle down impact on sectors such as housing.
In terms of commodities, the China impact has been crucial in the group’s view, though it notes much of the buying has been for re-stocking by producers and the government rather than as a function of an increase in industrial activity. The danger according to Fortis is the situation in China turns to one of excess supply, which would necessitate a correction in prices if import levels decline. This is seen as possible in coming months.
Fortis analysts point out such a decline may not happen or it may coincide with a recovery in demand from the rest of the world and so the impact would be mitigated, but it is their view that prices of late reflect the view of investors this is how the situation will play out when the reality could be somewhat different.
In other words, Fortis sees current prices as indicative of a high risk bet by speculative investors about the sustainability of the recent uptrend in commodity prices in general and the base metals in particular. This is a questionable bet in its view as while the Chinese stimulus package has forced additional credit and investment into the economy, the level of private investment remains quite low.
While globally the worst of the recession appears to have passed, Fortis sees the world as still reliant on China as the growth driver, which means domestic demand in that economy will be a key factor going forward as the world looks at how it can re-couple with China. For the likes of Japan and Germany, Fortis suggests the key will be working out how to produce the goods China wants, as meeting China’s needs is likely to be the main game for the next several years.
Nowhere is the Chinese effect clearer than in copper as Fortis notes China’s buying alone accounts for almost 90% of the fall in London Metals Exchange (LME) stockpiles since February. While the magnitude of this buying is difficult to justify, the stimulus package would account for at least some of the buying.
The problem is it is not enough to justify the price gains in the metal in recent months as on the group’s numbers Chinese total copper consumption would need to treble to offset demand weakness in the US, Japan and the EU-15 alone, let alone the rest of the world.
This implies the price gains have been artificial and so the rally is unlikely to keep going in the group’s view. Fortis’ forecast are calling for 3-month LME prices to trade between US$4,900-$5,650 per tonne over the short-term.
In the aluminium market the group notes there is evidence Chinese buying has come to an end now that prices have recovered off their lows, which implies risk to the downside in coming weeks, especially given the market remains one of production running well ahead of demand.
Having said that, the group sees any risk as somewhat limited as if prices were to weaken it is likely Chinese buying would again increase, though even after accounting for this, the analysts expect inventories will remain high. An accurate assessment of stocks is difficult given much product is now being held off-market, but in the group’s view if there is a reduction in buying, prices could be in line for a swift correction. For 3-month LME prices in the short-term the group is forecasting US$1,500-$1,750 per tonne.
Lead prices have followed the general trend in metal prices in recent months, while also benefiting from solid Chinese imports and lower output thanks to reduced zinc production (lead is a by-product), leading Fortis to suggest there are at least some fundamentals to justify the gains.
Prices appear to be slightly above where they should be in the group’s view, so short-term the analysts are forecasting 3-month LME prices of US$1,400-$1,900 per tonne.
Zinc prices have traded above US$1,500 per tonne in recent weeks, but Fortis sees this level as over-extended, suggesting a price closer to US$1,300 per tonne is more in line with the market’s fundamentals. While production cuts offer some cause for encouragement, as has the re-stocking of recent months, the group sees 3-month LME prices as trading between US$1,490-$1,740 per tonne in the short-term.
See also Rudi On Thursday, published on the FNArena website late on Wednesday this week.