Commodities | Jul 29 2009
By Greg Peel
“The rationale for this more positive view of the commodity outlook,” offered JP Morgan this morning, “is an improved outlook for global industrial production growth”.
There is little doubt commodities analysts have been quickly forced into a rethink these last couple of months. Late last year, commodity analysts were all about doom and gloom. Commodity prices had collapsed as a result of the GFC and the prospects for a return to strength looked bleak, other than perhaps a small bounce form oversold levels. Then China started to buy commodities aggressively, causing some sharp price hikes. But analysts were sceptical, believing such a restocking exercise would prove merely fleeting.
That has not been the case. It is now apparent that China means business, and that its planned infrastructure stimulus is a reality which has suddenly reinforced newfound commodity demand. Elsewhere in the developing world, industrial production is also on the rise. For the developed world, it’s still a matter of returning from dark depths, but the signs are that the global economy is stabilising, and a return to tentative growth should be in train by year-end.
JP Morgan believes global industrial production will grow by 7% from the second half of this year. To that end, the analysts have upgraded their expected average base metals prices. This results in their 2010 average price for copper and nickel rising by 21%, while aluminium rises 8% and zinc 14%. They have also upgraded their long term price forecast for copper by 6%, and lead by an impressive 25%. But the biggest price increase is reserved for the long term zinc price, which rises 28.6% to US81.6c/lb.
Given last night’s spot price for nickel was US75.2c/lb, this is an unusual circumstance. Rarely are long term prices set above spot prices, given higher spot prices draw a response of greater supply coming on line, thus diluting the market and sending prices back towards a lower long term average at which demand and supply are more balanced. While the zinc price has recovered from its oversold level at around US50c/lb late last year, it has fallen from a peak of over US$2/lb in 2006. The implication here is that zinc is now facing a lack of supply ahead.
One reason zinc has an uncertain supply-side future is because over the next 3-5 years, a number of major global zinc mines are scheduled to close due to “ore depletion”. This has nothing to with the zinc price, or mining costs, or credit availability, these mature mines are simply going to run out of zinc. And at this stage, it appears only one major new zinc mine is scheduled to come on line.
This means that from this point to some time in the next few years, a zinc supply gap could open up. If that gap cannot be filled, then the zinc price must surely begin a secular rally. There is still a small matter of the number of global mines which have been mothballed on a price/cost basis since the GFC, and the number of existing mines which are planning expansions.
UBS notes that through the GFC down-cycle zinc has shown “surprisingly robust” supply-demand dynamics, evident in only a 1.6 week peak in LME inventories. Past peak levels have reached as high as nine weeks. This figure is not necessarily all that accurate however, given zinc is traditionally stored off-LME as well due to its low price and high storage costs. Low inventories nevertheless bode well for a cyclical price recovery.
The demand side is not, however, hugely encouraging at present. While Chinese production of stainless steel appears to have jumped markedly, thus spurring on the nickel price, Chinese production of galvanised steel has barely hit positive growth, UBS notes. And Western production is down 40-70%.
At present, demand suggests those marginal mines that were shut down in the GFC will stay that way. UBS notes the zinc price will have to return to US80-95c/lb before such mines are brought back out of mothballs. And then if they are, of course, they will again create downward price pressure from the supply side.
UBS believes planned expansions of several large operating mines across the globe will be enough to offset the aforementioned closures of mature mines. Thus if rising global industrial production serves to increase the zinc price, the re-starting of marginal mines will keep a cap on the zinc price.
Canadian mining analyst Desjardins disagrees, suggesting the closure of the mature mines will have a significant impact. Desjardin also believes mine re-starts will serve to close the gap in withering mature supply, but only to the point of demand levels seen in 2007-08 – that is, pre-GFC. If zinc demand returns to incremental growth above 2007-08 levels, then demand will begin to outweigh supply. “Hence there is a very strong possibility that in the next few years,” says Desjardins, “prices may return to, and even surpass, the US$2/lb level”.
Desjardins has nevertheless set a 2010 forecast price of a less ambitious US85c/lb. UBS has settled on US$80c/lb, while JP Morgan has pencilled in US$77.7c/lb. But as JPM’s longer term price average suggests, and UBS and Desjardins debate about, price levels in later years may be more impressive.