Commodities | Sep 19 2011
– First signs of weakness in iron ore market
– Citi expects only slight weakness in coming months
– Chinese copper market picture increasingly positive
– Precious metal ETP flows weaker
– Headwinds may cap commodity prices shorter-term
By Chris Shaw
Chinese steel output fell 1% in month-on-month terms in August, Citi seeing this as the first signs of weakness in the iron ore market. The fall in steel output has lifted iron ore port inventories to a record level of 94.3 million tonnes. This equates to 34 days of cover, the highest level since the GFC.
Even allowing for the current market conditions Citi suggests the outlook remains constructive, as Chinese steelmakers have just ended a de-stocking phase and inventories should be relatively low as a result.
As well, Citi sees strong domestic production in China as pointing to a tight international seaborne market for iron ore. Citi continues to assume a soft landing in China, the current monetary policy stance seen as supportive of growth of around 9%.
While there is some downside risk to this forecast given external economic weakness Citi doesn't see any significant fall in growth. This, plus the fact iron ore is significantly exposed to higher growth in emerging markets, should protect prices from any significant downturn.
Citi continues to expect only slight weakness in iron ore prices in coming months. Citi's short-term iron ore price target for the next three months is US$165 per tonne, while the 6-12 month target remains unchanged at US$150 per tonne. This compares to current prices of a little below US$180 per tonne.
Still in China, Barclays Capital suggests the copper market in that country has offered a number of contradictory signals so far this year. Import levels of all types of copper are down sharply in year-on-year terms, this despite strong levels of output growth from semis fabricators.
At the same time, Chinese treatment and refining charges rose to multi-year highs in the June quarter of this year, even in a situation of strong refined output growth and constrained global concentrate production.
A consistent trend during this period of divergent data has been de-stocking along the supply chain, though Barclays suggests there is now evidence this de-stocking is coming to a close at the refined level.
Treatment and refining charges have weakened in recent weeks, Barclays seeing this as driven by extremely poor performance on the mine supply side. This reflects falling ore grades and elevated levels of disruptions to production from industrial action in particular.
The Chinese market has also experienced tightness in scrap supply, while Barclays notes smelter stocks of concentrate are approaching levels where spot market purchases will start to be necessary. Barclays suggests such a market environment could constrain refined production growth as well as imports of concentrates. Refined imports may be a beneficiary from this in the view of Barclays.
Market sentiment is impacting on copper price performance at present, but Barclays sees an increasingly positive picture for Chinese copper, especially as market fundamentals support a continued market deficit.
Barclays has also looked at inflows into commodity-linked ETPs or Exchange Traded Products, noting as at the end of July around US$142 billion of the total US$431 billion invested in commodity ETPs was in precious metal ETPs.
As Barclays points out, traditionally in periods of high distress and macroeconomic risk the precious metal ETPs see higher inflows. But so far this year commodity-linked ETPs have seen weak inflows, as for the year to the end of July such inflows totaled just US$7.8 billion.
This is down from US$11 billion for the sale period last year and US$31 billion for the same period in 2009. Barclays notes inflows into precious metal-linked ETPs have shrunk by as much as two-thirds so far this year when compared to last year.
This year has seen some of the largest ever monthly outflows from precious metal ETPs, which Barclays notes is in contrast to the rising official sector appetite for gold, especially physical gold. Given other ETPs, such as for the base metals, energy and even agriculture have also seen outflows in recent months, Barclays suggest it remains too early to identify any clear, lasting trend with respect to commodity-linked ETP investment in general and precious metal ETPs in general.
Looking at the general investment picture, Standard Bank suggests markets are thirsting for liquidity at present. The liquidity premium has risen and should move even higher in the next two weeks in the bank's view, which may mean commodities priced in US dollars struggle somewhat.
In the view of Standard Bank, commodity prices can withstand a sovereign debt crisis, but contagion and the fact European banks are struggling with US dollar funding is creating additional headwinds. Any subsequent breakdown in the money market, even if only temporary, would be bearish for commodities in the bank's view.
As funding risks rise, Standard Bank suggests it will be difficult for commodities to rally, as the downside risks have now increased. As well as the fundamentals of the present environment, Standard Bank also sees downside risk given the current speculative length that could be unwound. Platinum and palladium appear most at risk, then COMEX silver, NYMEX WTI and COMEX copper.
This implies a cap on base metal and brent crude prices, while platinum above US$1,850 per ounce will also find strong resistance in the view of Standard Bank. While the gold price is still expected to trend higher, Standard Bank suggests gold in euros should outperform gold in US dollars given an expectation the greenback will strengthen against the euro.
