Commodities | Nov 08 2011
– Pick-up in leading indicators for base metal demand centred on US
– Iron ore expected to trade back to US$140 per tonne level in coming weeks
– Base metal price risk positively skewed according to Goldman Sachs
– Steel market expected to tighten, margin improvement also possible
– Surplus to continue in silver market
By Chris Shaw
Given an improvement in October PMIs, Barclays Capital notes leading indicators for base metals demand have bounced back above a reading of 50 for the first time since May. This leads the group to suggest a pick-up in demand growth across the base metals complex is likely early next year.
The rebound in data was centred primarily in the US, as Barclays notes the “order book” of new orders and the backlog of orders for manufacturing goods in that market rose to 50 from 45.6 previously. This was the largest increase in this reading for 10 months. Expected purchasing of manufacturing goods also rose to 50.9 from 39.9 previously, reflecting both a fall in inventories and rising orders.
Chinese data were less promising, as both new orders and backlog of orders declined in month-on-month terms for the first time since June. Barclays suggests this is largely due to signs of external weakness such as softer demand from Europe, which is China's largest export market. Data from Europe continue to point to further weakening in the coming months.
For Barclays, the key message form the latest data is the pick-up in global leading indicators for base metal demand is highly biased towards an improved outlook for the US, as in both China and Europe the shorter-term outlook remains far more vulnerable.
In iron ore, Goldman Sachs suggests the scale and rate of the decline in index prices in recent weeks has been a surprise. At the same time, the strength of the Australian dollar when US prices of both metallurgical coal and iron ore have been under pressure has been almost equally as surprising and has exacerbated the earnings impact of lower ore prices for Australian producers.
While early November trading suggests iron ore prices are stabilising at a level a little above US$120 per tonne, Goldman Sachs continues to suggest the cost support level of seaborne iron ore lies in a range of US$130-$150 per tonne.
While cost support levels can be breached temporarily, Goldman Sachs doesn't expect annual average prices to fall below US$140 per tonne. Assuming there are no further significant cuts in Chinese steel production over the remainder of this year, Goldman Sachs anticipates iron ore prices should start to recover towards the US$140 per tonne cost support level in the next few weeks.
For copper, Goldman Sachs suggests prices have stabilised and rebounded a little ahead of expectations. Fundamentals have supported this rebound, as the supply disruption theme remains in place given ongoing industrial disputes.
LME stocks of copper have also been falling steadily, Goldman Sachs noting since the start of September stocks have declined by around 42,000 tonnes, mostly in Asia. Goldman Sachs expects the recent recovery in Chinese copper imports will likely continue through November, albeit at a reduced pace.
A downgrade to commodity price expectations in October by Goldman Sachs reflected both the macro environment at the time and a slower growth outlook for China. Forecasts were adjusted to deliberately conservative levels, with the expectation a return to upgrade mode would follow around the end of the year or early next year assuming Europe got a handle on its debt issues.
Following a review of the data of recent weeks, Goldman Sachs remains of the view the risk to its 2012 average price forecasts for key commodities is skewed to the upside, though it remains too early at present to consider lifting estimates.
Having reviewed its global steel market assumptions, Citi suggests steel prices are close to a trough as they are now cutting into fixed costs for some of Europe's higher-cost producers. This suggests scope for steel mills to see some margin expansion leading into the first quarter of 2012.
Further ahead, Citi expects steel markets will tighten in 2013 and 2014. In part this is because private sector balance sheets are not strong enough to sanction new projects, as well as returns currently being well below the cost of capital.
On Citi's numbers, global steel production is likely to grow by less than 3% in the medium-term, while iron ore exports should increase by more than 10% from 2013. This would correct a long-term trend of iron ore supply falling short of expectations, while from the same time steel supply is likely to consistently undershoot demand growth. This offers potential for a boost to margins.
In 2012, US demand should be solid and Citi also expects incrementally stronger demand from emerging market regions such as India and Brazil. A partial offset is lower expectations for demand from Europe.
For China, Citi expects sub-GDP steel demand growth, which implies steel consumption will stagnate. At the same time Citi suggests Chinese supply could also stagnate, with some room for a positive surprise if the government can deliver on the plan to close as much as 26 million tonnes of outdated capacity.
While the demand side of the silver market continues to attract most of the attention, Barclays notes the supply side has been responsible for keeping the market in surplus thanks to uninterrupted record levels of mine output since 2004.
In 2012 Barclays expects Mexico, now the world's largest producer, will again lead the way in terms of supply growth. Both Canada and China should also deliver higher production, offsetting declines from both Peru and Australia.
On the numbers of Barclays, global silver mine supply this year should increase by 1.9% year-on-year to a record 24,500 tonnes, while in 2012 supply should grow by 3.9% in year-on-year terms to 25,500 tonnes.
According to Barclays, while grades are falling at some mines and geopolitical risks are increasing, the marginal cost of production for primary producers at current price levels offers a favourable environment for extending mine life.
This leads Barclays to suggest the silver market will continue to have a sizable surplus despite expectations of growth in industrial demand.
