Metal Market Moves — Funds Or Fundamentals?

A number of the majorly traded metals have hit multi-year highs recently and out-performed most other commodities, with some observers heralding another boom for a sector that had been somewhat beleaguered. But are these rallies sustainable, and are they being driven by underlying fundamentals or speculative activity?

Metals eclipse other commodities so far in 2017

During a typically slower summer period, there has not been much from the "real" demand side that appears to have justified recent price action. Neither have there been any new, significant developments on supply that are tightening balance sheets. Different commodities do exhibit varying fundamental characteristics. Zinc, for example, has been waving a bullish flag for some time as mine closures and curtailments have tightened supply while demand in end-use markets such as construction and automotive has remained robust. Other metals, such as nickel and copper, have had less unambiguous supply/demand drivers. Commodity Briefing Service, an offering of S&P Global Market Intelligence, finds that the rise in prices has largely been driven by market and macro factors, with supply/demand fundamentals exerting secondary influences in many cases.

Chinese economic performance has exceeded expectations, as recent data has indicated, including second-quarter GDP growth. Given China's dominance in global metals and raw materials consumption, this has provided some confidence and underlying support to recent investment activity in industrial metals.

Ongoing macro developments in the key demand markets for metals, especially China, will also have a key role in how metal prices develop. Geopolitics, most notably how current U.S. and North Korean tensions play out, and the path of the U.S. dollar, including any impact from the U.S. Federal Reserve interest rate policy, will also be important contributors to future price movements.

Chinese data not conclusively positive…

As the main global consumer of metals and their raw materials, China's economic health is being closely monitored to see if the rally in prices is sustainable. Some of the headline numbers have provided support, but other data reveals underlying headwinds. On the positive side, recent Chinese purchasing manager indices, or PMIs, have indicated a pickup and expansion in manufacturing activity. The National Bureau of Statistics' measure, assessing large state-owned enterprises, increased to 51.7 in August from 51.4 in July; the Caixin PMI, covering small and medium-sized companies, rose to 51.6, a six-month high.

Inflation in China lifted in August; consumer prices by 1.8% year over year, compared with 1.4% in July, and producer prices by 6.3% compared with 5.5% a month prior. However, the last figures for retail sales in July showed growth of 10.4% year-over-year, down from 11.0% in June. Among other industrial or economic indicators, stronger year-over-year growth in electricity consumption in July of 9.7% (5.4% in June) was supportive, as was a continued pickup in China's foreign exchange reserves.

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Central bank data showed that these rose to US$3.09 trillion in August, a seventh successive month of gains and the highest level since October last year. U.S. dollar weakness has helped to push up the value of nondollar currencies in the country's holdings. The reduction in capital outflows, seen as one of China's biggest risks, has improved confidence and shows some impact from the clampdown on overseas investments by Chinese companies. Nevertheless, total forex reserves are still almost down US$902 billion since the June 2014 peak of US$3.99 trillion.

Less sanguine data releases have been seen for China's industrial production growth, which dipped to 6.4% year-over-year in July from 7.6% in June. House price growth in Tier 1 and 2 cities has continued to decline, falling to 9.7% year-over-year in July, compared with 10.2% the month before. Meanwhile, growth remains muted in buildings under construction and buildings that have been completed.

Chinese debt levels and credit risk remain a major threat to our outlook for the country's economy and its demand for industrial metals. The government continues to face a fine balancing act of controlling overheating in areas such as property investment while not tipping the market too far toward a sharp growth slowdown. New loans in August did fall to 825.5 billion Chinese yuan in August, from 1.54 trillion yuan in June. However, nonperforming loans continue to rise, reaching 1.636 trillion yuan at the end of the second quarter — the highest since the first quarter of 2005. The NPL ratio has remained resolutely fixed at 1.74% for several months, indicating growth in China's overall gross loan book.

…as metals still dance to the greenback boogie

Metals negatively correlated to US dollar

U.S. dollar weakness has been a major driver of the move in metal prices, especially since late June. Regardless of market fundamentals, the relationship with the dollar is likely to factor high in impacting future price moves. We would expect to see some continued underlying support, as the outlook for the U.S. dollar appears to have dampened recently, even if the decline has been recently halted as there have been no more North Korean missile tests and Hurricane Irma hit the U.S. with less force than feared earlier.

The likelihood of a Federal Reserve rate rise has been pared back by many market participants as comments from Fed members have become less hawkish and point to a more gradual raising of U.S. interest rates. According to CME FedWatch, the market does not anticipate any rate rise until December 2017 at the earliest. Even then, the probability is only about 31%.

Meanwhile, the U.S. dollar index hit its lowest level since the start of 2015 on September 8, and the euro recorded its highest level over the same period as remarks from the European Central Bank president indicated that plans to begin scaling back the ECB's two trillion euro quantitative easing program would be revealed in October. Underlining the U.S. currency's softness, the Chinese yuan and Japanese yen registered 21-month and 10-month highs versus the greenback, respectively.

The full report includes reviews of the copper, iron ore, nickel, and zinc markets in recent months. Complete the form to continue reading.

Oct 24, 2017
Sep 12, 2017