Metal-nomics – 2015 Outlook

The fortunes of the market hinges on China, as it consumes 40%-50% of most of the non-ferrous metals.

December 16, 2014 12:03 IST | IIFL
Nothing much transpired during this year, with the price trends remaining mixed in the non-ferrous metals. Nickel top-performed the pack, Aluminum, and Zinc registered decent gains, while Copper and Lead prices witnessed deterioration. On the supply/demand dynamics, things have relatively changed with several metals witnessing a transformation from a global surplus to a deficit. Looking ahead, we still cannot afford to get too optimistic about the price prospects, as although the inherent fundamentals are improving, the global macroeconomic backdrop appears fragile. The worrying sign for the market participants is that barring US, various economies are exhibiting signs of slowdown.

Source:  India Infoline Research *Prices as on November 12, 2014
Loose monetary policy may have helped the Americans, however the same seem not to be holding true for China, Japan, and Europe. Most importantly the fortunes of the market hinges on China, as it consumes 40%-50% of most of the non-ferrous metals. Recent statistics corroborate the perception of broad based slowdown in world’s largest metals consuming nation. In this respect, China’s Manufacturing PMI readings are dangerously close to the contraction levels. On housing side, average new home prices in 70 major Chinese cities fell 2.6% on yoy basis during October. Home prices fell in 67 of the 70 cities surveyed, a sixth consecutive monthly decline. Retail sales and fixed asset investment growth is well off earlier highs.  Meanwhile, China’s central bank has injected about US$125bn into the banks during September and October; however such measures are not helping the economy much. In fact, borrowing during October dropped by an alarming 36% on mom basis and money supply growth was reported at 12.6% (yoy basis), the slowest increment in 2 & ½ years. In addition, Chinese authorities lowered one-year rates by 0.25% to 2.75%, while also reducing the one-year lending rate by 0.4% to 5.6%). This was the first Chinese rate cut in two years. The euphoria regarding the rate cut has not lasted long, as markets are realizing the fact that lower interest rates will only benefit large state-owned Chinese companies and will not be of much help to smaller enterprises. Small and medium enterprises have been already frozen out of the banking system because of the high debt levels. Such enterprises totally rely on the on the shadow banking sector for funding. On monetary policy, there is more room for the Chinese interest rates to fall, considering the fact rates are well above the levels prevalent in the Western world. However, Chinese will be dissuaded from following the Western monetary policy, as abysmally low interest rates have failed to deliver any kind of steady rebound in economies like Europe and Japan. On growth prospects, Chinese regime expects GDP reading to come in at 7.5% for this year, the lowest level since 2002.

Source: Bloomberg, India Infoline Research
Europe – Reeling under the threat of deflation: During the early part of this year, the economic numbers from the Euro zone manifested a hint of stability. However, the recent flow of indicators has not been inspiring. Hefty taxes, inflexible labor policies, austerity measures and generous social programs have impaired the ability of the region’s economy to recover. Eurozone GDP expanded by meagre 0.2% during the third quarter of this year, after a timid growth of 0.1% during the prior quarter. The German economy is on the verge of contraction, manifested by sharp dip in industrial output. Italy’s GDP contracted by 0.1% during Q3, persisting with consecutive quarterly declines. On growth forecasts, ECB has downwardly revised the GDP projections for this year to 0.8% and 1% for next year. GDP during 2016 is projected to grow at 1.5%. On monetary policy front, ECB decided to keep the interest rates unchanged and signalled that it will wait until next year for further monetary stimulus measures. The central bank kept its main interest rate at its record low of 0.05%. The economy is in the state of dire straits, as cheap and easy money has not yet triggered higher business investments and consumer spending.
Japan – Abenomics seem to be failing: Japanese GDP unexpectedly contracted by an annualized 1.9% during Q3, preceded by a 7.3% decline in the economic activity during the prior quarter. The country’s economic trajectory has technically entered in to recession. Sluggishness prevail inspite of aggressive measures initiated by Prime Minister Abe to rejuvenate the economy. The regime introduced hefty monetary stimulus, public spending and economic reforms. Ensuing weaker yen failed to turn the fortunes of struggling export sector. To make matters worse, a hike in the sales tax from 5% to 8% early this year also dampened the consumer spending. Now it seems the government is contemplating at more easing and retreating from the plan to further hike the sales tax next year. On the political landscape, the Prime-Minister dissolved the parliament during November and has called for early elections seeking to revive the public consent for his various policies.
US economy seems to be the only bright spot (as mentioned before) and the recent flow of numbers is in complete contrast with the economic conditions in Japan, China and Europe. US GDP economy grew at an annualised rate of 3.9% during Q3, higher than the initial estimate of the 3.5%. Growth for the second quarter was also upwardly revised to 4.6%. In this respect, IMF expects US economy to grow at 2.2% this year, higher than the previous projection of 1.7%. 2015 GDP growth is projected at 3.1%. On labour front, US economy added 321,000 jobs during November, while the unemployment rate remained steady at 5.8%. November’s gain is the 10th consecutive month where economy has added more than 200,000 jobs, the longest sequence of job growth since 1995. In addition, wages rose by the highest amount since June 2013. Job addition during October is also upwardly revised by 44,000. On monetary policy, US Federal Reserve has concluded its quantitative easing program and now the focus has shifted towards the probability of hike in interest rates. Improving economic landscape can persuade the central bank to do the same. Although the recent FOMC minutes reveal that that the Fed is not in a hurry to hike rates, we believe that the hike will be earlier than expected, considering the buoyancy in labour markets. We infer that the apex bank will do the needful during the first half of next year.

Source: Bloomberg, India Infoline Research
Currency induced movement: US dollar will continue to influence the broader price trend in the non-ferrous pack.  With US economy standing tall, when compared with various nations, the greenback will remain in the reckoning. US dollar is currently trading literally at a five year high against the basket of currencies and it will be no surprise to see the US dollar index surging towards 95-100 levels during the course of next year. This will create more headwinds for the entire commodity pack.
What’s in store for 2015?
We infer that the 2015 metals price trajectory will be akin to the trends witnessed during this year, characterised by narrow range and restricted volatility. The price trend will be influenced by counterbalancing forces: subdued Chinese economic landscape on the one side, while improving fundamental profile for the metals on the other hand. However, bulls can derive hope from the fact that tightening supply in metals like Zinc and Aluminium will be able to resist any kind of broad based liquidation. In a nutshell, the prevalent scenario will ensure that substantial upside and prolonged declines remain in check.
To corroborate our view, we discuss the inherent fundamentals of the individual metals.

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