Precious and base metals prospects uncertain as China grows and West contracts

In its latest Asian Metals Monthly report, Fortis Bank/VM Group, looks at the uncertainties in metals prices given Chinese growth and Western economic weakness.

LONDON - 

The strategic summary from the latest Asian Metals Monthly report from Fortis Bank and prepared by the VM Group in London comments on the fact that there is conflicting data and opinions as to whether the global recession has reached its lowest point.  Recently George Soros reckoned the worst is behind us, but concrete evidence of that remains sparse, as job queues lengthen and global GDP growth estimates from agencies such as the IMF and World Bank remain firmly negative for the rest of this year. Having said that, the report points out  that base metals have enjoyed a remarkable recovery so far this year, based on expectations (if not conclusively lasting evidence) of China's growth prospects.

It is certainly the case, notes VM Group analysts, Gary Mead, Carl Firman and Matthew Turner, that, ignoring May's lower export figures, China's fixed asset investment, home sales and car sales have all soared, and Chinese imports of raw materials have continued to set new records.  This is of course very positive, but insufficient to bring about a rapid end to the global recession.

As a report on Asian Metals the two main features in the report focus on China and aluminium.

The "decoupling" theory regarding China, which argued essentially that its economy had become big enough to prevent it being hit by the recession, never rang true say the analysts.  China has suffered too. What's needed now, they conclude, is some planning about how best to re-couple the rest of the world's economy to that of China.

The aluminium feature inevitably considers China too. Its policy of supporting the country's domestic smelters by creating strategic stockpiles of the metal has helped them to survive - but only at the risk of a much longer, drawn-out structural problem for the global aluminium market. We face the risk of this market's supply-demand fundamentals becoming much more opaque says the report. Aluminium remains structurally the weakest of all the base metals, so a price rally of almost 9% in June has to be based on hope rather than reality. Apart from speculatively eager anticipation of future demand there is little reason for aluminium to trade above $1,200/t. The greatest risk is therefore to the downside, but such is the renewal of risk appetite that further price strength cannot be ruled out.

Looking at other metals the report points out that golds latest rally failed to beat its 2009 high, and with the dollar recovering the price fell back sharply. The analysts consider that there is little internal news to get in the way of further dollar-based losses.  When little else is going on, gold inversely follows the dollar quite closely, but more pronouncedly, i.e. for a given dollar move gold moves more in the opposite direction. This is because it is seen by many investors, especially those who are dollar-based, as a dollar hedge. With further dollar gains likely, the report sees gold falling back to levels seen in April. Then all eyes will be on physical demand. Short-term London fix prediction: $880/oz-$950/oz.

Silver shot higher and collapsed back, as is in its nature; nevertheless it remains higher relative to gold than it has been for most of this year. What happens next will depend on a combination of the dollar, which we expect to rally, thus meaning lower silver prices, and perceptions of the economic recovery. These are very volatile scenarios, changing with every release of new economic data, but the analysts' short-term bias is towards a more protracted and difficult, uncertain exit from the recession, one that will not become conclusively apparent until 2010. Longer-term, the prospects for silver are considered to be looking better than for several years, thanks to the cutbacks in silver produced as a by-product, and the emergence of new end uses.  Short-term London fix prediction: $12/oz-$15/oz.

Copper is seen as approaching the point where there is danger of oversupply. The persistently high price has given miners and smelters the perfect justification to restart idled production and go ahead with mine expansions and the commissioning of new projects. The rally essentially boils down to the notion that Chinese fiscal stimulus-fuelled growth will more than absorb the contraction in copper demand from the developed world. If that proves not to be the case then a sharp price correction in 2H 2009 could be seen. However, right now the momentum is with bullishly-inclined speculators. Short-term LME three-month price prediction: $4,900/t-$5,650/t.

Zinc producers have responded better than those for any other base metals (save nickel) to the global recession, in the sense that they have made the deepest production cuts, estimated by to be 15% of 2008's production, and these cuts moreover seem to be sticking. This creates scope for a much stronger price recovery once the recession is over and demand growth returns, as it surely will in zinc's main end-use, in galvanising steel.

As with zinc, supply-side responses to the recession by lead producers have been encouraging in that production cuts have been made of about 10% of last year's output and they are holding firm.  A  global surplus of some 165,000t of refined lead in 2009, falling to 84,000t in 2010 is still in prospect though.

Chinese steel producers want at least a 40% discount to the benchmark contract price, but iron ore producers are only willing to give a smaller 33% discount.  With many Japanese, South Korean and Taiwanese steel makers succumbing to the iron ore miners' charms, the Chinese are fighting an uphill battle. Their case hasn't been helped by the high rates of Chinese production in 2009. Global apparent steel use is expected to decline by more than 14% in 2009 to 1.019bn tonnes, with Chinese demand expected to fall 5%, US demand to fall by 36.6% and EU demand to fall by 28.8%; the iron ore contract price settlements though could put pressure on steel producers to increase prices or reduce output. So long as the world remains optimistic about an economic recovery, this may not be a problem; but if demand recovery is slower than expected then there could be trouble ahead.

Overall the report sees the fact that the Chinese growth trend continues to be positive, which on the whole is considered encouraging: China's economy has taken a beating, but it has not collapsed. Industrial profits in the first months of this year fell almost 28% compared to the same period of 2008, according to the country's National Bureau of Statistics, but the worst of that drop was stacked up in Q1.  However western decline is more than matching any Chinese growth which is going to continue to make the metals price pattern uncertain in the short to medium term - and perhaps longer.

Disclaimer

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