Commodities Weekly: End of Restocking Will Help Accelerate Price Falls

Stocking-cycles are glaring features of commodity price-cycles. De-stocking (reducing private inventory holding) and re-stocking (increasing private inventory holding) can be easily confused as change in net consumption and can smudge the big picture; analysts and researchers find it quite difficult to separate consumption from stocking without making arguable assumptions. Since stocking cycles are price-sensitive, high volatility in prices make these cycles even bigger and more confusing. The last 6 months are a clear vindication of this. Now, with a well-supplied China and waning stimulus-driven demand in the west, the re-stocking cycle is close to its end for several commodities. We fear that a drop in commodity prices could accelerate as fundamentals take hold. We expect prices to eventually give back about 50% of their bottom-to-top gain since Mar09.

End of re-stocking and price fears

In first 8 months of 2009, China has imported almost twice the quantity of refined copper it imported in 2008 altogether. Despite a steep fall in monthly imports over the last two months, the Chinese rate of monthly import of refined copper is twice the average monthly imports last year. Besides, onshore copper production is rising at 7-9% yoy. Clearly, after a steep reduction in private inventory levels in most of 2008, restocking has been a large part of Chinese activities in 2009. Antaike, a government funded research firm in China, estimates total stockpile of copper to reach 1.2 million tons, sufficient to feed the country for 80 days. While, these numbers can be argued, we agree that China is well stocked on Copper now. We hear further softening in onshore cathode premiums and some offers at sub LME levels in international markets. Copper, in our estimate, will be a loss leader amongst commodities in weeks to come.

While visible and private inventories of other base metals remain quite high, several “short-term” price-supportive factors may not make these metals as vulnerable to price falls as Copper. Financing deals on LME inventories and the absence of Rusal’s production from Asia in the most of 2009 has created a “temporary” shortage of Aluminium; the story holds well even now. Aluminium premiums remain high (see “The last week” below) in Asia. However, with the restart of about 3.5 milion tons of idled smelting capacities, stocks are rising again. Total stocks in Aug09 rose to 2.306 million tonnes from a revised figure of 2.254 million tonnes in the previous month, a rise of 1.2% that halted a six-month period of consecutive declines, preliminary data showed. We disagree with several analysts and think that re-stocking demand for Aluminium in the west was mainly inspired by government aided auto and housing incentive programmes. Auto sales in US fell by 23% m-o-m in September as the “Cash for Clunkers” programme ended; fear is rising in UK car industry as about 2/3^rd of the allocated money for car incentive programme was used. We feel that “artificial” shortage of supply will ease gradually; we expect a slow decline in Aluminium prices.

Similarly, Lead prices are supported by widening Chinese investigation into polluting smelters. Government agencies are taking time in completing the full investigation and may come up with “compliance standards”. While small polluting smelters may be forced to shut down, we do not expect the big-ones to be affected. On the contrary, in Aug09 Chinese Lead production rose 26% yoy to a monthly record, registering a rise of 6% over Jul09 production. We feel that despite weak fundamentals, selling may not become aggressive before the Chinese investigation report is made public.

Despite a 6-year high LME stocks, Tin prices are holding well due to the “cornering” of LME inventories by a UK based fund; a case of “temporary” price support again. Market sources suggest that the drama could continue till the third Wednesday of Dec09. Shorts may not attempt to build fresh positions ahead of this expiry.

Zinc prices are at a crossroads. Despite inventories at 4-year highs, spot demand for zinc is supported by the restart of idled steel capacities, both in the east and the west. On the other hand, the restart of idled Zinc smelters is picking momemtum as well with Nyrstar leading the case. While the near-term price outlook for zinc looks quite balanced, we feel that the restart of steel capacities is “too quick, too soon”. Despite ample supplies, several Chinese steel producers are unwilling to cut production with hopes of revival in demand in Q4. Government’s efforts towards reducing Chinese crude steel overcapacity could take a long time to work, and meanwhile surplus production will keep seeping into nearby regions. Europe HRC prices are the latest to come under pressure by Chinese exports; traders expect exports to accelerate after Chinese return from holidays. We expect an announcement of production cuts by major Chinese steel producers in the near future.

The last week

Poor economic data from the US, strengthening industrial production in China and India, and a recovery in the dollar and fall in commodity prices featured prominently in last week's news.

For the last 6 months, US economic data have shown signs of recovery. The pace of job losses has been slowing, industrial activity is picking up momentum, durable goods and factor orders are adding up and consumer confidence is returning. Last week’s data on all these fronts showed a break in the up-trend. Job losses in September (263k) were higher than expected, sending the unemployment rate to a 26 year high. US factory orders fell for the first time since Mar09 and durable goods orders fell at the fastest rate since Jan09. The ISM manufacturing index showed continued expansion in activities in September, but the pace slowed to 52.6 against 52.9 in August. We feel that stimulus driven economic activities are looking to take a breather and will eventually await either another stimulus or private investments to take over. Most of the asset prices have yet to discount a “potential” gap in growth trajectory.

Base metal prices dropped after an effort of “window dressing” on quarter end. Metals closed the week on weak footing and could come under more pressure after small consolidation. US treasury yield has now convincingly broken below the uptrend since Mar09 and has gone back to lows seen in May09. Demand for safety is clearly rising.

Chinese holidays kept the physical market very quiet and premiums soft. Asian demand for Aluminium continued to remain firm with South Korean fob premiums quoting at $90-100, Japanese CIF premiums at $115, and US premiums at $5-10 fob.

Market mood
We continue our bearish stance on Copper. Our first downside target of 5850 has been reached; we now expect 5600 in 2 weeks time. We eventually expect copper prices to fall down to $4600-4650 region sometime in 2009, where dip buying could start lending support.

Lead prices have crossed and closed below short-term support. The metal has shown close linkage with copper and could slide together. We expect a fall to 1900-1950 region in coming 4-6 weeks.

Despite a pile of inventories, Nickel and Aluminium prices are holding well; there are noticeable similarities in the price-pattern of the two metals. We expect these metals to remain range-bound in the short term, and eventually break below once 16,000 and 1800 respectively are convincingly broken.

Zinc prices have held quite well recently and have remained rangebound in 1850-1970 region for almost two months. It is too early to conclude whether this is a topping pattern. However, zinc will find it difficult to ignore weakness in the base metal complex and could come under pressure. Bearish trend is not seen till 1800 is convincingly broken below.

Disclosure: None