By Andy Home
London
This year has brought plenty of reminders of just how contrary and difficult markets can be.
A year that was supposed to be characterised by supply divergence among the base metals traded on the London Metal Exchange (LME) is ending with all of them falling in tandem in response to growing concerns about demand.
There is plenty to be concerned about. Take your pick from collapsing oil prices, stagnation in Europe and the still-unfolding Russian crisis.
But for industrial metals the persistent underlying worry throughout the year has been slowdown in China, a drag on demand growth that shows no sign of ending any time soon.
It’s not that there have been no supply stories for investment money to chase. It’s just that either they’ve not been the ones expected or they have not turned out as expected.
Indeed, among the core LME base metals only copper and, to a lesser extent, zinc have performed anywhere close to script but even that statement comes with plenty of caveats.
No wonder many investment funds and banks have been departing the sector.
Even Hermes Investment Management, one of the trailblazers for commodities investment, has thrown in the towel after finding it “increasingly challenging to deliver sustained, active returns”.
And looking at some of the developments in base metals this year, who’s to disagree with them?
Nickel looks set to be the best performer of the year, up 12% as of Friday morning relative to the start of January. But few analysts thought much of its prospects back then. The median forecast in a Reuters poll that month was for the nickel price to fall marginally over the course of 2014.
That all changed when Indonesia sprang a surprise by enacting its long-promised but still largely unexpected ban on the export of nickel ore, cutting off a key raw material supply for China’s massive nickel pig iron (NPI) sector.
So began a spectacular rally that peaked in May, at which stage the price had risen by close to 50%.
Analysts were vying to outdo each other with increasingly bullish price forecasts and hot money poured into the market, particularly the options segment, with ever more bullish bets on the upside.
What everyone underestimated was just how much replacement ore could be supplied by the Philippines. Not as good quality as Indonesian ore, true, but Chinese NPI producers have been blending it with their stocks of Indonesian material to eke out their raw materials lifeline. The much-touted mass closure of NPI capacity simply didn’t happen.
What really killed off the nickel rally, however, was another surprise, this one coming in the form of the Qingdao port scandal at the end of May.
The resulting surge of stockpiled nickel out of Chinese ports to safe-haven LME storage elsewhere in Asia has propelled visible inventory to previously unheard-of levels, crushing bullish exuberance.
Remember those layers of December call options, stretching all the way up to $30,000 per tonne?
The cash price of nickel on December 3, LME options declaration day, was just above $16,300, leaving all that bullish hubris lying shattered in barren out-of-the-money ground.
As nickel’s apparently compelling storyline started to unravel, bulls transferred their deficit dreams onto zinc and its narrative of accumulating mine closures.
The galvanising metal surged in the second quarter, a rally that peaked in July, when it was up more than 16% on the start of the year.
That rally too, though, was undermined by Qingdao and the subsequent relocation of collateral stocks from China back out to the rest of the world. The country, a consistent net importer of refined zinc for many years, switched to net exporter in October for the first time since December 2008.
Zinc bulls could, at least, take heart from lower visible exchange stocks and the monthly deficit headlines generated by the International Lead and Zinc Study Group, even though both signals are highly ambivalent.
More problematic for the market is the simple fact that tangible evidence of deficit is still conspicuous by its absence.
Physical premiums for refined metal remain weak and, more importantly for a market supposedly facing raw materials crunch, there is no sign of any supply stress coming from the concentrates market.
Still, at least zinc is on course to end the year in positive territory, fulfilling analysts’ expectations, although on current form it’s going to be a close thing.
Sister metal lead, by contrast, is competing with copper and tin for worst performer of 2014, even though analysts back in January picked it as likely second-best performer after zinc for the same mine-supply-crunch reasons.
In truth, lead has been out of favour all year, a market defined more than anything else by collective indifference.
Ah yes. Tin, the perennial bull pick for its combination of structural mine shortfall and Indonesian supply volatility.
Here too, though, deficit remains curiously elusive. China has been destocking tin. It’s not the first time this has happened in recent history but there has been a new, surprise factor in the mix this year.
Against a backdrop of chronic underinvestment in new tin mines, Chinese smelters seem to have tapped a previously unknown source of raw materials in Myanmar.
Industry body ITRI recently said it expected the country to supply around 26,000 tonnes of contained tin this year. That may not sound like a lot but in a 350,000-tonne global market it is, enough to postpone (again) tangible evidence of underlying supply deficit.
Copper, on the other hand, has largely performed in line with its anticipated narrative.
The metal was expected to fall in price this year in the face of accelerating mine production, and that’s what happened.
It’s just strange that the supposed resulting surplus is still so difficult to locate.
LME stocks are chronically low and spreads across the front part of the LME curve remain chronically tight. The benchmark cash-to-three-months period has been in almost constant backwardation over the course of the year and it remains so, valued at $47 back as of Thursday’s valuations.
So, where’s all the copper?
Mostly, it seems, in China. Not only was there no post-Qingdao mass movement of copper out of the country, but the government stockpile agency, the State Reserves Bureau, has been scooping up metal.
Exactly how much, nobody knows, but it’s sufficient to help prevent raw materials surplus travelling down the supply chain into the refined metal market.
So far at least.
Outright price weakness says more surplus is coming. Spreads say it’s not here yet.
That divergence has been the defining feature of this market all year and 2014 looks set to close without any resolution of the conundrum.
Talking of divergence and conundrum, aluminium remains as enigmatic a market as ever.
The LME price is up almost 7% so far this year as the market shifts from years of surplus to deficit thanks to smelter cutbacks.
Well, deficit outside China at least. The world’s largest producer is still expanding output and shipping ever-increasing amounts of domestic surplus to the international market in the form of semi-manufactured products.
That blurs the global supply-usage picture to the point there is still fundamental disagreement among analysts about this market’s fundamentals.
And, of course, LME price is only one, diminishing, part of the overall picture.
The “all-in” price remains fractured between LME basis and physical premium. Indeed, it’s increasingly questionable whether the yawning gap will ever be fully closed again.
If you’re looking for the ultimate bull market in the industrial metals space, forget nickel and zInc Aluminium premiums started the year by going supernova and they’ve not come down since.
The only problem for most investors and fund managers is that trading in physical premiums is out of bounds and for the few that have dipped their toes in the water, it’s been a perilous experience.
Andy Home is a columnist for Reuters. The opinions expressed are his own.
