Direction of market all depends on China
Tom Stundza, Executive Editor -- Purchasing, 2/3/2005
Predicting the nonferrous metals market's short-term direction is a mug's game, a usually futile endeavor. But one thing does seem clear: With China accounting for half of the global growth in demand in recent years, slowing Chinese demand could stall a two-year commodities rally that the rising Chinese demand had created.
The reason: Earlier commodities' rallies were fueled largely by the Middle Kingdom, as the populous country gobbled up metals to build factories and consumer goods. Now, investment analysts and market commentators are getting skittish about China, just weeks after they were forecasting higher prices for nonferrous metals because of earlier expectations of tight supplies in the face of robust demand.
For example, at the close of 2004, Charles Ober, manager of the T. Rowe Price New Era investment fund in Baltimore, projected higher prices for several sectors where supplies are tight, including industrial metals. "I'm particularly intrigued by the metals," Ober said at the time, "because there has been a lack of major discoveries for a significant amount of time in the raw materials used to make aluminum."
In addition, in December, commodity strategist Stuart Schweitzer at J.P. Morgan Fleming Asset Management in New York, suggested that "commodity prices are likely to be firmer in the future than most people have been expecting." His rationale: "Traditionally high commodity prices gave producers an incentive to build additional capacity. But, having been burned in the past by adding capacity prematurely, companies grew cautious (in 2003 and 2004)."
However, recent events have changed the view that China's economic juggernaut would ensure a high demand that would keep supply tight and prices high. China is making every effort to slow demand growth to avoid hyperinflation. That's why its 9%-plus annual economic growth of 2004 is expected to moderate to 7.5% this year. Yet, if China steps on the brakes too hard and the economy slows to a much greater extent than is now expected, the main casualties would be the steel and the nonferrous metals commodities.
"China started reducing its economic growth rate in the middle of last year by limiting government support of loans and by raising interest rates, and this year it is trying to maintain a slow annual rate of economic growth," says Rob Vanderhooft, president and chief investment officer at Greystone Capital Management in Regina, Saskatchewan. "There's going to be a big risk of a price collapse in the commodity markets if China's growth rate slows to 7% or lower."
Commodity prices likely were at a cyclical peak by the end of 2004, when the cumulative average world price of aluminum, copper, nickel and zinc was sitting at a 15-year high, which was lofty enough for some investors to take profits early in the new year. That created a volatile pricing scenario in the first trading days of 2005 when aluminum and copper prices on the London Metal Exchange (LME) plunged, temporarily halting a year-long rally. "There was going to be some sort of shift out of commodities by investors and speculators this year,'' suggests analyst Maqsood Ahmed at Calyon Financial in London. "Maybe it [is] just happening sooner than we thought it would.''
Overall, global economic growth is poised to slow from close to 5% last year to below 4% in 2005, suggests Craig Alexander, deputy chief economist at TD Bank in Toronto. "Although this still implies robust demand for raw materials, the extent of the moderation in demand growth may disappoint market expectations and lead to a change in market sentiment toward commodity prices." As a result, the TD Bank economist predicts that commodity prices are likely to give up some of their past gains in the months ahead.
However, other analysts suggest that the recent exchange-based adjustments pinned to sentiment over China aren't the real trendsetter. "Even if Chinese demand is slowing this year, it still remains strong enough to support base metal prices," says analyst Raymond Goldie at Salman Partners in Vancouver, British Columbia. "With demand for aluminum, copper and nickel predicted to outstrip supply this year, commodity prices do not necessarily look overheated, he says, "The reality does not seem to require a sharp drop in prices."
Looking at the metalsLME aluminum averaged 78¢/lb last year, as compared with 65¢ in 2003—the highest annual average price since 1998. Behind last year's newfound optimism was rising demand for aluminum in places such as China. However, analysts at Barclays Capital in London see demand growth for aluminum slowing to 5.3% (or 31.2 million metric tons) this year from 8.1% in 2004. China, the world's No. 2 user of aluminum, has been responsible in recent years for half of the global growth in demand. In 2004, with Chinese demand sizzling and forecasts of a deficit widespread, world consumers used lots of primary ingot inventory.
Stockpiles monitored by LME dropped 51% last year to close December at 694,750 metric tons. But, with the Chinese government's recent repeal of an 8% value-added-tax rebate for aluminum exports, more of the light metal will stay at home in 2005. That's partly why the new consensus forecast price for 2005 of 85¢/lb is lower than earlier projections.
China also has a large impact on copper prices as it surpassed the U.S. in 2003 as the world's biggest copper consumer. Prices for copper cathode surged 60% last year to an annual average of $1.30/lb (up from 81¢/lb in 2003) due to strong demand from China.
Looking ahead, Bloomsbury Mineral Economics of London had assumed that, led by even-stronger Chinese offtake, 2005 global consumption would rise 8.2% to 16.8 million metric tons, leading to a huge deficit. Now, however, most analysts expect copper to show demand deceleration worldwide in 2005. And they also think inventory levels will build up, rather than disappear. With demand growth for copper in China slowing to 10% (from 15% last year), "there will be some supply hiccups," agrees Vanderhooft of Greystone Capital. So, even though analysts see a 2.5% annual average growth in price to $1.33, that is tempered from earlier forecasts of a price of $1.39
Also, recent strong metal prices have prompted some new investment in the copper mining sector. Brazilian iron ore giant Companhia Vale do Rio Doce, for example, opened the Sossego copper mine in Brazil's Amazon region and has plans for as many as four new copper mines worldwide that would require an investment of up to $2.7-billion.
| '00 | '01 | '02 | '03 | '04 | '05/f | |
| Aluminum | 70.3 | 65 | 62 | 65 | 78 | 85 |
| Copper | 82.3 | 72 | 72 | 81 | 130 | 133 |
| Zinc | 51 | 40 | 36 | 37 | 48 | 52 |
| Lead | 21 | 22 | 20 | 23 | 40 | 40 |
| Nickel | 392 | 270 | 326 | 440 | 678 | 643 |
| Tin | 247 | 203 | 192 | 223 | 386 | 391 |
| SOURCE: LONDON METAL EXCHANGE FORECAST: ANALYST CONSENSUS | ||||||
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