Metal market moves — funds or fundamentals?
By Sanjay Saraf | 12 September 2017
A number of the major traded metals have hit multiyear highs recently and out-performed most other commodities, with some observers heralding another boom for a sector that had been somewhat beleaguered. But are these rallies sustainable, and are they being driven by underlying fundamentals or speculative activity?
During a typically slower summer period, there has not been much from the "real" demand side that appears to have justified recent price action. Neither have there been any new, significant developments on supply that are tightening balance sheets. Different commodities do exhibit varying fundamental characteristics. Zinc, for example, has been waving a bullish flag for some time as mine closures and curtailments have tightened supply while demand in end-use markets such as construction and automotive has remained robust. Other metals, such as nickel and copper, have had less unambiguous supply/demand drivers. Commodity Briefing Service, an offering of S&P Global Market Intelligence, is of the view that the rise in prices has largely been driven by market and macro factors, with supply/demand fundamentals exerting secondary influences in many cases.
Chinese economic performance has exceeded expectations, as indicated by some recent data, including second-quarter GDP growth. Given China's dominance in global metals and raw materials consumption, this has provided some confidence and underlying support to recent investment activity in industrial metals.
Ongoing macro developments in the key demand markets for metals, but especially China, will also have a key role in how metal prices develop. Geopolitics, most notably how current U.S. and North Korean tensions play out, and the path of the U.S. dollar, including any impact from the U.S. Federal Reserve interest rate policy, will also be important contributors to future price movements.
Chinese data not conclusively positive…
As the main global consumer of metals and their raw materials, China's economic health is being closely monitored to see if the rally in prices is sustainable. Some of the headline numbers have provided support, but other data reveals underlying headwinds. On the positive side, recent Chinese purchasing manager indices, or PMIs, have indicated a pickup and expansion in manufacturing activity. The National Bureau of Statistics' measure, assessing large state-owned enterprises, increased to 51.7 in August from 51.4 in July; the Caixin PMI, covering small and medium-sized companies, rose to 51.6, a six-month high.
Inflation in China lifted in August; consumer prices by 1.8% year over year, compared with 1.4% in July, and producer prices by 6.3% compared with 5.5% a month prior. However, the last figures for retail sales, in July, showed growth of 10.4% year over year, down from 11.0% in June. Among other industrial or economic indicators, stronger year-over-year growth in electricity consumption in July of 9.7% (5.4% in June) was supportive, as was a continued pickup in China's foreign exchange reserves. Central bank data showed that these rose to US$3.09 trillion in August, a seventh successive month of gains and the highest level since October last year. U.S. dollar weakness has helped to push up the value of nondollar currencies in the country's holdings. The reduction in capital outflows, seen as one of China's biggest risks, has improved confidence and shows some impact from the clampdown on overseas investments by Chinese companies. Nevertheless, total forex reserves are still almost US$902 billion down since the June 2014 peak of US$3.99 trillion.
Less sanguine data releases have been seen for China's industrial production growth, which dipped to 6.4% year over year in July from 7.6% in June. House price growth in tier 1 and 2 cities has continued to decline, falling to 9.7% year over year in July, compared with 10.2% the month before. Meanwhile, growth in buildings under construction and those completed remains muted.
Chinese debt levels and credit risk remain a major threat to our outlook for the country's economy and its demand for industrial metals. The government continues to face a fine balancing act of controlling overheating in areas such as property investment while not tipping the market too far toward a sharp growth slowdown. New loans in August did fall to 825.5 billion Chinese yuan in August, from 1.54 trillion yuan in June. However, nonperforming loans continue to rise, reaching 1.636 trillion yuan at the end of the second quarter — the highest since the first quarter of 2005. The NPL ratio has remained resolutely fixed at 1.74% for several months, indicating growth in China's overall gross loan book.
