The Prevailing Demand, Pricing Environment And Future Outlook For Metals

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This year has been characterized by extreme volatility in the prices of both precious metals as well as metals used in industry. Broadly, metals have been characterized by subdued pricing environments this year and this has been reflected in the stock prices of companies in the metals and mining space. In this article we will take a closer look at the reasons for the prevailing demand and pricing environments for various metals, as well as the outlook for demand and pricing going forward.

Steel

The principal consumers of steel products are the automotive, construction, appliance, machinery, equipment, infrastructure and transportation industries. The nature of business of these sectors is cyclical, with demand generally correlated with macroeconomic conditions. Thus, demand for steel products is generally correlated with macroeconomic fluctuations in the global economy.

Steel prices have fallen over the last few years, driven primarily by weak demand due to adverse macroeconomic conditions in the developed economies and an oversupply situation. This is indicated by trends in the London Metal Exchange (LME) Steel Billet Prices. [1] Over the course of last year or so, steel prices have recovered somewhat, driven by an economic recovery in the developed economies, particularly in the manufacturing sector. The Manufacturing Purchasing Managers Index (PMI) measures business conditions in the manufacturing sector of the concerned economy. When the PMI is above 50, it indicates growth in business activity, whereas a value below 50 indicates a contraction. This metric has consistently registered values of over 50 for all months in 2014 for the U.S. [2] This indicates strong manufacturing activity in the U.S. This was reflected in the half-yearly results of ArcelorMittal, the world’s largest steel producer. Average realized steel prices in the North American Free Trade Agreement (NAFTA) region rose 1% year-over-year in the first half of 2014 to $848 per ton, from $838 per ton in the first of 2013. [3] Going forward, steel demand in the NAFTA region, which consists of the U.S., Canada and Mexico, is expected to grow by 3.8% and 3.4% in 2014 and 2015, respectively. [4] Thus, steel pricing in the U.S. and the broader NAFTA region is expected to remain strong.

The Manufacturing PMI for the Eurozone has faltered somewhat lately, indicating slowing manufacturing activity. The Manufacturing PMI for the Eurozone, which stood at 54 for January 2014, has declined to 50.3 for September. [5] Sluggish manufacturing activity in the Eurozone was reflected in ArcelorMittal’s half-yearly results. Average realized steel prices in Europe fell around 1% year-over-year in the first half of 2014 to $804 per ton, from $813 per ton in the first of 2013. [3] With faltering economic growth and manufacturing activity, as indicated by the manufacturing PMI figures, steel pricing is expected to remain weak in Europe.

Chinese steel demand growth is expected to slow to 3% and 2.7% in 2014 and 2015 respectively, from 6.1% in 2013. [4] A slowdown in economic growth has tempered the demand for steel. China’s GDP growth is expected to slow to 7.3% and 7.1% in 2014 and 2015 respectively, from 7.7% in 2013. [6] Further, a Chinese government crackdown on polluting steel plants has forced many of them to shut down. In addition, tightening of credit by Chinese banks to steel mills that are not performing well, will negatively impact these mills’ prospects. [7] Furthermore, the Chinese leadership has proposed structural reforms of the economy, shifting the emphasis from investment and export driven growth to services and consumption led growth. Such a transformation of the Chinese economy may negatively impact Chinese demand for steel in the long term. Chinese Manufacturing PMI, reported by China’s National Bureau of Statistics, stood at 51.1 for September, and has ranged between 50.2 and 51.7 for the whole year. [8] With weak Chinese manufacturing growth, demand for steel is expected to remain subdued in China.

Iron Ore and Metallurgical Coal

Both iron ore and metallurgical coal are major inputs in steel making and the demand for these commodities is to a large extent correlated with the demand for steel. International iron ore prices are largely determined by Chinese demand since China is the largest consumer of iron ore in the world. It accounts for more than 60% of the seaborne iron ore trade. [9] Weak Chinese demand for steel has translated into weak demand for iron ore as well.

On the supply side for iron ore, expansion in production by majors such as Rio Tinto and BHP Billiton despite weak Chinese demand, has created an oversupply situation. A combination of weak demand and oversupply is likely to result in lower iron ore prices in the near term. [10] Iron ore prices stood at $82.38 per dry metric ton (dmt) at the end of September, around 38% lower than at the corresponding point of time last year. [11] As per Goldman Sachs, the worldwide surplus of seaborne iron ore supply will rise to 175 million tons in 2015, from an expected 72 million tons for 2014 and 14 million tons for 2013. [12] In view of the persisting oversupply situation, iron ore prices will remain subdued in the near term.

China is also the largest consumer of metallurgical coal in the world. Demand for the commodity by the Chinese steelmaking industry has been weak, adding to subdued demand from other major consumers such as Japan and the EU. Weak demand coupled with an oversupply situation due to expansion in production by major mining companies, has resulted in plummeting coal prices. [13] The benchmark Australian metallurgical coal price stands at around $119 per ton, around a third of its 2011 peak level of $330 per ton. [14] In view of the oversupply situation, metallurgical coal pricing is expected to remain subdued.

Copper

Copper prices fell to their five-month lows recently due to concerns over weakness in Chinese demand for copper. China is the world’s largest consumer of copper, accounting for nearly 40% of the world’s demand of copper. ((Copper Ends at 5-Month Low on China Worries, Wall Street Journal)) Copper has diverse applications in industry, particularly in the manufacturing, power and infrastructure sectors. The HSBC China Manufacturing Purchasing Managers’ Index (PMI) reported a value of 50.2 in September, lower than previously expected. [15] LME spot copper prices stood at levels of around $6,700 per ton at the end of September. These are sharply lower as compared to levels of around $7,200 per ton at the end of September last year. [16] With concerns about Chinese economic growth persisting, copper prices are expected to remain weak in the near term. The trajectory that these prices take in the years to come will to a large extent be determined by Chinese demand for the commodity.

Aluminum

Aluminum has diverse applications in industry. It is an important input in the packaging, aerospace, automotive, construction, commercial transportation, power generation, capital goods and consumer durables industries. Thus, demand for aluminum is broadly correlated with industrial growth. The European debt crisis and slowing Chinese growth have contributed to the weakness in aluminum demand, and consequently prices over the last few quarters. [17]

On the supply side, production capacity was not reduced corresponding to the subdued demand conditions over the last few quarters. Persistently high aluminum inventory levels relative to demand have kept LME aluminum prices depressed. This inventory was built up partially as a result of aluminum being tied up in financing deals, which were made possible due to low interest rates. ((Aluminum Price Premiums: Disconnect Between LME and Reality Continues, Metal Miner)) Despite inventories being at a record high, market forces failed to rationalize supply through the shutdown of smelting capacity. Though global aluminum majors like Alcoa and Rusal did make significant smelting capacity cuts, the same was not true of Chinese companies. This was primarily due to state intervention in the form of provision of subsidies or renegotiated power contracts to smelters, which serve as a disincentive to cut production. China accounted for around 45% of the world’s aluminum production in 2013, and the expansion in production by Chinese producers more than made up for capacity cuts by global majors. [18] ((Alcoa, Rusal’s Aluminum Production Cuts Not Enough With China Smelting, Metal Miner)) This oversupply situation kept aluminum prices depressed over the last few quarters.

However, aluminum prices have rebounded recently. Global smelting capacity cuts in response to low prices have finally taken effect. LME warehouse stocks of aluminum were down around 10% in July, since the start of the year. [19] In view of the global smelting capacity cuts, as per a poll conducted by Reuters in July, the market for aluminum is expected to move from an oversupply of 235,500 tons in 2014 to a deficit of 4,444 tons in 2015. [20] LME aluminum prices averaged roughly $1,800 per ton over the course of the third quarter in 2013. These prices have averaged close to $2,000 per ton in the third quarter this year. [17] However, global smelting capacity restarts in response to higher aluminum prices are expected to lower or eliminate the extent of the deficit next year. In addition, the trajectory of Chinese economic growth will influence aluminum prices to a large extent. With slowing Chinese growth, there is unlikely to be any significant upside to aluminum prices.

Gold and Silver

Gold and silver are often viewed as an inflation hedge and safe haven investment by investors. Thus, the prices of these metals are to a large extent influenced by a set of related factors including the macroeconomic outlook for the U.S. and world economies, the performance of alternative assets such as equities and the U.S. Dollar, the trajectory of interest rates and geopolitical uncertainty.

A strengthening U.S. economy has fueled expectations of an interest rate hike. This was responsible for the decline in gold and silver prices last month. London PM Fix gold prices fell nearly 8% in the first week of October, from levels of close to $1,290 per ounce at the beginning of September, before recovering to levels of around $1,240 per ounce by the middle of October. The recovery in prices was primarily due to demand for gold as a safe haven asset in the backdrop of global economic weakness and indications by the Fed that weaker foreign economic growth posed a risk to U.S. economic growth. [21] This dissipated fears of a sooner than expected interest rate hike. Unless there is extended global economic weakness, the consensus is that the Fed will raise interest rate some time in 2015, though the exact timing of an interest rate hike is contingent upon the pace of economic and jobs growth in the U.S. [22] [23] An interest rate hike is likely to lead to a decline in the prices of gold and silver, as investors shift towards higher yielding assets. Thus, the prices of these precious metals will be influenced to a large extent by the unfolding macroeconomic situation both in the U.S. and internationally. 

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Notes:
  1. Steel Billet Prices, LME []
  2. U.S. Manufacturing PMI, Trading Economics []
  3. ArcelorMittal’s Q2 2014 Earnings Release, SEC [] []
  4. Short Range Outlook for Apparent Steel Use 2013-2015, World Steel Association [] []
  5. Euro Area manufacturing PMI, Trading Economics []
  6. Goldman Sachs cuts China growth forecast sharply, Market Watch []
  7. The Latest Iron Ore Price Slump: Causes and Effects, Forbes []
  8. China Manufacturing PMI, Tradinfg Economics []
  9. China Ore Stockpiles Rise to Record on Financing Deals, Bloomberg []
  10. BHP, Rio Gamble with Stacked Iron ore Deck, Mineweb []
  11. Iron Ore Spot Prices, Y Charts []
  12. Iron Ore Price Forecast Cut by Morgan Stanley on Supply, Bloomberg []
  13. Coking coal price crashes through $100, Mining.com []
  14. Metallurgical Coal at 6-Year Low as Chinese Demand Slows, Bloomberg []
  15. Copper Ends at 5-Month Low on China Worries, Wall Street Journal []
  16. LME Copper Prices, LME []
  17. LME Aluminum Prices, LME [] []
  18. U.S. Geological Survey Mineral Commodity Summary-Aluminum, 2014 []
  19. Aluminium prices hit 17-month highs, Financial Times []
  20. Aluminium smelter restarts seen undermining global deficit outlook, Reuters []
  21. Gold Posts Longest Rally in Two Months on Haven Buying, Bloomberg []
  22. Janet Yellen Warns of Uncertain U.S. Economic Outlook, Financial Times []
  23. Upbeat Economic Reports Signal Sustained Improvement, Wall Street Journal []
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