Commodities Comment. Chinese steel sentiment extremely positive ahead of peak season GLOBAL. Feature article. Latest news

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1 GLOBAL LME cash price % change US$/tonne day on day Aluminium 1, Copper 6, Lead 2, Nickel, Tin 19, Zinc 2, Cobalt 47,7. Molybdenum 14,898. Other prices % change day on day Gold (US$/oz) 1, Silver (US$/oz) Platinum (US$/oz) Palladium (US$/oz) Oil WTI USD:EUR exchange rate AUD:USD exchange rate LME/COMEX stocks Tonnes Change Aluminium 2,195, LME copper 221,425-2, Comex copper 4,891 Lead 189, Nickel 384, 1,116 Tin 5,8 Zinc 387, -1,7 Source: LME, Comex, Nymex, SHFE, Metal Bulletin, Reuters, LBMA, Macquarie Research, February February 17 Chinese steel sentiment extremely positive ahead of peak season Feature article Market sentiment towards the outlook for the steel market is at extremely elevated levels in anticipation of a strong outlook for steel demand into the peak spring construction season. Our survey respondents are the most bullish they ve been in over five years. This bullishness is clearly reflected in recent price moves in steel and iron ore, and we believe prices are now factoring in expectations that are becoming too elevated, as we wrote about yesterday. Latest news February s flash manufacturing PMIs, released Tuesday by Markit, showed the industrial recovery continues in the Eurozone and Japan but is easing in the US. In the Eurozone, the manufacturing PMI rose to 55.5 from 55.2, a -month high. In Japan it gained to 53.5 from 52.7, a 35-month high. But in the US it fell to 54.3 from 55., implying growth but at slower pace. The Chinese manufacturing PMIs, both Markit s and the official NBS version, and the US ISM manufacturing PMI, our preferred measure of the US manufacturing sector, will be released on 1 March. Global crude steel production output continues to accelerate, with the January data released by worldsteel on Tuesday showing output of 136.5mt in the month (1,7mtpa), up 7% YoY. However, this is over a weak January 16 base, and output levels are still down on January 15 on a like-for-like basis (since this time worldsteel figures now include output from Vietnam). Interestingly, the symmetry in steel output continues, with both China and ex-china output rising 7% YoY. Global blast furnace output rose 5.2% YoY to 1,149mtpa, while direct-reduced iron (DRI) output rose ~15% YoY. Meanwhile, latest data from the American Iron and Steel Institute shows US crude steel output last week rose to 83.3mtpa, the highest level since June 16. YTD output is up 5.8% YoY, as expectations of a US recovery, coupled with protectionist policy, continue to support domestic expectations. Swiss trade data for January showed gold exports to China of 18t, rather less than the record 158t in December and the 43t of January 16. This is consistent with our assumption that much of that gold in December went into stockpiling ahead of the pre-new year strong demand season. Similarly, we note the premium of the Chinese gold price over the London gold price has fallen to about $/oz, still higher than for much of 2H16 (when it was ~$5/oz) but well down from the >$/oz seen in December. The China Coal Association called a meeting with 19 major coal producers in China today to discuss the potential resumption of the 276 working day policy post the end of national heating supply (ie, by end-march). The leading coal producers at the conference suggested a full resumption of the 276 working day policy, according to industry consultant SXcoal, ahead of the seasonal downturn for coal in spring for further details please see this note from our resources analyst, Coria Chow. We believe a selective relaxation is likely, with the SOE mines favoured by the government to achieve the aim of supply concentration under the 13 th Five Year Plan. Please refer to page 8 for important disclosures and analyst certification, or on our website

2 Mar-14 May-14 Sep-14 Nov-14 Mar-15 May-15 Sep-15 Nov-15 Mar-16 May-16 Sep-16 Nov-16 Sentiment index Chinese steel sentiment extremely positive ahead of peak season Market sentiment towards the outlook for the steel market is at extremely elevated levels in anticipation of a strong outlook for steel demand into the peak spring construction season. Our survey respondents are the most bullish they ve been in over five years. This bullishness is clearly reflected in recent price moves in steel and iron ore, and we believe prices are now factoring in expectations that are becoming too elevated, as we wrote about yesterday. Fig 1 Market bullishness at highest level in over five years Are you positive or negative on the market over the next three months? Increasing number of respondents positive Mills Steel traders Iron ore traders Increasing number of respondents negative Source: Macquarie Research, February 17 Orders and sales: The bullish sentiment is reflecting expectations for post Chinese New Year demand rather than recent orders. Orders have been more subdued as is to be expected around the Chinese New Year holiday. The auto sector remains the strongest area of demand nonetheless, while orders from infrastructure and construction sectors started to show a mild improvement last month ahead of the seasonally strong spring construction season. The question of whether orders can come through strongly enough not to disappoint versus expectations will be key to the price direction for steel in coming weeks. Fig 2 Mill steel orders robust, but this is a seasonally quiet time of year Fig 3 Auto demand remains the leading sector for orders Have domestic orders increased or decreased over the last month? Net change in orders at mills and traders - end use sectors Increasing no. of mills seeing orders rise Construction Infrastructure Machinery Autos White goods Shipbuilding Increasing no. of mills seeing orders fall - - Source: Macquarie Research, February 17 Source: Macquarie Research, February February 17 2

3 Mar-14 May-14 Sep-14 Nov-14 Mar-15 May-15 Sep-15 Nov-15 Mar-16 May-16 Sep-16 Nov-16 Export business by Chinese steel mills remains weak, but this is largely due to the elevated steel prices on the Chinese domestic market that have made Chinese steel exports less competitive in recent months. We expect to see a further decline in steel export volumes over 1H17, which should be supportive to ex-china steel prices. Fig 4 Chinese steel exports in 4Q16 were their lowest since early-14 Fig 5 Mills continue to see a decline in export orders as Chinese steel prices are not competitive Mt 12 Chinese monthly steel exports Have export orders increased or decreased over the last month? Increasing no. of mills seeing orders rise Increasing no. of mills seeing orders fall Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Source: China Customs, Macquarie Research, February 17 Source: Macquarie Research, February 17 Production and profitability: Steel mill margins continue to improve, aided to some degree by the easing in coking coal prices in recent months. Operating rates at mills remain low; however, this is due to seasonality, and we expect to see a surge in steel output in the weeks ahead. Chinese steel output traditionally rises strongly from March through May and tends to peak every May or June before steadying over 2H17. Fig 6 Increasing number of mills are profitable following the recent surge in steel prices Fig 7 Profitability is extremely elevated, but it s only a matter of time before output responds What is the current level of profitability? Increasing no. of mills making money % % % % % % % Mysteel % of mills making money - LHS Mysteel mills operating rate-rhs 95% % 85% % % % 75% Increasing no. of mills losing money % % % Source: Macquarie Research, February 17 Source: Mysteel, Macquarie Research, February February 17 3

4 May-12 Sep-12 May-13 Sep-13 May-14 Sep-14 May-15 Sep-15 May-16 Sep-16 Days of sales mn tonnes May-13 Sep-13 Nov-13 Mar-14 May-14 Sep-14 Nov-14 Mar-15 May-15 Sep-15 Nov-15 Mar-16 May-16 Sep-16 Nov-16 Fig 8 Output levels have shown little change over the holiday period Fig 9 Operating rates will pick up strongly in springtime, but which mills will lead? What is your current capacity utilisation rate? 1% Increasing no. of mills running above % % % % % % Decreasing no. of mills running above % % Blast furnace operation rate -Mysteel Small mills Medium mills Large mills Source: Macquarie Research, February 17 Source: Mysteel, Macquarie Research, February 17 Inventory: Steel mills have seen minimal inventory build despite the optimistic outlook towards orders, but this is probably better reflected in steel trader inventory. Trader inventory levels are at their highest levels in nearly three years, and their expectations for strong orders and ongoing price increases are clearly behind the strong inventory build. As we enter the strong demand season over the next couple of weeks the pace of draw in steel trader inventory should help to give an insight into the strength of demand. Fig Mill inventory is still reasonably low Fig 11 In volume terms mill inventory has risen a little but remains low for this time of year What level of steel inventory are you currently holding? - Macq steel sector survey CISA mill inventory, volume 6 Source: Macquarie Research, February 17 Source: CISA, Macquarie Research, February February 17 4

5 Wk -11 Wk -8 Wk -5 Wk -2 Wk 1 Wk 4 Wk 7 Wk Wk 13 Wk 16 Wk 19 Wk 22 Wk 25 Wk 28 Wk 31 Wk 34 Wk 37 Wk Days of sales Fig 12 Steel traders have built inventory ahead of the traditionally strong order period post CNY Fig 13 Steel trader inventory has jumped, according to Mysteel data 25 What level of steel inventory are you currently holding?-to traders mn tonnes Trajectory of MySteel trader steel inventory Source: Macquarie Research, February 17 Source: Mysteel, Macquarie Research, February 17 Raw materials: Steel mills have clearly built iron ore inventory in anticipation of lifting steel output in the months ahead. Moreover, despite already-high inventory levels, mills in our survey report that they plan to raise purchases further over the next month, meaning iron ore prices may still be supported in the very near term. As we wrote about yesterday, however, we believe that with inventory at extremely elevated levels at mills and record highs at ports, it won t take much of a turn in sentiment for prices to move sharply lower. Fig 14 Mill ore inventory continues to rise ahead of planned output hikes Fig 15 Mills still have plans to buy more iron ore near term despite high inventory levels Is iron ore inventory rising or falling? Increasing no. of mills with falling inventory Iron ore Increasing no. of mills with rising inventory Do you plan to increase or decrease iron ore purchases? Increasing no. of mills planning to raise Increasing no. of mills planning to reduce Source: Macquarie Research, February 17 Source: Macquarie Research, February 17 While iron ore inventory is extremely high, there has been a less-pronounced build in coking coal inventory at mills. This is somewhat surprising given the clear threat of coal production restrictions in China reappearing from March as the 276-day policy is likely to be reapplied in some form. We expect to see mills look to raise coking coal inventory more aggressively ahead of these potential restrictions, and this is why we think the near-term outlook for coking coal prices is more positive than that for iron ore. 21 February 17 5

6 Fig 16 Coking coal inventory has started to rise again, but less so than for iron ore Fig 17 Steel mills appear to have less-aggressive plans to lift coking coal purchases Is coking coal inventory rising or falling? Increasing no. of mills with falling inventory Do you plan to increase or decrease coking coal purchases? Increasing no. of mills planning to increase purchases Increasing no. of mills with rising inventory Increasing no. of mills planning to decrease purchases Source: Macquarie Research, February 17 Source: Macquarie Research, February February 17 6

7 Tuesday 21 February 17 Prices Closing price * Closing price * 21-Feb Feb-17 -Feb-17 -Feb-17 % ch. day 17 YTD Ave 16 US$/tonne US /lb US$/tonne US /lb on day US$/tonne US$/tonne LME Cash Aluminium 1, , ,675 1,5 Aluminium Alloy 1, , ,478 1,555 NAASAC 1, , ,661 1,4 Copper 6, , ,375 4,863 Lead 2, , ,5 1,872 Nickel, , ,443 9,9 Tin 19, , ,692 18,6 Zinc 2, , ,559 2,95 Cobalt 47,7 2,166 47,7 2, ,746 25,655 Molybdenum 14, , ,77 14,453 LME 3 Month Aluminium 1, , ,676 1,6 Aluminium Alloy 1, , ,491 1,577 NAASAC 1,5 86 1, ,679 1,725 Copper 6, 275 6, ,391 4,867 Lead 2, , ,5 1,878 Nickel, , ,491 9,657 Tin 19, , ,684 17,912 Zinc 2, , ,567 2,2 Cobalt 47,7 2,166 47,7 2, ,746 25,758 Molybdenum 15, 6 15, 6. 14,77 14,472 * LME 2nd ring price - hrs London time. Year-to-date averages calculated from official fixes. Gold - LBMA Gold Price (US$/oz) Silver - LBMA Silver Price (US$/oz) Platinum - London 3pm price (US$/oz) Palladium - London 3pm price (US$/oz) Oil WTI - NYMEX latest (US$/bbl) EUR : USD exchange rate - latest AUD : USD exchange rate - latest 1,233 1, ,115 1, , Exchange Stocks Change since last report Cancelled End-16 Ch. since (tonnes) 21-Feb-17 -Feb-17 Volume Percent warrants stocks end-16 LME Aluminium 2,195,375 2,195, 275.% 662, 2,2,175-6, Shanghai Aluminium 189, ,218.%,722 88,496 Aluminium 2,384,593 2,384, % 662, 2,2,897 81,696 LME Copper 221, ,25-2, -1.2% 95,3 311,825 -, Comex Copper 4,891 4,891.% -,112 24,779 Shanghai Copper 295,7 295,7.% - 146, ,132 Copper 622,46 624,646-2, -.4% 95,3 538,535 83,511 LME Zinc 387, 388, -1,7 -.5% 129, 427,8 -, Shanghai Zinc 197, ,456.% - 152,824 44,632 Zinc 584,6 586,256-1,7 -.3% 129, 5,674 3,832 LME Lead 189, 189,7.%,2 194, -5, Shanghai Lead 61,946 61,946.% - 28,726 33,2 Lead 251, ,696.%,2 223,626 28,1 Aluminium Alloy 12,8 12,8.% 12,9-1 NASAAC 116,8 116,8.% 6 97,3 19,4 Nickel 384, 383,784 1,116.3% 3, ,66 12,834 Tin 5,8 5,7.9% 9 3,7 2, Source: CME, LBMA, LME, Reuters, SHFE, Macquarie Research 21 February 17 7

8 This publication was disseminated on 21 February 17 at 18:36 UTC. 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