WEEKLY COMMODITY REVIEW Thursday 8 th November, 2018 Base Metals Q3 2018 Review & Q4 Outlook Overview The third quarter of 2018 not surprisingly proved to be a very difficult period for the base metals sector, driven lower under the weight of trade disputes between the US and the world (China in particular), combined with a strong US dollar and higher interest rates. As a result, the base metals sector fell by an average of 10.4% during the quarter. The US dollar index moved 0.41% higher during Q3 and is up 3.2% so far in 2018. All of the six base metals that trade on the London Metals Exchange (LME) declined during Q3, compared to their prices at the end of Q2. The best performing commodity in the base metals sector during the quarter was tin which fell by 3.45%. By comparison, copper fell by 5%, aluminium by 5.8%, iron ore by 6%, zinc by 13%, nickel by 16% and lead by 17%. The first round of protectionist measures on China took effect on July 6, with China retaliating proportionately with equal tariffs on US goods. To up the ante, President Trump placed restrictions on technology investments in the US by China and slapped another 10% tariff on $200 billion worth of Chinese exports to the US during Q3. Those duties will rise to 25% by the end of the year if there is no progress on trade. Moreover, the President threatened China with another $257 billion in tariffs at the higher rate if they continue to retaliate. China represents the demand side of the fundamental equation with respect to commodities as a result of its massive population and economic growth. However, trade issues have weighed on both the Chinese economy and the prices of industrial commodities. While the sector is down 10% on the year going into the final three months, a trade agreement could cause a considerable relief rally as many of the metals that trade on the LME are ground zero for trade issues facing the world. The reality is that tariffs distort supply-demand fundamentals with respect to all commodities. As we head into Q4, the trade issues and path of least resistance of the US dollar are likely to continue to provide direction for these industrial commodities that are the building blocks for global infrastructure. 1
Copper The red metal posted a gain of just over 18% gain on the COMEX and 17.4% gain on the LME in 2016. In 2017, COMEX and LME copper gained by 31.57% and 30.25% respectively. Copper was trading at the highest price since 2014 at the end of 2017. COMEX copper closed Q3 at the $2.8050 per pound level as the red metal fell by 5% during the third quarter of 2018. Copper on the COMEX futures market was 15% lower over the first nine months of 2018. Copper rose to its highest level since January 2014 when COMEX futures traded at $3.32 per pound in December 2018. In mid-august, the red metal fell to its low for the year under the weight of a strong dollar and trade issues with China. COMEX copper traded in a range from lows of $2.55 to highs of $3.32 over the first nine months of 2018, with the highs coming during early June and the low in mid- August. We witnessed an increase in price volatility in June as the price moved to within 0.65 cents of the December 2017 highs on the potential of a strike at the world s leading copper mine, Escondida in early June. Copper fell on the back of the rising dollar and trade issues despite the rising odds of a strike through the summer months, but labour and management reached a deal on a new contract which averted a work stoppage during Q3. Copper had already declined through its critical level of technical support at $2.87 per pound, which has become technical resistance. Copper has since fallen to its lowest price level since June 2017. As we move into Q4, the same factors that impacted the path of the price of copper will guide it for the rest of 2018. However, as can be seen from the graphic opposite, inventory data from the LME has been a supportive factor for the price of copper since it hit rock bottom in August. WEEKLY COMMODITY REVIEW 2
Nickel The price of three-month LME nickel plunged by 43% in 2015 and then rallied by 16% during 2016 and 22% during 2017. During Q1 2018, the buying continued and the price rose by 8%, making it the bestperforming LME metal for the first three months of 2018. Nickel put in a repeat performance during Q2, leading the base metals sector with a 12.8% gain. However, Trump s trade war and the higher dollar caught up with the nickel market during Q3, with the metal dropped by 16%. Overall, nickel has posted a 2.3% gain over the course of the first nine months of this year. Russia is a major producer of the metal, but China is the world s leader in nickel production. The bullish market price action was the result of a widening of the supplydemand deficit as Chinese demand for nickel supported the market. Economic growth around the world is bullish for the price of nickel, which is a critical ingredient in the production of stainless steel. Environmental production cuts in China has led to a sharp decline in global stockpiles. Keep an eye on iron ore and steel demand over the months ahead. Nickel is likely to be highly sensitive to changes in global economic conditions. Russia is a major producer of the metal, and sanctions against the Putin government are likely to continue to cause some dislocations in the nickel market in coming months. Nickel is a very volatile metal, so we could see a wide price range for the metal over the coming three months. Three-month nickel forwards closed Q2 at $12,580 per ton. Support for nickel is at the $12,000 level on three-month forwards, the level from which the metal broke to the upside. Zinc The price of zinc dropped by 26% during 2015, however it was the best-performing LME metal during 2016 with a 60% gain. Zinc further added to its gains during 2017 with a 28% increase. During Q1 2018, zinc posted a marginal gain of 0.6%, before declining by 12% during Q2 below the $3000 per ton level. WEEKLY COMMODITY REVIEW 3
During Q3, selling continued as the price shed another 13% of its value. As a result, zinc has moved 23% lower over the first nine months of 2018, making it the worst-performing base metal of this year. Three-month zinc forwards on the LME closed at $2,536 per ton on September 28, 2018. After achieving a multiyear high in February, the price of zinc plunged during Q2 and Q3, on the back of a combination of increasing stockpiles and weak Chinese demand. Supplies of zinc concentrates have been rising because of high prices earlier this year, and that trend is likely to continue. New production from China and Peru weighed on the price of zinc, with lower demand because of escalating trade tensions sending prices significantly lower. The zinc market had been tight because of depleted mine supply, but higher prices brought new production to the market, and the price has slipped back to the $2500 per ton level. The fundamentals for zinc have shifted somewhat, with new production incentivised at higher prices. Tin The most volatile and illiquid metal traded on the LME, tin declined by 25% during 2015, before recovering to be the second best-performing base metal of 2016 with a 44% gain. During 2017, tin was the only loser in the base metals sector, with a 5.4% loss. During Q1 2018, tin posted a 6.3% gain, before falling by 7.1% during Q2. WEEKLY COMMODITY REVIEW 4
During Q3, the price of tin slipped by 3.5% - which actually made it the best-performing LME base metal. So far in 2018, tin has fallen by 4.7%. China is the world's largest producer and consumer of tin. The global tin market should move into a slight surplus based on current production and consumption levels. Indonesian output is on the decline, but in other areas of the world, it has risen. Above $20,000 per ton, things got dicey for tin throughout 2017, but economic growth in China provided stability and support for the price. However, tin is slipped below that level again at the end of Q2, with weakness in some of the other base metals. Even though the tin market has moved into a small surplus, the illiquidity of the market always has the potential to make huge price moves eventuate. Lead The worst-performing non-ferrous metal in 2014 was lead, with an 18% fall before becoming the bestperforming non-ferrous metal in 2015 with a 3.4% fall. During 2016, lead gained by 11% and by 25% in 2017. During Q1 20187, the price of lead fell by 3.6%, before posting a 1% gain during Q2. During Q3, lead was the LME s worst-performer with a 17% decline. In all, lead declined by 19.4% over the first nine months of 2018. Lead is a thinly-traded metal and it is always a possibility that there are both price and stockpile manipulation in the lead market. China is, by far, the world's largest producer and consumer of lead and the biggest player in the market, which lends the price of the metal to price manipulation. Lead had suffered from lower oil prices as demand for electric automobile car batteries decreased when oil moved lower in 2016, but the rally in NYMEX crude oil to above the $73 per barrel level has provided support for the metal as demand for electric vehicles increases. Lead is a promising metal because of its consumption in batteries, a global market that continues to grow. Aluminium The price of aluminium moved 12% higher during 2016, after falling by 18% during 2015. In 2017, aluminium moved 32% higher and for the first nine months of 2018 it is down 10%. For Q3 2018, aluminium is down 6%. The Trump administration imposed a 10% duty on aluminium imports into the US to prevent dumping and improve the economics for US producers. Tariffs alter the economics of production and consumption in the commodities market and can cause price distortions and increase WEEKLY COMMODITY REVIEW 5
market volatility. Based on the price action in Q3, the aluminium market reacted favourably to the protectionist move of the US administration, as the price experienced a smaller decline than many of the other base metals that trade on the LME. However, it is likely that sanctions on Russia, a significant producer of aluminium, have boosted prices over recent months. Chinese production of aluminium is declining because of new rules governing emissions by smelters and refineries near cities in China. Less production in China translates into more demand for imports from around the world for the world s leading commodities-consuming nation. Outlook for Q4 2018 There are lots of factors facing the industrial commodities sector of the raw material market that could cause lots of price volatility over the final three months of 2018. The dollar is closer to the highs than the lows of this year, interest rates are rising in the US and QE will come to an end in Europe at the end of 2018. While economic growth continues to be a supportive factor, the most significant variable continues to be the trade issue over the coming weeks and months. Trade issues will continue to dominate price action in the industrial metals over coming weeks and months. A trade agreement between the US and China would be bullish for the sector (just like the recent trade agreements with Mexico and Canada), as it could spur global economic growth. However, any riskoff period that comes from a trade and currency war, could continue the selling in this sector of the commodities market. The prices of the base metals are all closer to the lows than the highs of 2018. Each non-ferrous metal traded on the LME has different supply and demand fundamentals. Some of the metals are in deficit, whilst some have surplus inventories. On a macroeconomic basis, these strategic metals are all essential building blocks of infrastructure, and as such, China is the number one consumer across the board. Meanwhile, the prospects of infrastructure building in the United States, if the administration can ever garner support and votes in the legislature, would provide additional demand for the sector that could bolster prices. Keep a close eye on the price of copper as it is the leading barometer when it comes to the health and well-being of the global economy. The news cycle will have lots of influence on LME metals and other industrial commodities, along with markets across all asset classes. WEEKLY COMMODITY REVIEW 6
Disclaimer: Gavin Wendt, who is a director of Mine Life Pty Ltd ACN 140 028 799, compiled this document. It does not constitute investment advice. I wrote this article myself, it expresses my own opinions and I am not receiving compensation for it. In preparing this article, no account was taken of the investment objectives, financial situation and particular needs of any particular person. Investors need to consider, with or without the assistance of a securities adviser, whether the information is appropriate in light of the particular investment needs, objectives and financial circumstances of the investor. Although the information contained in this publication has been obtained from sources considered and believed to be both reliable and accurate, no responsibility is accepted for any opinion expressed or for any error or omission in that information. I have no positions in the stock mentioned and no plans to initiate any positions within the next 72 hours. WEEKLY COMMODITY REVIEW 7