Visit us at www.sharekhan.com May 07, 2015 Buy nickel, sell zinc 1. Sell zinc /Buy USD-INR spot 2. Sell zinc /Buy 7 lots of nickel mini Reco rate: 1. LME zinc $2,347; MCX May Rs150.60 USD-INR spot Rs63.52 2. LME zinc $2,340; MCX zinc May Rs150.10 LME nickel $13,880; MCX nickel May Rs887.50 Key points 1. The base metals have been rallying very sharply for the last two months. This stunning rally in the base metals seems surprising and somewhat unjustified given the state of the global economy, especially given the fact that the major economies are showing significant slowdown. 2. The world s largest economy, the USA, almost stalled in the Q1 of 2015, while China s economy, which is the world s biggest consumer of base metals, is losing steam as reflected in the key major economic data. 3. We suspect that this breathtaking rally in the base metals is based on stimulus speculation as traders think that China would ease further and the US Federal Reserve (US Fed) would refrain from hiking rates for a longer time frame. 4. Weakness in the US Dollar has also played a crucial role in this rally. 5. With the China s peak demand season getting over in May, the demand for the metal is likely to weaken. 6. With the crude oil prices rising again, the inflation concerns re-emerge. This could force the central banks to go easy on their aggressive accommodative campaign. 7. The US Dollar is likely to resume its ascent as the US Fed is likely to start tightening the policy from September 2015 as the job market remains healthy. A stronger dollar would weigh on commodities as the global economy is still not very strong. 8. China is unlikely to ease aggressively. 9. We suggest selling zinc at $2,347 with a stop loss at $2,535 for a target of $2,100-2,000. 10.We think that nickel is undervalued with respect to zinc as the nickel market is likely to tighten from the second half of the year. We suggest buying nickel over zinc with a stop-loss of Rs55,000 for a target of Rs100,000. Our calls Zinc appears to be ahead of its intrinsic fundamentals in the current global economic scenario. We suggest selling zinc. We had initiated the following calls on May 1, 2015. 1. Fundamental medium- to long-term call: Sell zinc at $2,347 and MCX May at Rs150.60 with a stop loss at $2,535 for a target of $2,100-2,000 with a time frame of six to nine months. Roll-over would be needed. On May 5, 2015 we also advised clients to buy 12 lots of USD-INR spot at Rs63.52 to hedge the sell call on zinc. It is to be noted that the Indian currency market was closed from May 1 to May 4, 2015. 2. Fundamental call: Sell zinc May at Rs150.10, buy 7 lots of nickel mini May at Rs 887.40 with a stop loss at Rs55,000 and a target of Rs100,000 with a time frame of six to nine months. The London Metal Exchange (LME) 3-month nickel was trading at $13,880 and zinc 3-month was trading at $2,340. Roll-over needed. For Private Circulation only REGISTRATION DETAILS Regd Add: Sharekhan Limited, 10th Floor, Beta Building, Lodha ithink Techno Campus, Off. JVLR, Opp. Kanjurmarg Railway Station, Kanjurmarg (East), Mumbai 400042, Maharashtra. Tel: 022-61150000. Sharekhan Ltd.: SEBI Regn. Nos. BSE - INB/INF011073351 ; BSE- CD ; NSE- INB/INF231073330 ; CD-INE231073330 ; MCX Stock Exchange - INB/INF261073333 ; CD-INE261073330 ; DP - NSDL-IN-DP-NSDL-233-2003 ; CDSL-IN- DP-CDSL-271-2004 ; PMS-INP000000662 ; Mutual Fund-ARN 20669 ; trading through Sharekhan Commodities Pvt. Ltd.: MCX-10080 ; (MCX/ TCM/CORP/0425) ; NCDEX-00132 ; (NCDEX/TCM/CORP/0142) ; NCDEX SPOT-NCDEXSPOT/116/CO/11/20626 ; For any complaints email at May 07, 2015 igc@sharekhan.com; Disclaimer: Client should read the 1 Risk Disclosure Document issued by SEBI & relevant exchanges and Do s & Don ts by MCX & NCDEX and the T & C on www.sharekhan.com before investing.
Call rationale China s industrial production Part A: With China and the USA slowing down, zinc rally unlikely to last 1. China s economy slowing down: China, the largest consumer of base metals, is slowing down and it is evident from its industrial production, gross domestic product (GDP) growth rate, retail sales and manufacturing purchasing managers index (PMI). The nation s economy grew in the first three months of 2015 at its slowest quarterly pace in six years. The Q1 GDP rose by 7% year on year (YoY) which happens to be the nation's slowest annual expansion in 25 years. China s GDP growth rate Retail sales in March rose by 10.2%, the slowest increase in nearly a decade. China retail sales China's official manufacturing PMI came in at 50.1 for April. The index shows that the manufacturing activity contracted in February and March before barely moving into the expansion zone. Still, even in April, there was a steep decline in the new orders component with smaller declines in the employment and purchasing activity components. China s PMI In March 2015, the industrial production rose by 5.6% YoY, its slowest increase since late 2008. May 07, 2015 2 2. China going for surgical strikes rather than full fledged easing While China has taken some broad easing steps, including two interest rate cuts, we expect the People s Bank of China (PBoC) would henceforth continue its measured approach rather than getting into an aggressive easing. The central bank has been using the below given tools to rejuvenate its economy: a. Reserve-requirement ratios for banks deposits b. The setting of benchmark lending rates and moneymarket operations c. The Pledged Supplementary Lending (PSL) programme, which was used last year to channel funds through to building low-cost housing, via the state-owned lender, China Development Bank. PSL is likely to be used to help local-government debt purchases. d. Re-lending facilities, where it accepts collateral from banks in return for fresh money that can be used for new borrowing. e. Recapitalisation of policy banks so they can boost lending to government-favoured projects. Source: Bloomberg
3. US economy doesn t look very promising US bordering upon recession The USA s trade deficit for March exploded as against the expectations of a $41.7 billion deficit. The USA generated a deficit of $51.4 billion, which is the worst since October 2008. Exports rose by just $1.6 billion, while imports soared by $17.1 billion with the goods deficit with China soaring from $27.3 billion to $37.8 billion in March. This huge trade deficit could push the Q1 GDP of 0.2% annualised rate into the negative territory, which with a Q2 GDP of 0.8% (as per the Atlanta Fed) means the USA is this close from a technical recession. (Source: zerohedge) USA s quarterly annualised GDP (in %) USA s ISM manufacturing index Housing starts: Languishing near lows Housing starts rose less than forecast in March 2015 from the weakest pace in more than a year. USA s housing starts (in'000) US durable goods orders: The USA s business investment spending plans fell for a seventh straight month in March. Demand for items excluding aircraft and defence, a proxy for business investment, fell by 0.5% and has declined for the straight seventh month. USA s durable goods orders (in %) US Industrial production: Posted its biggest drop in more than 2 years in March For the first quarter, the industrial production of USA declined at an annual rate of 1.0%, the first quarterly decrease since the second quarter of 2009. USA s industrial production (in %) US ISM manufacturing: Near two year-lows The pace of USA s manufacturing growth held at its slowest in almost two years in April, as a rebound in new orders was offset by employment shrinking to its lowest level in more than five years. May 07, 2015 3
PART B: Metal-specific factors 1. Zinc-specific fundamental factors China s zinc imports remain lacklustre despite a pickup in April 2015 Laggard Chinese property market A persistent downturn in the Chinese property market, which accounts for about 15% of the China's economy, is one of the key factors for its slowing economy and a major concern for the metal s demand. China s refined zinc imports (M-o-M) (In tonnes) To gradually overcome the downturn in the property market, PBoC lowered the minimum down payment levels on second homes nationwide in late March 2015. Due to which the fall in house prices in China slowed in April. Still, the slowdown is unlikely to turnaround anytime soon. Land purchases by the real estate developers plunged 32% by area in the first three months of the year. Metal financing probe seen as somewhat negative for the base metals Qingdao Port International said the financing fraud of metals uncovered at the port in May 2014, involved about 400,000 tonne of base metals. A cargo of base metals stored at the port under Qingdao Hongtu Logistics was detained as part of the investigation. Banks suspect the same cargo of metals was pledged multiple times for loans at different banks. The investigation has prompted lawsuits from trading firms, warehouses and banks around the world. In this fraud, majorly copper and aluminium stocks were used, but if banks reject the use of metal as security and unleash a flood of supply it may affect the whole metals pact. China s zinc imports for January 2015 tumbled 74% YoY to 23,693 tonne. China s refined zinc imports surged by 136.5% in the month of March to 40,900 metric tonne. A sharp monthon-month (M-o-M) rise in zinc imports came on extremely low level of imports in February caused by the Chinese New Year holiday and on concerns of deficit due to the closure of major mines. China net exporter of refined zinc China s refined zinc exports (M-o-M) (In tonnes) Rising production of zinc in China has affected the nation s zinc imports adversely China s refined zinc output in the first two months of 2015 rose by 17% YoY to 966,000 tonne, after smelters churned out a record of 5.83 million tonne in 2014, according to the data from the National Bureau of Statistics. China s zinc production near all-time high China s refined zinc production (in mt) China became a net exporter of refined zinc during October 2014 for the first time since December 2008. We expect that the Chinese domestic zinc market would be in a surplus this year as domestic output and imports rise, while slowing economy and tightening environmental standards could weigh on the demand for the metal. Rise in refining and treatment charges The treatment charges have risen to $245 per mt, which is an increase of 10% from last year. Treatment charges May 07, 2015 4
rise with supplies as the producers compete to find smelters to process their raw material, thus the zinc market doesn t look as tight as perceived by the traders. 2. Nickel-specific fundamental factors Persistent price support/driver is Indonesia's laterite export ban On January 12, 2014, Indonesia had banned exports of raw mineral ores, most notably nickel and bauxites, in a bid to encourage domestic processing and extract more value from its mineral deposits. Although the expected tightness in the nickel ore market hasn t materialised due to China s destocking, we think that the market would tighten from the second half of 2015 as China s ore stock is likely to last till this year-end only. Nickel pig iron output supported by high-grade ore stocks China s destocking of nickel, which has led to a huge increase in London Metal Exchange (LME) nickel stockpiles, is rooted in the stockpiles of high-grade Indonesian ore (27 million tonne HG/MG ore) that the nation built prior to the Indonesian export ban. These stockpiles, blended with the Philippines ore, helped China in producing high levels of nickel pig iron production in 2014 (480 Kilo tonne of nickel), albeit with a decreasing production on a Q-o-Q basis. Estimated at over 20 million tonne (MT) at the start of the year 2014, stockpiles of high-grade ore in China are currently below 10MT and are trending toward critical levels. Thus, we expect the market to eventually tighten from the second half of 2015. High and Mid grade Chinese nickel ore inventory (kt) As per the statistics given by the INSG, the global demand for nickel is expected to increase to 1.94MT in 2015 vs 1.87MT in 2014, while the output is expected to shrink to 1.96MT vs 1.99MT in 2014. The increase in nickel ore exports from the Philippines is unlikely to fill up the Indonesian supply gap. Possibility of the Philippines new legislations on exports In the hope of tapping the untouched mineral resources in the Philippines, the country mulled over implementing the same law that transformed Indonesia s mining industry for the better. On January 12, 2014, Indonesia surprised the mining industry by enacting an almost unprecedented law by banning exports of raw mineral ores, most notably nickel and bauxites, in a bid to encourage domestic processing and extract more value from its mineral deposits. The new legislation on the Philippines ore ban has already reached the committee stage after the bill was introduced in July. However, the bill received many criticisms, especially from labour organisations and local mining companies. Risk to our view 1. Mine closures and depleting LME stockpiles supportive Positive for zinc prices Zinc has got support in the possible supply shortage story. It is expected that due to resulting in closures the aging mines would remove a million tonne of supply from the market. The LME stockpiles have dropped to the lowest level since 2009. However, the markets have been expecting supply crunch for quite some time. In October 2014, the ILZSG predicted a zinc deficit of 366,000 tonne for 2015, but in April 2015, the group revised its deficit estimates lower to 151,000 tonne. As zinc miners break-even at $2,200, we can expect an increased supply response as the prices rise. 2. Nickel LME stocks a major concern for nickel prices LME nickel stocks Source: Bloomberg Nickel surplus to shrink dramatically The global nickel surplus will shrink to about 20,000 tonne this year as an export ban on nickel ore by a top producer, Indonesia, further crimps production in China, the Lisbonbased International Nickel Study Group (INSG) said in April 2015. Last year's surplus was 120,000 tonne. May 07, 2015 5
The unstoppable rise in LME nickel inventory continues leading to a possible third consecutive year of rising LME stocks. Currently, the LME nickel inventory stands at over 444 kilo tonne (kt), which is up some 165kt or 60% YoY. However, it is being estimated that as much as 80,000 tonne of the almost 185,000-tonne inventory increased since the start of 2013 is due to the metal moving out from Australian stockpiles and Chinese bonded warehouses after a probe into loan fraud in Qingdao Port International. We expect the inventories level to gradually move lower as the year progresses and as China comes back into the market. The nickel market is likely to be a balanced market this year and would move into a deficit by next year. View Our calls are based on our understanding that zinc is getting ahead of its intrinsic fundamentals as this rally has been more about easing speculation and external factors like wider markets and weakness in dollar. The global macro-economic backdrop is not encouraging enough to sustain this rally. So, we have initiated a sell call on zinc. Nickel fundamentals are likely to improve going forward as China comes back in the market with Indonesian ore export ban turning the market tighter. Thus, we expect nickel to outperform zinc in the next six to nine months. To know more about our products and services click here. For Private Circulation only Home "This document has been prepared by Sharekhan Commodities Pvt. Ltd. and is intended only for the person or entity to which it is addressed to and may contain confidential and/or privileged material and is not for any type of circulation. Any review, retransmission, or any other use is prohibited. Kindly note that this document does not constitute an offer or solicitation for the purchase or sale of any financial instrument or as an official confirmation of any transaction. If you have received this in error, please contact the sender and delete the material immediately from your computer/mailbox. The information contained herein is from sources believed reliable. We do not represent that it is accurate or complete and it should not be relied upon as such. We may from time to time have positions in, or options on, and buy and sell securities referred to herein. We may from time to time solicit from, or perform investment banking, or other services for, any company mentioned. Any comments May 07, 2015 or statements made herein do not necessarily reflect those of Sharekhan Commodities Pvt. Ltd." 6