May 2014 Analysis & Outlook of Non-Ferrous Metals Market Trends Mark Keenan Head of Commodities Research - Asia Important Notice: The circumstances in which this publication has been produced are such that it is not appropriate to characterise it as independent investment research as referred to in MiFID and that it should be treated as a marketing communication even if it contains a research recommendation. This publication is also not subject to any prohibition on dealing ahead of the dissemination of investment research. However, SG is required to have policies to manage the conflicts which may arise in the production of its research, including preventing dealing ahead of investment research.
GENERAL COMMODITY MARKET OVERVIEW We continue to expect that most metals will exhibit moderate volatility during the remainder of this year as the global economy recovers. The recent volatility spikes for a few metals, provide a reminder that volatility regimes (profiles) can change abruptly. Sources of general commodity market volatility so far this year have been the weather, geopolitics (Ukraine) and fears of a sharp slowdown in emerging markets (China in particular). The biggest source of uncertainty for commodity prices this year coming from emerging markets. This year is particularly critical for China as the government has allowed the first few corporate defaults to take place in what is likely to be the first of many. Given the large amount of estimated bad debt, there are fears that this could trigger a vicious cycle of defaults, resulting in a potential negative risk to the Chinese economy. The market is starting to get worried about this, which explains the recent sharp drop in the copper price. Copper is particularly exposed to fears of a sharp slowdown in China 1) the copper price trading some 40% above its marginal cost of production, 2) China accounting for 35-40% of global copper consumption, 3) copper mine supply accelerating which is likely to result in an inventory surplus this year and next 4) The use of copper in collateralised lending. Our economists expect China s government to successfully control the pace of defaults to avoid a hard landing. Our economists see a 20% probability of a hard landing (sub 5% growth). We expect a strong bounce back in US macro economic data over the rest of the year after weather-driven weakness in Q1 with 2014 GDP growth of 3.0%. Fed tapering should be completed before year-end with the first rate hike around mid- 2015. The euro area should grow by 1.0% this year while China is expected to slow to 7.1% growth. Global at 3.6% 2
COPPER RISING SURPLUS AS SUPPLY OUTSTRIPS DEMAND 9000 8500 1) March decline driven by fears of Chinese credit issues - possibility that copper held as collateral against loans may be sold. 2) Now - growing understanding that Copper is typically hedged in these financing deals - falling copper prices should not trigger their unwinding. Despite this Good hedge e.g. Australia Pension funds 3) What we have learnt - the large amounts of copper channelled into financing deals in China suggests physical demand less than implied. (bonded stocks 800kt) 4) Going forward - we believe that tight credit conditions, weaker Yuan, and negative arbitrage will likely discourage further finance linked copper imports over months ahead. 8000 7500 7000 6500 5) In spite of a China slowdown, the outlook for 6000 copper demand is an improving one, with global GDP growth set to accelerate in 2014. 5500 6) We forecast Dec-11 consumption growth Jun-12 of 4% Dec-12 Jun-13 Dec-13 yoy to 21.63Mt in 2014 compared to a 3.0% yoy gain in 2013 of 20.80Mt. Things to watch out for this year: - El Nino - India - June / July Copper Spread 7) Despite consumption growth in 2014, we expect copper to move into a surplus of 0.47mt as mine supply increases. (Chile, Mongolia, Peru) Price 2014 $6875 2015 $6500 2016 $6000 2017 $6500 2014 Q3 $6800 2014 Q4 $6500 2015 Q1 $6500 9) We believe that over the longer term and given time taken to bring a project from the exploration stage through into production, a prolonged period of underinvestment will again lead to a supply lag by 2016/17 and onwards. 2018 $7000 2019 $7500 8) In 2015 we forecast a surplus of 0.50mt as mine supply accelerates. 3
EL NINO WHAT IS IT & ITS POTENTIAL IMPACT ON COPPER, ZINC AND NICKEL On 6 an El Niño watch was declared by scientists at the National Oceanic and Atmospheric Administration (NOAA). The scientists attributed a 50% chance of El Niño developing during the summer or fall and even suggest this event might rival the record El Niño event of 1997-1998. Currently - the International Research Institute for Climate and Society (IRI) at Columbia University now report a 70% chance of El Niño occurring in August, rising to a 75-80% probability by October. 4
INDIA THE NEW CHINA? After three long decades of political alliances of every hue and colour; India has given a clear majority to a single party at the centre of the political spectrum. The BJP, led by Narendra Modi, has won the general elections by a clear margin, gaining 282 seats out of 543 in the lower house. This is the first time since 1984 a single party majority has ruled India and represents a significant shift. The last three decades were marked by the politics of coalition and alliances where consensus building was crucial for government, both to push forward any agenda and to remain in power, thereby significantly slowing growth and developed on many fronts 12.00% 10.00% 8.00% 6.00% 10.10% 9.36% 8.63% 8.16% 7.83% 7.71% 7.23% 7.02% 6.48% 6.03% 4.00% 2.00% 0.00% GJ DL MH TN AP IND BH KA WB UP Average Real Grow th Rate of States (GSDP %) at Constant Prices (Period 2002-2012) 5
INDIA COPPER THE MOST SENSITIVE? Crude Oil consumption (China LHS, India RHS) - linear trend for both countries Coal consumption (China LHS, India RHS) - linear trend for both countries. Copper consumption (China LHS, India RHS) - linear trend for both countries until 2009 China India China India China India 12% 10% 8% 6% 4% 2% 0% 1995 1998 2001 2004 2007 2010 5% 4% 3% 2% 1% 0% 60% 50% 40% 30% 20% 10% 0% 1995 1998 2001 2004 2007 2010 10% 8% 6% 4% 2% 0% 50% 4% 40% 3% 3% 30% 2% 20% 2% 1% 10% 1% 0% 0% 1995 1998 2001 2004 2007 2010 2013 Industrials metal and steel consumption in India rebased to 100 in 1995. (Steel 1998-2012) Industrial metals and steel consumption in China rebased to 100 in 1995. (Steel 1998-2012) 800 3000 700 600 500 Copper Aluminium 2500 2000 Copper Aluminium 400 300 200 100 Zinc Nickel Lead Steel 1500 1000 500 Zinc Nickel Lead Steel 0 1995 1998 2001 2004 2007 2010 0 1995 1998 2001 2004 2007 2010 2013 6
JUNE COPPER SQUEEZE? The Jun-Jul copper spread could move into a much steeper backwardation as outstanding shorts from the March sell-off are likely to struggle to buy back positions or deliver against them given low LME stocks. Severe tightening looks inevitable given the presence of large shorts/trade hedge shorts and the absence of lenders. Looking at the latest LME data there appears considerable short interest outstanding on the June prompt date which will have to be covered. LME data shows one entity alone holds a short position equal to 30-40% of market open interest. The Jun-Jul spread backwardation is currently trading at $27.50-30/t from flat in March, while the cash-3 s backwardation has widened to $93/t from $10/t. What about the possibility of a surge in copper exports from China to relieve the situation? The LME nearby backwardation is not yet sustained or extreme enough to trigger a surge in Chinese exports. The SHFE-LME arbitrage has widened slightly, but is still much narrower than it was earlier in Q1. In addition, bonded premia are high to probably attract deliveries from Chinese smelters rather than for metal to be exported. The cash-3 s backwardation will need to approach $150/t or thereabouts before we are likely to see exports of copper from China. 7
ALUMINIUM MODERATELY HIGHER PRICES LOOK LIKELY 2400 2300 2200 2100 2000 1900 1800 1700 1) Overall, Aluminium remains under pressure from weak fundamentals, namely high inventories and a global market in surplus. 2) Speculative sellers have dominated market activity, but some have covered their shorts in recent weeks in response to the rising political tensions between Russia and Ukraine. 5) Production growth should outstrip consumption in 2014, leaving the aluminium market in surplus to the tune of 0.55Mt, the eighth successive year of surplus. 6) With the rate of growth of aluminium consumption one of the fastest among the base metals, moderately higher prices look likely, although the huge inventory overhang, strong production growth will cap the upside. Price 2014 $1765 2015 $1900 2016 $2000 2017 $2100 2014 Q3 $1775 2014 Q4 $1825 2015 Q1 $1850 Things to watch out for this year: 1600 Dec-11 Jun-12 Dec-12 Jun-13 Dec-13 3) Physical premiums recently spiked and continue to remain elevated. It remains to be seen what the impact will be surrounding the LME warehouse issue. - Indonesian ore export ban. Despite huge Chinese bauxite imports last year & 10m tonnes of aluminum stocks, the cost of landing bauxite in China has increased form $40/t last year to $60/t due to cost of bringing form further away. (Australia & India) 4) Overall, and separately from the LME issue, we believe that stronger physical demand, production cuts and scrap shortages will support physical premiums. 8
ZINC - BULLISH - SMALLER DEFICITS AS CONSUMPTION RISES 2600 2500 1) Underlying zinc consumption in 2014 is forecast to increase in all of the major economies. 2) Global consumption in the automotive, infrastructure, construction and white goods sectors, is expected to rise by 5.0% in 2014 (13.35mt to 14.02mt). In 2013 it grew 4.0%. 3) The outlook for global refined production remains positive with few constraints on mine supply. Higher treatment charges should also boost smelter output. 4) Global refined output should advance by 6.2% yoy in 2014 (13.00mt to 13.80mt). 2400 2300 2200 2100 2000 1900 1800 1700 2) European demand will make a more meaningful contribution and US consumption looks positive. Things to watch out for this year: - El Nino 1600 Dec-11 Jun-12 Dec-12 Jun-13 Dec-13 Price 2014 $2075 2015 $2200 2016 $2400 2017 $2500 2014 Q3 $2050 2014 Q4 $2125 2015 Q1 $2150 5) Adjusting for full year 2013 data, we have made some minor changes to our supply and demand balances. 6) We have slightly smaller deficits forecast for 2014 (-0.22), but a slightly larger deficit for 2015 (-0.29) 9
LEAD - BULLISH - ONGOING SUPPLY CONSTRAINTS, ROBUST CONSUMPTION 2800 1) Lead continues to be characterised by bullish fundamentals, with ongoing supply constraints, robust consumption - which is likely to be further boosted by restocking. 3) Continuing strong automobile production and sales have boosted demand in the US and in China while recent data suggests that conditions in Europe are improving. 4) Lead demand will probably get a further boost over the coming months as restocking is likely both in the US and parts of Europe following extremely cold weather. 2600 2400 2200 2000 1800 Things to watch out for this year: - High scrap availability Price 2014 $2225 2015 $2400 2016 $2500 2017 $2600 2014 Q3 $2250 2014 Q4 $2400 2015 Q1 $2400 1600 Dec-11 Jun-12 Dec-12 Jun-13 Dec-13 2) LME stocks are at their lowest level in just over three years and further falls are likely given the expected restocking by battery manufacturers. 4) After a balanced market in 2013 we are forecasting a deficit of 50kt for this year, and in 2015 of 160kt. Continued strong fundamentals should support price increases going forward 10
NICKEL TURNAROUND IN PRICES 23600 21600 1) Although LME stocks have continued to rise to record highs, supply-driven fears have been reflected by elevated cancelled warrant numbers which now stands at 44% of total LME stocks. 2) Indonesia s ban on ore exports and possible western sanctions on Russia, potentially restricting nickel exports, have led to these fears. 3) Aside for supply issues - stronger global growth outlook is likely to drive higher nickel usage in stainless and non-stainless sectors. 4) After an increase of 7.3% in 2013 we expect global nickel consumption growth to accelerate to 8% yoy in 2014 to reach 1.99Mt. 19600 17600 15600 13600 3) Indonesia s ban on nickel ore exports which we expect to be enforced, is likely to shift the nickel market from structural oversupply to a balanced outcome this year. 11600 Dec-11 Jun-12 Dec-12 Jun-13 Dec-13 Price 2014 $17000 2015 $21000 2016 $22000 2017 $23000 2014 Q3 $18000 2014 Q4 $19500 2015 Q1 $20000 Things to watch out for this year: - El Nino - Russia - Indonesia 4) Our supply/demand balances show the global nickel market essentially in balance this year but moving into a large deficit in 2015. 11
THE COMMODITY COMPASS 1. SG trade recommendations 2. Commodity market analysis 3. SG Cross Asset Research - Commodity Indices 4. Principal Component Analysis (PCA) 5. Dispersion analysis 6. Significant option trades 7. Brent & gold option open interest (OI) maps 8. Key changes/assessments across the major forward curves 9. Commodity ETP flows 10. Commodity index notional value (CFTC) 11. CFTC Commitment of trader analysis futures & options positions 12. CFTC Commitment of trader analysis number of traders 13. Short-term price forecast vs forward prices* 14. Long-term price forecast vs forward prices* 12
COMMODITY COMPASS RESERCH EXAMPLES 13
May 2014 THE END Mark Keenan Head of Commodities Research - Asia Important Notice: The circumstances in which this publication has been produced are such that it is not appropriate to characterise it as independent investment research as referred to in MiFID and that it should be treated as a marketing communication even if it contains a research recommendation. This publication is also not subject to any prohibition on dealing ahead of the dissemination of investment research. However, SG is required to have policies to manage the conflicts which may arise in the production of its research, including preventing dealing ahead of investment research.
MACRO FORECASTS Source: SG Cross Asset Research 15