(The opinions expressed here are those of the author, a columnist for Reuters.)
LONDON, Oct 19 (Reuters) - Thank heavens for Glencore .
The Swiss trading and mining giant’s announcement of massive production cutbacks just ahead of LME Week did at least lighten the otherwise decidedly downbeat mood among the great and the good of the metals business meeting in London last week.
The industrial metals sector is collectively reeling from the unexpectedly sudden end to the so-called commodities supercycle.
“No-one could have forecast the extent of the slowdown in China,” Rio Tinto’s head of copper and coal, Jean Sebastien Jacques, told a Bloomberg seminar. “We are no doubt facing tough times”.
And there was no shortage of industry executives and analysts agreeing with that gloomy warning.
Just how tough will depend first and foremost on China, which is a problem since no-one seems to have any clear idea as to what exactly is happening in the country.
Moreover, as the industry relearns what an old-fashioned non-supercycle looks like, China’s own metals production capacity is injecting a new uncertainty principle into how supply should respond to low prices.
CHINESE BEAR COCKTAIL
China was the core driver of the commodities supercycle, not least in terms of the industrial metals needed to build all those new cities and associated infrastructure.
And it is China that has this year dowsed any remaining supercycle flames.
The whole world, it seems, is fixated with the China slowdown story but for metal markets “slowdown” doesn’t capture the severity of what has actually materialised.
And that may be down to the fact that metals usage has been rocked by a triple-whammy of negative structural, cyclical and destocking hits.
The nexus of this bear cocktail has been the construction sector, previously a pillar of metals demand growth in the country. Residential construction in particular is suffering from a combination of all three trends.
Disentangling shorter-term drivers from structural shifts in China is proving extremely tricky and may help explain why, to quote Rio’s Jacques, “both industry and investors are finding it difficult to read the market”.
The best attempt at an answer came from CRU Group’s Grant Colquhoun, speaking at the research house’s Tuesday breakfast meeting, which was, as ever, one of the week’s more thought-provoking seminar sessions.
China, Colquhoun argued, is “suffering from a cyclical downturn whilst managing structural change.” CRU’s view is that the cyclical is about to turn more positive but still within the context of “the overriding story” of fixed asset investment slowdown.
He highlighted the more positive signals currently emanating from the services sector, citing a spectrum of “lower profile consumer indicators” ranging from air passenger numbers to movie box office revenues, and suggested that rising consumer confidence would eventually help refire the struggling housing market.
Throw in catch-up spending by the metals-intensive energy grid and new targeted infrastructure spend by central government and some sort of short-term bounce in usage is likely, albeit one diminished by the bigger structural shifts underway.
QUESTIONS OF SUPPLY
Which may all be cold comfort for producers wrestling with metal prices that are trading into industry cost curves.
Chinese “slowdown” has hit different metals in different states of supply readiness.
At one extreme is aluminium, where the outlook is “awful”, CRU director Paul Robinson told the Bloomberg seminar.
Nickel is possibly just as bad with Andrew Mitchell of Wood Mackenzie vying with Jorge Vasquez of Harbor Aluminium for just which metal had the worse fundamentals during one session of the LME’s Monday seminar.
The problem with both is the lack of supply response to current low prices.
The aluminium market is profoundly sceptical that China, which is now the world’s largest producer of the light metal, has the will or even the desire to cut production in sufficient quantities to rebalance the market.
For aluminium you could also read steel, another sector in which Chinese capacity has grown massively over the course of the last decade.
“There has been absolutely no reaction to falling (steel) prices,” noted Ken Hoffman of Bloomberg Intelligence. “The market can’t seem to clear” and rebound to margin positive territory, he added.
It’s not all China’s fault.
Around 55 percent of the global nickel production sector is cash negative right now, according to Woodmac’s Mitchell but the supply response has to date been anaemic.
That’s in large part because everyone is waiting for the demise of China’s nickel pig iron sector, which is trapped between rising costs and falling raw materials supply.
And while they hang on in there, stocks are steadily rising to the point that even if the world does move into a supply deficit this year, as many expect, the feed-through to higher prices will be dampened by high inventory.
At least Glencore’s announced zinc and lead cuts gave those two markets a little cheer last week, but there is widespread concern that China, a major supplier of both, might simply lift its own production levels to a point where the cuts are negated.
Or as Alistair Ramsey of Metal Bulletin Research told the LME Seminar, “for every shortfall China will find a supply solution”.
Copper, by the way, remains polarised between bears and bulls, or maybe that should read between super- and not-so-super bears.
It’s been a long time since the metals markets experienced such a dramatic downturn in prices. No-one counts the Global Financial Crisis of 2008-2009 because of China’s shock-and-awe infrastructure programme, which boosted both usage and prices across the metallic board in double-swift time.
And analysts’ traditional toolkit of using production cost-curves to help define price troughs is looking decidedly rusty.
Not only do costs move in real-time with prices, meaning any cost curve calculation is by definition a “rear-view mirror”, in the words of CRU’s Vanessa Davidson, but the cost-curve doesn’t mean much if a large part of the supply base doesn’t react to lower prices.
And that’s the problem this time around. China is no longer simply buyer of imported metal as it has been in the past but is now major producer as well and there is growing evidence that it is playing by different rules.
A Chinese supply response to current low prices, is “one of the great unknowns and may be a reason why history might not repeat itself,” conceded CRU’s Colin Pratt.
Pratt did, though, describe the current gloom and doom as a case of “irrational depression”, arguing that based on long-term marginal costs, several metals are trading at levels which have defined previous cycle troughs.
Or as one banker more pithily put it, “if things were really that bad, we’d all be out of jobs”.
Amid the dazed confusion that characterised last week’s events, though, one thing is certain.
The supercycle is now history. And boom and bust has returned with a vengeance. (Editing by David Evans)
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