Metals Outlook 2009 -- January 2009
Executive Summary: As we gaze into what 2009 could conceivably hold for commodities in general and for metals in particular, the outlook is incredibly cloudy. It is almost as if someone flipped a switch back in September, causing worldwide growth to stop in its tracks. Fast forward four months later, and most of the world is either in, or heading into, recession. Most frustrating, is that there are no hints as to how long the current downturn will last, as in many ways, it is quite unique compared to previous experiences.
By now, readers are familiar with the reasons behind the deteriorating macro picture and the ensuing commodity selloff that has set in since last summer, and so we will not rehash the depressing details here. Suffice to say, that in addition to the worsening growth outlook, metal prices have been cut down further by the unprecedented freeze in the credit markets. In previous recessions, producers have been able to muddle through slow growth periods by cutting costs and refinancing their balance sheets. In fact, there were recessionary periods when producers even increased production amid falling prices in an attempt to keep operations and cash flows intact. This option is not on the table this time around-- not only are producers finding it difficult to tap the bond and equity markets to refinance their debt, they are also feeling the pressure from bankers who are squeezing their credit lines. As a consequence, producers are finding that they have no alternative but to cut production, which most have done in varying degrees. However, this is not helping arrest the price declines, as cutbacks take time to flow through the system. More importantly, deteriorating demand is still outpacing the rate at which production is being slashed. This is evidenced by the rising level of LME stocks, where inventories are up sharply over the past six months in four of the six base metals complexes we follow, with lead and tin being notable exceptions.
How long will we be mired in the current recessionary conditions and when could we expect metal markets to recover? Assuming certain assumptions take hold, we believe the recession should be over by the end of this year. We also suspect that the recession will be more “U”-shaped, as opposed to “V” or “L”-shaped in nature-- the “V” being a short-lived affair, while the “L” typifies the dreadful Japanese experience of the 1990’s. We expect the middle part of our “U” to last for most of 2009, which means that we could expect to see a “basing pattern” set in for metal prices possibly by mid-year, as participants start to discount some stabilization in supply/demand balances. In fact, metal prices could move measurably higher by 2010 if revived pent-up demand crashes against ongoing producer cutbacks. Listed below are our projected forecasts for the various metals for both this year and next, as well as the Reuters consensus forecasts, which overall, are generally higher than ours. We address our reasoning behind our numbers later in the report.
|
|
2009 Trading Range |
2009 Price Average (Reuters) |
2010 Trading Range |
2010 Price Average (Reuters) |
|
Copper |
$2650-$4250 |
$3250 ($3417) |
$3000-$4750 |
$3600 ($4239) |
|
Aluminum |
$1050-$1650 |
$1250 ($1604) |
$1350-$1850 |
$1600 ($1984) |
|
Zinc |
$950-$1400 |
$1050 ($1250) |
$1150-$1600 |
$1300 ($1441) |
|
Lead |
$1000-$1400 |
$1250 ($1146) |
$1100-$1850 |
$1450 ($1316) |
|
Nickel |
$8500-$15000 |
$10500 ($11222) |
$10000-$18000 |
$13500 ($13227) |
|
Tin |
$9000-$15000 |
$11500 ($12092) |
$10500-$19500 |
$15000 ($13500) |
The current banking crisis - A key assumption behind the price forecasts we tabulate above and our corresponding call for a macro recovery in 2010, is predicated on the notion that the banking crisis will be stabilized over the next few months. In our view, this is the most pressing issue confronting both the equity and commodity markets, and far outweighs the problems we are also seeing in housing and autos. Simply put, if the banks do not function -- or lend-- it will be next to impossible to get growth back on track anytime soon.
Looking back at the US government’s efforts so far, it seems to us that the original TARP program will have to be completely revamped, as it has been poorly designed and administered. In its stead, we expect the Obama administration to introduce something far more ambitious, most likely along the lines of a “super-bank” that could take up the toxic securities and problem loans on bank balance sheets and hold them for an indefinite period. This is similar to what the RTC did with nonperforming commercial loans in the late 1980’s. We think this will likely involve a massive initial outlay by the government, but could end the specter of banks soaking up taxpayer capital just to beef up constantly deteriorating balance sheets. Moreover, it will allow the banks to “come clean”, and give the equity markets some assurance that the sector is not in danger of imploding. Although nationalization of the banks remains an option that cannot be ruled out, we do not think it will be pursued, as it will dig the government into a far deeper hole, saddling it with both financial and managerial responsibilities.
If the banking problems are stabilized through some sort of government entity, other variables--assuming they fall into place along the lines we outline below-- make a compelling case for a gradual economic recovery over the next year. We discuss some of these variables below:
Governments are all on the same page: Unlike earlier in 2008, practically all governments are aware by now that the major threat facing their economies is recession, not inflation. In fact, fear of inflation consumed the European Central Bank for much of last year until it recently threw its lot in with the US and introduced massive stimulus programs. The EU has now proposed a combination of $430-440 billion in tax and spending incentives, and authorities have made it clear that more can be added to this total if needed. Japan has earmarked about $430 billion, and out of China, the government is bringing on stream a $580 billion stimulus package. The Chinese program needs to be rolled out quickly, as the authorities need to re-achieve growth rates of 8-10% a year just to accommodate the 10 million or so workers that enter the country's labor market each year. (Already, it is estimated that about 7 million people have lost their jobs in the wake of recent factory closures over the past year). Here in the US, the latest stimulus figures are in the $875 billion range comprised of a combination of new spending and tax cuts. This is in addition to the second installment of TARP money that was recently authorized for use.
These stimulative measures should eventually kick-start global growth and trade and help lift metal prices going into 2010. We have to remember, however, that these programs will take time to implement, and hence, we should not get too carried away about upside price prospects in metals for at least most of 2009.
Autos and Housing May Stabilize - The fate of the automakers has been troubling metals in recent weeks, (particularly during December) but we suspect that the industry, just like the banks, is just too big to fail. In mid-December, the Bush administration released money from the TARP program to help the automakers. We expect this money to be a band-aid of sorts until the Obama administration gets a chance to review longer-term plans that the auto companies have to submit by March. We suspect that more money will be heading towards the auto companies, as they are forced to restructure and possibly merge. Faced with poor choices all around, the government will begrudgingly conclude that it will be more advisable (and economical) to keep the car companies going rather than to risk a wider collapse in the economy that their bankruptcy would generate.
On the housing front, the overall situation remains dreadful, with only tentative signs of stabilization evident. However, housing is not immune to the basic laws of supply and demand. With very little new housing units coming through, buyers will eventually whittle down existing and foreclosed inventories. In fact, the most recent data shows that inventories -- although still high-- are finally coming down, while regional sales in some parts of the country, like the West Coast, are actually picking up. In this respect, December existing home sales in the West Coast were up 13.6% month-over-month, and up by a more impressive 31.6% from a year ago, as foreclosed inventory continues to move out at distressed prices. However, housing prices are still languishing-- down 15% year-over-year nationally, and off by some 31% in the West. This price plunge is not necessarily bad news, as it is now makes housing now more affordable than at anytime since the 1980’s. The problem is that many buyers, including creditworthy ones, are finding it difficult to get mortgages, while many others, unnerved by the deteriorating labor market, are deciding to sit on the sidelines. Nevertheless, we expect housing to “bottom” sometime late in 2009, and start to stabilize throughout 2010, especially if credit starts to flow back to the sector.
Currency impact could be bullish for metals: Although the dollar has been getting stronger over the last few months, exerting downward pressure on metals, we doubt it can continue along its bullish track for much longer given the massive amounts of liquidity that needs to be created. In fact, the dollar’s safe-haven status will no longer be a “magnet” once the credit markets start to thaw out and growth resumes. The prime beneficiary of dollar weakness will be commodities, and in this regard, we see oil, base metals, and precious metals all doing better by 2010, as the focus shifts away from recessionary conditions towards growth -- and potential inflation. As an aside, we should note that gold is holding up remarkably well despite a stronger dollar, perhaps an early sign that investors are already bracing for future inflation.
Metal production continues to come down, offering support: We expect metal producers to scale back production for most of this year, as in addition to the credit issues, the cost pressures they face are enormous. Our research shows that copper costs for about 70% of global producers is roughly between $3000-$3500 a ton, (basically where we are now), while on the zinc front, about 65% of producers are now operating at a loss. Most aluminum smelters, (in excess of 75% in our view) including a majority of Chinese smelters, are said to be losing money. We suspect that a majority of nickel producers are also in the red, although lead and tin producers, despite protestations to the contrary, are probably all right for now. One estimate we came across calculates that 119 new mining projects are likely to be deferred both this year and next, representing $193bn of capital expenditure spending over the next 5 to 7 years. However, markets will not appreciate the scope of these cutbacks until they see the evidence come through in the form of falling stocks. In this respect, stocks are still rising faster than cutbacks are taking place, aggravated by the fact that the demand is in very poor shape. We suspect that markets will start to discount a far healthier supply/demand balance by the middle of 2009, at which point, base metals should stabilize and work higher going into 2010.
LME stocks are not as high compared to previous recessions: Although currently rising, LME inventories are historically speaking, still rather low in at least for four of the six metal complexes we follow. LME copper stocks, for example, are at 450,000 tons right now, and even if they were to double from current levels, they will still be below the record peak of 1,000,000 tons reached in early 2002. Zinc stocks are now a little more than one third of where their 2002 peaks, while lead and tin stocks, interestingly, have both been falling since the second half of last year, and are about 70%-80% below where they were during the last recession. Only aluminum and nickel stocks are in extreme territory, and so these two complexes will likely be relative laggards for most of 2009.
At this point, we like to say a few words about each of the metals:
Copper: Copper producers have been slow off the mark in cutting production compared to others in the group. This is partly because many producers are still breaking even given that costs are currently estimated to be between $3000-$3500 a ton. In fact, recent estimates have the cost number even lower, as inputs have been falling dramatically. If true, this means that most producers are keeping their operations in the black, or at least in breakeven territory. Moreover, many copper producers were experiencing production problems before the recent price collapse, and therefore did not expand output that aggressively, which is probably serving them well right now.
Nonetheless, the pace in cutbacks has picked up in recent weeks given that demand has yet to pick up. It is now estimated that about 260,000 tons of production has been cut back over the past few months, (excluding Chinese output). In this regard, Freeport McMoRan Copper & Gold announced that it would reduce 2009 output by about 90,000 tons and 2010 output by a more significant 225,000 tons. India's Hindustan Copper also announced a production cutback of about 20%, while Japanese producers Nippon Mining and Sumitomo Metal Mining have both said that they intend to cut production in the first half of this year. The Chilean government expects Chile’s copper output to rise by 3.7% this year, but we suspect that the actual number will be close to unchanged or slightly lower, as in addition to Escondida warning in July that output would fall 10-15% in 2009, 10 of the 19 largest mines in the country are now producing less copper now than they did during the beginning of 2008.
Out of China, it is was reported that some 40% of China's refined copper capacity could be rolled back. Based on an overall Chinese copper refining capacity of 4.6 million tons, this could be a big number, but we have our doubts that we will see such extreme cutbacks, particularly at current price levels.
The cutbacks announced thus far should cap the size of the surplus expected for 2009, which the International Copper Study Group now estimates to be less than 300,000 tons, (coming off a 2008 surplus of around 200,000 tons). Other extreme estimates have the 2009 copper surplus as high as 630,000 tons, but whatever the ultimate size, we suspect the excess will be enough to keep rallies in check, and prices within our forecast trading range. On the downside, a possible short-lived dip to $2650 between now and then of the year cannot be ruled out.
Aluminum: Of the six LME metals we cover, we are least friendly towards aluminum, as we suspect that the inordinately high level of aluminum stocks will limit any sizable rally in the complex. Currently, LME aluminum stocks are around 2,700,000 tons, a record high, and there is talk of an additional 1,000,000 tons of stock being held in China. In addition, International Aluminum Institute figures show that western world unwrought aluminum stocks fell to 1.604 million tons at the end of November, only marginally less than the 1.626 million seen in October, and well ahead of the 1.465 million tons recorded in November 2007. Just taking the verifiable amount of metal on the LME and what the IAI shows, we note that inventories on hand are close to 11% of global production. With such a large overhang, (not to mention what is conceivably being held by the Chinese), high inventories will blunt the production cutbacks that are bound to take place over the year, and suggest that ali prices could fall even further before production cutbacks make themselves felt.
China will remain a wild card in the aluminum equation for much of 2009. Although about 4 million tons of existing aluminum capacity is projected to be sidelined in 2009, with another 4 million tons of new capacity deferred, these cutbacks have yet to be reflected in the official data. Numbers supplied through December of last year, for example, show that Chinese December primary aluminum output was at 1.147 million tons, down 18% from a year-earlier, and off by roughly the same percentage from November. Overall 2008 production, however, still finished the year about 4.1% ahead of 2007 levels, meaning that the cutbacks have only just started, with the key question being whether the Chinese will, in fact, continue to make these cutbacks throughout the year.
Outside of China, the production data remain uninspiring as well. Latest figures from the International Aluminum Institute for example, show that total production in December 2008 (31 days) was 2.130 million tons, slightly higher than both the 2.082 million tons produced in November (30 days) and the 2.166 million produced in December 2007.
With regard to how much is going to be cut this year we are hearing estimates that anywhere between 4,000,000 to 6,000,000 tons of actual or proposed production will be sidelined over the course of this year, (including Chinese cutbacks), but despite this, aluminum’s 2009 surplus is estimated at anywhere between 500,000- 2,000,000 tons. (MF Global's estimate is 1,000,000 tons). This is because much of the sidelined production-- such as in China’s case-- is not being closed down completely, but rather is on standby, and could be turned back on rather short notice.
Future projects are similarly being deferred, but not entirely canceled. To wit, Rio Tinto Alcan recently announced that it would abandon plans to take a 49% stake in a $10 billion smelter with Saudi Arabia’s Maaden group. However, Maaden said that it would take up the project on its own, although the projected rollout will now be extended to 2012. In the US, Alcoa is planning to reduce total primary aluminum output by more than 750,000 tons, but this is only 18% of its overall output, suggesting that there is room for yet more cuts. Similarly, Russian producers have announced cutbacks, but we suspect that they could do far more given the magnitude of the price decline.
Zinc: Although LME stocks have more than tripled over the past year to about 320,000 tons, they are still well below the record 800,000 tons reached on the LME in 2004. Zinc producers have taken drastic steps to cut output, arguably moving much earlier than others in the sector, and well before the general price collapse hit commodities last fall.
It is thought that at current prices 65% of zinc producers are operating at breakeven or more likely at a loss. As a result, we have seen a spate of production cutbacks in the last 18 months, including reductions by the Gordonsville mine complex in Tennessee, Lennard Shelf in Australia, and Aljustrel in Portugal. More recently, production cuts have come from the likes of Boliden, Nyrstar, Teck Cominco, and South Korean producers Young Poong and Korea Zinc. This month, Xstrata confirmed that it would reduce ore throughput at its McArthur River mine in Australia, and Russia’s Chelyabinsk Zinc also announced a hefty production cut for 2009 of some 70,000 tons. Japan Sumitomo Metal Mining lowered its October 2008-March 2009 production forecast by 16% to just under 36,000 tons, and expects these cuts to be extended through to June.
All in all, we estimate that, (excluding China), around 550,000 of production capacity, equivalent to almost 5% of global output has been closed. Despite this, the International Lead and Zinc Study Group projects a 134,000-ton zinc surplus for 2008 (through November) along with a preliminary 330,000-ton surplus for 2009. We suspect that the 2009 number could come down in light of the aggressive production cuts we have been seeing, and this could return a measure of stability to prices by the second half of 2009. In the meantime, we could drift lower and briefly test the bottom end of the trading range at $950 early in 2009.
Nickel: Nickel prices seem to be stabilizing at low levels despite LME stocks recently surpassing ten-year highs. It is estimated that about half of nickel producers are now operating at a loss, with costs variously estimated at between $10,000- $15,000 a ton. As a result, we have seen a host of producers scale back production in recent months.
Despite these cutbacks, some big projects are coming on stream. Brazil's Vale expects its global nickel project in Goro to deliver about 60,000 tons of metal in 2009, while concentrate production is already underway at Canada's Voisey's Bay, with first commercial deliveries expected this quarter. It is not known how aggressively Vale will ramp up production from both these venues, but we suspect the pace will be slowed dramatically until demand has a chance to recover.
On the demand front, things look very sluggish. With stainless demand accounting for the lion's share of nickel offtake, (at around 70%), there is no sign yet of any turnaround in this sector, and several stainless producers are warning of poor results as a result. Finland's Outokumpu issued a profits warning this month, saying that the company is taking actions to “prepare for a period of possible prolonged demand weakness”. The ferrochrome market, which tracks nickel closely as another input in stainless production, is also in a similar predicament. Japan's Nippon Steel & Sumikin Stainless said this month that it is considering passing up on first-quarter ferrochrome shipments because it does not need the units.
Nickel is expected to be in surplus this year, variously estimated at 45,000 tons (by ourselves), and 110,000 tons (by the International Nickel Study Group). Surpluses are expected to be with us in 2010 as well, but they are not expected to be as large, allowing a measure of price recovery to set in. However, at least for most of 2009, we believe nickel, along with aluminum, will be a laggard in the group.
Lead: In our view, lead has looked the most constructive in the complex from a supply/demand point of view for some time now, but this has not prevented prices from taking a pounding-- off by some 70% from the 2007 high. The International Lead and Zinc Study Group has supply and demand in surplus by about 8,000 tons in 2008, (through November), but significantly, is tentatively projecting a balanced situation for 2009. If this proves correct, lead prices could stabilize at a much earlier point than other metals. However, we suspect that these surplus numbers will be revised significantly in the ILZSG’s next release. In fact, the consensus among analysts polled by Reuters shows that lead is expected to be in surplus by 137,000 tons in 2009 and by 86,000 tons next year. Our estimates are much lower than that, as we are not seeing any evidence of mounting stock surpluses on the LME. Although it is quite likely that there are some invisible stocks on hand, we suspect that, similar to visible stocks, they are not ratcheting higher. Also somewhat constructive, is the fact that the lead concentrate market has become tighter on the back of the mounting zinc-induced mine cuts.
Like many of the other metals, lead demand is in poor shape given the steep fall in battery demand caused by the implosion in the global auto sales (and notwithstanding the seasonal bounce brought on by the cold winter). Outside of the car industry, industrial battery demand and lead sheet used in construction are two other sectors that are also suffering. Nevertheless, our price forecast for lead is ahead of the Reuters consensus, as we suspect that low levels of LME inventories will be supportive, coupled with the fact that we are not seeing massive surpluses developing.
Tin: Much like lead, LME tin stocks have been declining sharply this year, and despite recent rises, stocks are still about 43% lower than where we were at the start of 2008, and about 25% off peak levels hit in 2002. Tin prices have held up better than any of the other metals over the past two years, and looking forward, we do not see much in the way of severe price declines, since much of the world's tin comes from Indonesia. This is important to note, as it reduces the diversity of tin’s production base, thus handing the country a rather unique monopolistic role in influencing prices. Already, the Indonesians have said that production will be scaled back this year, and should they follow through on their intentions, they could singlehandedly stabilize prices and set the stage for a significant rebound in 2010.
MF Global Inc. ("MFGI") is a registered futures commission merchant, a member of the NFA, and a registered broker-dealer and member of the CBOE, FINRA and SIPC. Except as otherwise indicated, references to MFGI also refer to all affiliates of MFGI (collectively "MFG"). MFG does not warrant the correctness of any information herein or the appropriateness of any transaction. The contents of this electronic communication and any attachments are for informational purposes only and under no circumstances should they be construed as an offer to sell or a solicitation to buy any futures contract, option, security, or derivative including foreign exchange. The information is intended solely for the personal and confidential use of the recipient of this electronic communication. If you are not the intended recipient, you are hereby notified that any use, dissemination, distribution or copying of this communication is strictly prohibited and you are requested to return this message to the sender immediately and delete all copies from your system. All electronic communication may be reviewed by authorized personnel and may be provided to regulatory authorities or others with a legal right to access such information. At various times, MFG or its affiliates may have positions in and effect transactions in securities or other financial instruments referred to herein. Opinions expressed herein are statements only of the date indicated and are not given or endorsed by MFG unless otherwise indicated by an authorized representative. Due to the electronic nature of electronic communication, there is a risk that the information contained in this message has been modified. Consequently, MFG cannot guaranty that messages or attachments are virus free, do not contain malicious code or are compatible with your electronic systems and MFG does not accept liability in respect of viruses, malicious code or any related problems that you may experience. Trading in futures, securities, options or other derivatives, and OTC products entails significant risks which must be understood prior to trading and may not be appropriate for all investors. Please contact your account representative for more information on these risks. Past performance of actual trades or strategies cited herein is not necessarily indicative of future performance. Privacy policy available upon request.