Commodities » Industrial Metals

Ferrous and base metals review (March 2010)

By PSQ Analytics

Review of the past quarter

The last three months have seen a number of major transactions in the metals space, although these were overshadowed by Rusal’s USD2.2 bn public offering. Meanwhile, a stream of positive economic data has indicated that the global economic recovery is underway, with the Chinese and US economies growing by 10.7% and 5.9% in 4Q 09 respectively. Growth in industrial production was also robust across all major economies, with double digit y-o-y expansions in China and India leading to increased appetite for basic materials. On the supply front, capacity utilization rates were on the rise across all metal segments (as exhibited in 1.0% m-o-m and 11.6% y-o-y improvement in global crude steel capacity utilization to 72.9% in January 2010), while production cuts by metal companies helped to reduce excess inventories. Despite this, metal inventories remain well above historical levels; LME aluminium inventories stood at 4.5 Mt (as of January 2010) or 110 days of global demand, compared to the historical average of around 50 days. Nevertheless, there has been a clear improvement in metal demand from the previous quarter, with iron ore leading the pack, illustrated by a greater than 20% m-o-m increase in iron ore imports into China during December 2009.

Looking towards a robust set of economic indicators, metal prices continued to firm, peaking in the first half of January 2010. However, showing concern regarding the scale of bank lending and inflationary pressures in the Chinese economy, the country’s central bank has hiked its reserve requirements and raised the interest rate on its three-month bills. These moves are expected to dampen the uptrend in industrial growth over the coming quarters, limiting growth in demand for industrial metals. Impending liquidity tightening measures in the US will further limit growth in metal demand. Meanwhile, sovereign default risk perception has soared amid scandals both in Dubai and Greece; investor apprehension could trim risk appetite and drive funds away from metals into more defensive assets. Nevertheless, the metal sector’s long term fundamentals remain solid, as ongoing development in African, Asian and Latin American economies reduces the disparity between per-capita consumption of natural resources between developed and emerging economies.

Although metal prices have been volatile over the last three months, the net price impact, except in the case of iron ore, has been mostly cancelled out. While industrial metal prices continued to soar in December 2009, investor concerns about liquidity tightening measures by governments and central banks across the globe led to a correction following their peak in the first half of January 2010. Industrial metals gave back most of their December gains and remain at or around similar levels to the time of publication of the initiation report.

Transactions and developments

The dual listing of Rusal, the world’s largest aluminium company, was the industry’s foremost deal over the past three months, although regulators only approved the USD2.2 bn listing on the basis that retail investors be excluded from subscription and discouraged from trading through high lot sizes. Various other metals and mining giants including Severstal and Companhia Siderurgica Nacional (CSN) plan to spin off their non-core assets through public offerings in the coming months. However, doubts over the stability of the global economic recovery have diminished investor appetite for pure metal plays. Valuation issues have further complicated matters, hindering several equity offerings and acquisition deals. The plunge in Rusal's trading price since its debut has further shaken confidence. Australian billionaire Clive Palmer’s plans to launch the largest mining IPO since 2007 in Resourcehouse Mining plc have been met with poor investor response and regulatory concerns.

Outlook

Our outlook for base and ferrous metals broadly remains unchanged over the long term, although concerns over liquidity tightening measures and sovereign default risk in Europe pose a near-to-medium term risk to the global recovery and industrial metal consumption. We continue to anticipate stagnation in aluminium and copper prices with moderate downside potential from current levels over the near-to-medium term, as high inventory levels and a potential increase in supply from mothballed production facilities are likely to offset the positive impact of economic recovery on demand growth. Nevertheless, we expect automakers’ and builders’ preference for aluminium over other metals, particularly steel, to be reinforced over the long term. Coupled with the gradual anticipated decommissioning of high-cost production plants, this will tighten demand-supply dynamics and lift aluminium prices over the long term. For copper, we anticipate a high-value, low-volume demand scenario, restricting upside potential while limited availability and a high industry concentration ratio should prevent any abrupt fall in prices.

Medium term demand fundamentals for steel have softened marginally as governments across the globe tighten their belts and begin implementing exit strategies for unwinding stimulus and monetary easing measures. Despite the prospect of moderation in stimulus-led demand, fragmentation in the steel industry will make it difficult for producers to effectively limit supply. Therefore, our view is that the upside potential for steel has been exhausted and we have moderated our medium term outlook from bullish to neutral. We expect the gradual shift in a number of industrial processes away from steel, towards substitutes such as aluminium and synthetic materials like plastics, to gradually weaken steel’s fundamentals. Therefore, our long term view remains bearish. Furthermore, despite the expectation that steel demand will moderate, we believe that the significant disparity between spot rates for iron ore and annually negotiated contract rates is a sign that contract rates will increase sharply at the next round of contract negotiations between iron ore miners and steel producers. This viewpoint is strengthened by the fact that iron ore mining is a highly concentrated industry, which enhances its negotiating power. Over the longer term however, we believe that iron ore prices will have to moderate in order for steel producers to be able to meet the market.