The first part of the commodities recovery seen this year was driven by sentiment, while the second has been driven by fundamentals, according to research published in the Commodities Compendium by Macquarie. “It looked very weak, but things began to turnaround in January. The Chinese introduced massive fiscal support for infrastructure by way of credit growth. So the banks began boosting their lending to public projects,” says Vivienne Lloyd, a base metals analyst with Macquarie in London.
This particularly benefitted iron ore, steel, and other ferrous metals. A knock-on effect is also anticipated for non-ferrous metals in the short-term. But the analysts still caution that “the long-term challenges of overcapacity and lower industrial demand growth than recent norms are still very much in place.”
So, while the “China collapse” card is off the table, for now, it is unlikely fiscal support will continue into the future. Either way, what happens in China will be front and centre for commodity producers.
The report notes that China continues to account for most of the world’s economic growth, estimated at 53% of the global total during the second quarter of the year. Its share of overall metal demand is equally high, at 46-48%. But the strength of its influence can be seen in its share of the growth of metals demand, which is estimated at 66-80% of the world’s total. So for most commodities, it is the only show in town.
Macquarie thinks the prospects for natural gas, zinc, and gold are the most attractive.
“Zinc is the only metal with a strong raw material constraint story,” write the analysts. “It’s been an extremely positive story,” says Lloyd. “There was some doubt as to whether the [production] cuts imposed by Glencore would lead to a reaction from the price, but that has certainly been the case year-to-date.”
In respect of gold, Lloyd says people have “dampened their expectations” around the speed at which the Federal Reserve will raise rates in the US. The implication is that this will be supportive of the gold price going forward.
Lloyds expects steel and bulk commodities to come under pressure towards the end of the year, as seasonal patterns take hold. “Into year-end people don’t like to hold much inventory. You also have a lot less external construction activity in the winter seasons in the northern hemisphere. This is particularly true for iron ore.”
On the downside, the authors express concern that the longer-term challenges of persistent overcapacity are underappreciated for potash, alumina, aluminium, and steel. “Our effective view across all of them is that there is process over-capacity, so they can produce as much as they want,” says Lloyd. The respective industries all enjoy flat supply cost-curves, which means the difference between the most and least expensive producer is minimal. “The differential can typically be explained by labour and power costs,” says Lloyd. This makes it challenging to remove excess capacity.
Ironically, China’s pollution problems in the short-term may restrict capacity, but in the longer-term may cause them to win more market share. The Chinese government has been reducing domestic steel and aluminium overcapacity by telling the older, more inefficient producers to close down, but this has been partially offset by the build-out of new capacity. “In the past, you could say Chinese steel mills’ quality and efficiency was weaker than their global counterparts, but we don’t see that anymore,” says Lloyd. “Nowadays they have the newest technology and their efficiency is up there with the best in the world.”