Each Quarter FastMarkets and Sucden Financial produce an analysis and forecast report on the precious and base metals – The Sucden Financial Metals Reports, Oct 2015.
Below is the metal market summary and economic overview, to read the full report covering all the metals in pdf form click here.
Subscribers have access to these reports before they are published through the research tab in FastMarkets Professional.
Outlook – Global growth remains mired in uncertainty. The macro picture is polarised, with developed nations picking up steam and looking to take their recoveries to the next stage while emerging market (EM) economies are wobbling. This divergence has largely been epitomised by developments in the US and China. Whereas US economic expansion has pushed the dollar from strength to strength on speculation of an impending rate rise, Chinese economic growth continues to falter during the shift to a more consumer-driven model, renewing speculation for a hard landing. It is no surprise that the IMF may be readying in October to lower its 2015 global growth forecast of 3.3 percent.
In September the US Federal Reserve decided to maintain the federal funds rate at the lower bound, citing low domestic inflation and international factors. “Recent global economic and financial developments may restrain economic activity somewhat and are likely to put further downward pressure on inflation in the near term,” chair Janet Yellen said.
By taking foreign factors into account, the move reflects how interconnected the global economy has become and reignited fears that the global economy may be on the brink of a renewed downturn. The world must come to terms with a China unable to provide double-digit expansion. This divergence is most readily observable in the FX market where the dollar and the euro have been appreciating. This contrasts sharply with currency depreciations in EMs – attempts to remain competitive in an environment of reduced global demand.
US a victim of its own success – The timing of the US Federal Funds rate rise continues to dominate market attention, with most now expecting a rise by the end of the year. December is the likeliest date following the FOMC’s decision to maintain rates at the lower bound in September. This reflects its forward guidance, which had continually narrowed in on either September or December and US economic data signalling rising growth, as highlighted by the jump in second-quarter GDP growth to 3.9 percent. The Fed appears to have achieved half of its dual mandate – that of maximum employment and price stability. The fall in the unemployment rate to 5.1 percent signalled that the previous slack in the labour market has been taken up so the FOMC now appears closer than ever to this decision. The decision to keep rates unchanged in September might have been expected to trigger a downward correction in the dollar but by identifying international factors for holding firm it bolstered safe-haven demand for the greenback as well as gold and the yen.
This puts the global economy up against it – dollar strength is a key drag factor on global growth, as acknowledged by the Fed, which is wary of exacerbating faltering growth by adding more dollar strength to the pot. As well, the IMF in June broke with protocol by directly calling on the Fed to delay a rate rise until the start of 2016. The stronger dollar is also likely to continue to weigh on US domestic growth, hindering its expansion. As has been the case several times, the dollar strengthens in anticipation of an impending rate rise, thereby smothering expansion by further eroding US competiveness internationally just as momentum begins to pick up. Although making imports cheaper as a result, it forces the US to export domestic demand and effectively import deflation, compounding the situation – this is why the official and ISM manufacturing PMIs for August fell to levels not seen since 2013. There is potential for increased dollar strength to cause the economy to stall while growth is picking up, especially while EMs are devaluing their currencies.
EM threat – EM weakness poses the biggest downside risk to global economic growth – this is evident in the FOMC’s reasoning in maintaining rates at the lower bound. Economic weakness has become synonymous with China despite several rounds of government stimulus intended to bolster growth. Its manufacturing sector remains in contraction, with the September Caixin flash manufacturing PMI falling to 47.0, the lowest since March 2009. This has led to further speculation for a hard landing in China; this risk has been amplified by the mid-year rout in China’s equities, which has cast serious doubts on the country’s ability to meet its 2015 GDP growth target of seven percent.
Falling domestic consumption has weighed heavily on commodity prices, putting EMs under increased pressure. China’s unexpected devaluation of the yuan exacerbated this, making the country more competitive for remaining global demand and triggering a round of devaluations across the other EMs. Despite Chinese Premier Li Keqiang’s assurances that Beijing has no plans to devalue the currency further, the divergence between the developed markets and EMs has become increasingly pronounced, drawing comparisons with the 1997 Asian Crisis.
Capital outflows from the region, which were already driven by the search for higher yields in developed economies as well as a flight to safety, have picked up. The worsening state of EM health has been highlighted by Standard & Poor’s decision to lower its credit rating on Brazil in September to junk status and by significant weakness in the Brazilian real, the Indonesian rupiah and the South African rand. There remains potential for a fresh round of competitive currency devaluations in the EMs, which would widen the competitive void between them and the US while exporters fight for remaining global demand. This could subsequently delay an FOMC rate rise to 2016.
Europe not out of the woods – Europe has survived the ‘Grexit’ saga – the potentially disastrous effects of the first country to leave the eurozone reached crisis point before an agreement of a new bailout programme reduced contagion risk, allowing investment to return. The Greek people returned to the voting booths in September, awarding a surprise victory to the Syriza party and reaffirming its new mandate to back the bailout programme. But with voter participation falling to around 55 percent and Syriza still split internally over the acceptance of the bailout, uncertainty over the stability of this new coalition government remains. Uncertainty has become a code word for Europe recently, despite the introduction of a €1.2 trillion quantitative easing programme by the ECB in March, growth continues to falter. The ECB in September lowered its 2015 GDP forecast to 1.4 percent from 1.5 percent and to 1.7 percent from 1.9 percent in 2016.
Although the ECB is buying €60-billion per month of public and private assets to stimulate growth in the region, growth and inflation rates remain below expectation across much of the region. This has raised speculation that the ECB will need to expand and extend the programme past the current designated end-point of September 2016. ECB president Mario Draghi alluded to this when he said the programme “is intended to run until the end of September 2016, or beyond, if necessary”. In particular, inflation remains far below the ECB’s two-percent target – the ECB sees annual HICP inflation of only 0.1 percent in 2015 and 1.1 percent in 2016. The EU CPI has now been falling since May and is currently at 0.1 percent, raising the potential for the bloc to return to a deflationary environment.
Europe is one of the few regions that stand to gain from dollar strength, which should slow the appreciation of the euro and boost its global competiveness. Despite sustained dollar strength, we believe it is highly likely that the ECB will extend asset purchases due to the maintained downside risks from a faltering global economy. We expect the euro to trade in a weaker range of 1.0850-1.1150 in the fourth quarter.
Total vehicle sales – Vehicle sales remain a mixed bag – while US and European auto sales have maintained their upward trend, China and EM sales continue to slow in recent months and at an alarming pace. US auto sales in the first eight months of the year were up four percent compared with 8.6 percent in the EU but Chinese sales were up just 2.6 percent – the pace of growth has been falling since June. Expectations for continuing strong growth in EM auto sales may need to be reined in for a while.
Overall – The mood in the base metals markets is depressed; the main driver is the slowdown in China and how that is affecting prospects for global growth. In recent years, confidence in the worlds’ financial system and markets after the financial crisis were restored by the Fed pulling out all the stops and by the ECB’s Draghi saying he would do “whatever it takes”. But China’s currency devaluation in August and its impact on world markets means the Fed and the ECB are no longer in total control. China’s step into the global arena seems to have unnerved broad market confidence; the fact it has had to do this also raises the concern that growth there may slow further, which could keep demand for metals low for a long time; in turn, that might mean oversupply becomes a bigger problem.
There seems to be growing acceptance that metals prices might have to fall further to correct the supply surplus and the stock overhang. In those metals where there is excess capacity and/or large stocks, prices may well head lower and this may trigger more supply responses, which could see some metals start to recover later in 2016.
(Macroeconomic commentary/analysis: Tom Moore, Research Analyst, FastMarkets.com, and Steve Hardcastle, Head of Client Services, Sucden Financial Limited)