Base metals’ reaction suggests Wuhan virus may differ from SARS outbreak

Base metals prices have reacted quite aggressively to the spread of the coronavirus, more so than most equity markets, leaving markets sending out different signals. While it is too early to say how this will unfold, here are some early concerns and observations.

Once the outbreak of the coronavirus became widely reported in mid-January, various markets reacted differently and continue to do so. Base metals’ prices have fallen by an average of around 11%, while western equity indices had a much milder reaction.

The Dow Jones Industrial Average peaked, based on the close, at 29,348.10 on January 17, before falling to 28,535.80 by January 27, a 2.8% drop, while over the same period the Euro Stoxx 50 dropped by 3.4% to 3,677.84 from 3,808.26.

Indices that are more dependent on trade with China have been affected quite differently, with Australia’s ASX 200 dropping by 1.9%, while the Hang Seng was recently trading 9% below its January 17 level. Although it is not surprising that the Hong Kong SAR Hang Seng Index has fallen more than the others - given its proximity to mainland China - it is somewhat surprising that Australia’s index has not suffered more given that so much of its commodity exports go to China.

With London Metal Exchange base metals prices focused on global supply and demand factors, the fact that prices are down by an average of 11.1% since the market began reacting to the virus outbreak, does imply that Dr Copper and the rest of his team are the most worried about the development.

Given the reaction in industrial metals, you would expect havens to be buoyant but gold prices - while firm and recently quoted at $1,576 per oz compared with $1,552 on the day before the markets started to react to the virus - are hardly racing higher. Indeed they are below the peak ($1,611.25 per oz) reached when United States’ forces assassinated Iran’s General Qasem Soleimani in early January.

All in all, the markets are, therefore, sending mixed messages about the likely fallout from the virus, which in a way is not surprising as it is still early days.

China first reported the virus to the World Health Organisation on December 31 and, as of January 30, some 9,776 infected cases and 213 deaths have been confirmed. The virus is spreading rapidly, with the total number of reported cases climbing by around 28% per day in recent days and given the size of China’s population - 1.4 billion - the numbers of infected could inflate before it is contained. Although, reporting may well have been restricted due to the Lunar New Year holiday. As such, in many ways it is foolhardy to try to second guess what the impact will be, but we have listed a few of our concerns.

Demand shock in China

  • China GDP growth will take a hit in, at least, the first quarter while our team in China report that shopping malls, restaurants, coffee shops, cinemas and other entertainment places are shut. The travel, services and retail sectors of the economy will, therefore, suffer and that will likely hit workers earnings too, which could dampen consumer spending for a while.
  • The much awaited post Lunar New Year recovery in China’s growth is bound to be delayed with the return to work, at best, slowed and likely to be a lengthy process. For example, Shanghai’s municipal government has extend the CNY holiday to February 9, which could dampen demand for the metals. There could also be a double whammy…
  • …if manufacturers that restocked in anticipation of a stronger recovery decide to destock now, which could weaken apparent demand and hit prices further.
  • The slow return to work and travel restrictions will disrupt supply chains. Although Chinese domestic manufacturers’ order books may be weak and, therefore, may not need to be resupplied in a hurry, the disrupted supply chain could well hit the country’s ability to export. In 2019, China’s trade surplus was worth $422 billion or an average of $35 billion per month, which equates to a lot of potential disruption.

International impact

  • With China exporting and feeding the world’s supply chain, today’s just-in-time inventory management systems may well prove to be a weak link. If China’s exports are delayed, this is likely to hit retail and manufacturing while shortages are felt, but this is not so much the case for metal supply. China is, in most cases, a net importer of refined metal, certainly for copper, zinc and nickel.
  • If port activity is delayed then exporters sending material to China may suffer delays in landing cargoes. This could snarl up shipping, causing logjams, while shipments may be diverted to other ports and inventory levels could build up, causing distress selling when financing costs mount.
  • It may be that China’s proactive response to the virus outbreak means there is a short-sharp shock and the country gets back to work quickly. If we look at what happened to China’s production and consumption of metal during the SARS epidemic, there seemed to be few hiccups.

Metals’ reaction during SARS epidemic
China’s refined metal production was mixed, with lead and aluminium production flatlining over the two quarters following the outbreak in the fourth quarter of 2002, while nickel and tin climbed and only zinc took a hit.

China’s consumption of metals showed zinc demand also fell, as did lead, while nickel and tin climbed the most and copper and aluminium moved higher.

Fastmarkets’ analysts in China, however, think the impact may be stronger this time than it was during SARS. Back in 2003, the economy was experiencing double-digit growth so was able to take a hit amid the SARS outbreak, but this time round the Chinese economy is weak and the outbreak comes amid the economy suffering from an 18-month trade war with the US. That said, given the weak economy, the supply chain is likely to be lean, so there may not be a lot of room for further destocking.

Most LME prices did dip during the SARS outbreak - especially copper, aluminium, lead and zinc - while the smaller metals, nickel and tin, were not too affected (see chart below). The main impact on metals prices was in March and April 2003, three months into the outbreak.

This time , the Chinese have been much more proactive in handling the outbreak than they were at the time of the SARS outbreak. Social media has helped ‘spread the word’, so perhaps it is unsurprising that metal prices have reacted quickly.

The other big difference between then and now is that the now famous super-cycle was getting under way in 2002 while today global growth is weak after enduring 18 months of trade wars. Market participants were hopeful there would be a rebound in China in 2020, which would bolster the global economy, but this will probably now be delayed - but hopefully not too long.

This article has been written by our team of analysts at Fastmarkets, who are responsible for providing an independent view on market developments and forecasting their future performance.

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