Materials Risk

1) Stainless steel

Stainless steel currently accounts for around 70% of nickel demand. Nickel is used as an alloying input in its production. Whenever there is growth in car sales, increasing activity in the construction sector and higher consumer spending on household appliances then it follows that nickel demand also increases.

Photo by Adam Dachis on Unsplash

2) Chinese demand

Nickel is a commodity that typically sees demand increase once infrastructure is in place. As families furnish their homes with large appliances the demand for nickel typically increases. The price of nickel typically reacts in advance to signs of faster or slower growth in Chinese demand.

3) Supply

There is a two-tier market for nickel. The first is for high-purity nickel delivered by the conventional route of nickel ore processing and refining. Some of the major producing countries include Russia, Canada and Australia.

The second tier has grown up from the increasing role of nickel pig iron (NPI) production. Nickel ore is shipped from mines in the Philippines and Indonesia to China to create cheaper nickel units in NPI.

4) Innovation

As with all commodities high prices encourage innovation and the commercial use of technologies previously thought to be uneconomical. Nickel is no different.

In early 2007 Chinese stainless steel producers (the production of which requires nickel and iron ore) were up against the wall as supplies were dominated by western companies operating in places where nickel reserves were being depleted.

There were plenty of lower-grade laterite deposits in Indonesia and elsewhere which could be refined into nickel pig iron. But processing the laterite ore required lots of energy and created lots of pollution. After encouraging early trials, Tsingshan (one of China’s major stainless steel producers) tried rotary kiln electric furnaces, which use around 40% less energy than blast furnaces and can extract more nickel from the ore.

5) Batteries

While lithium may have captured the attention of battery producers looking to supply into the automotive sector, it is nickel that could help bring electric vehicles into wider adoption. the switch to NMC and NCA batteries means battery cells contain more nickel (in the region of 20%-50%). Meanwhile as battery packs become bigger to increase the range of vehicles between charging then there is likely to be greater use of nickel. Batteries currently represent around 4%-5% of global nickel demand.

As of now, the EV-battery market wants tier 1 (class 1) material, sourced from mined nickel sulfide ores. The high-quality nickel metal produced from those is used to make the nickel sulfate needed for batteries. The problem is that none of the NPI produced by Indonesia and the Philippines is suited for production of the nickel sulphate powder desired by battery makers.

6) The weather

Perhaps surprisingly the commodity that has typically seen the biggest price impact from the weather phenomenon known as El Niño during the 20 year period to 2015 has been nickel. This has been because dry weather in Indonesia lowered water levels in canals, preventing the metal from being exported.

7) Political uncertainty

Political uncertainty is one of the main factors affecting the nickel market. After Indonesia introduced an export ban on nickel ore in early 2014 nickel prices promptly surged by over 50% reaching a high of just over £21,000 per tonne five months later. Prices were also buoyed by geopolitical concerns elsewhere, namely the risk of sanctions on the worlds biggest nickel producer, the Russian company Norilsk Nickel. Meanwhile, geopolitical concerns resurfaced in the nickel market after the Us imposed sanctions on Russian oligarchs.

8) Stock levels

In theory rising nickel stock levels should be indicative of a weak market, as supply exceeds demand. It is normal for prices and inventory levels to generally move in opposite directions. When nickel producers don’t like the market price and think that they can get a better one by waiting, they put their production into warehouse storage and wait for better times. When prices rise up to or above a price level that the producers like, nickel starts coming back out of inventory and onto the market. So watching nickel inventory levels can give us insights about where the producers think a fair price is. Both the LME and the Shanghai metals exchange report nickel stocks.

9) US Dollar

Like most internationally traded commodities nickel is priced in US dollars. At its most basic a decrease in the value of the US dollar relative to a commodity buyer’s currency means that the purchaser will need to spend less of their own currency to buy a given amount of the commodity. As the commodity becomes less expensive demand for the commodity rises, resulting in an increase in the price and vice versa.

A weaker dollar can also act as a disincentive to producers to increase output. For example, a depreciation of the US dollar against the Indonesian Rupiah can reduce profit margins for a nickel miner in Indonesia. All of the miner’s revenues will be received in US dollars, which will now buy less Rupiahs, but some proportion of the costs will be denominated in Rupiahs and will remain constant (at least in the short term). Therefore, the prospect of a lower profit margin acts as an incentive to decrease the supply of nickel.

10) Scrap availability

Stainless steel scrap is another important source of supply for the stainless steel industry. In the future the recycling of batteries from electric vehicles is likely to become an important source of supply for the nickel sulfide used in those battery packs.

Related article: Copper prices: The top 10 most important drivers

In markets, we often hear of these precise levels, beyond which everything is said to unravel.  The so-called “psychologically important level” or “breaking point.” Their allure is undeniable. If these levels could be relied on then one could fully prepare for it in advance, exiting unscathed before the stampede of the masses.

The power of belief goes some way in explaining why these levels appear to exist. Jonathan Kingsman, in his book “The Sugar Casino”, argues that although individual human beings are irrational and emotional, group behaviour becomes repeatable and predictable. Humans use their experiences of past events to show them how to react to current ones. With enough technical traders with sufficient collective experience of the market, you might get repeatable price patterns.

One argument against relying on these levels and the broader field of technical analysis rests on what its based on – the price. It’s especially hard to put a price on an asset that doesn’t produce income. It’s hard to say what the right price is for a commodity like oil and, thus, when the price is too high or too low. Was it too high at $100-plus? Was it an unsustainable blip? History says “no”: it was that price for 43 consecutive months leading to August 2014. And if it wasn’t too high then, is it too low today? The answer is that you can’t say. Ditto for whether the response of the price of oil to the changes in fundamentals has been appropriate, excessive or insufficient. And if you can’t be confident about what the right price is now, then you can’t be definite about whether the price was correct six months ago, a year ago or ten years ago.

Much as we are told that markets always reflect the collective demand and supply of a particular asset, that isn’t actually true, at least not all of the time. Markets much like wider society are arenas in which the most motivated participant is omnipotent. And this is especially important during periods of sharp reversals or periods of price congestion followed by a break-out.

Psychologically important levels do exist. The question is always do those same levels still exist now? The motivated buyer or seller that drove the price action at that last price level may not be as motivated anymore, he or she may not even be in the market anymore!

This is why positioning analysis is so important. It can offer insights into whose done what in the past, and what happened when they did too much of it and how much positioning then relates to other factors like price, curve structure and fundamentals.

Related article: Positioning analysis in commodity markets: An interview with Mark Keenan

At first sight the confluence of major market peaks, extreme but apparently unrelated events followed by subsequent market reversals may seem like just a coincidence. Often though the best contrarian indicators in financial markets are those that are either completely ignored or ridiculed.

Peter Atwater of the research firm Financial Insyghts offers some compelling examples of recent instances where confidence in the markets is at extremes and the timing has been reflected by desperate acts. Atwater believes that when our mood is high, we take bold chances, underestimating risks and discounting all potentially negative consequences.

The first of two recent examples Peter gives are earlier this year when former Russian spy, Sergei Skripal, was nearly assassinated — investigators suggested that his poisoning was the work of the Russian government. This coincided with multi-year highs in the Russian stock-market.

The second example came just days after Brent crude prices also hit a multiyear high. This time Jamal Khashoggi was killed in the Saudi Arabian consulate in Turkey.

Its not just Atwater that believes that broader confidence in the world around us affects behaviour. Back in May 2011, writing for the “The Socionomist, Mark Galasiewski shared:

The assassination of al-Qaeda head Osama bin Laden on May 1, 2011 was a result of the cooperation and success accommodated by the positive social mood trend underlying the global stock market advance since 2009. Bin Laden had been fighting two inverse trends: the increasing commitment of the intelligence analysts pursuing him and the decreasing commitment of his own followers. The increasingly positive social mood behind the stock market advance encouraged those trying to find bin Laden, while the waning negative mood deprived him of many of his traditional sources of support, thereby undermining his security.

These extreme events also relate to the common knowledge game. The basic idea is that there is private, public and common knowledge. Private knowledge as it suggests is what only a small sample of people know about something. Public knowledge is when everyone knows it. Common knowledge is public knowledge with a twist. Common knowledge is when everyone knows that everyone else knows.

This concept is central to game theory but once you understand it you see it in all aspects of our lives from financial markets to celebrity scandals. For knowledge to make the transition from public to common you typically need a mouthpiece (the media for example) or an event that pushes it into the public consciousness so that no one can be in any doubt that everyone else now knows it too.

Why does this relate to the over-confidence brought on by financial markets given in the examples above? Well, emboldened by the notion that “this time is different” the chief protagonists push things too far, make a mistake, talk to the wrong person.

As sentiment becomes stretched sophisticated investors on the other side of the market look for evidence of a shift. The common knowledge game illustrates how that shift can take on a life of its own — everyone now knows that everyone else knows that sentiment is extreme, and markets start to reverse.

For investors these mood connections are critical to understanding the world around us. Extreme events suggest extreme sentiment, cautioning that a major trend reversal is likely.

Also published on Medium