Time is running out for China to support commodity prices in 2015

“With only months left before the mid-year peak in sales of commodity-intensive goods, time is running out for China to support commodity prices in 2015…Instead of delivering its reliable first-quarter seasonal expansion in trade, China’s metal processing industry remains dormant.”

Amid this downbeat assessment Morgan Stanley has slashed its forecasts for base metals in 2015 and 2016. The bank reduced its 2015 estimate for nickel by 23% to $14,815 per metric tonne and copper by 16% to $5,945 per tonne. Although the bank also cut its 2016 outlook too, both nickel and copper prices are still higher than 2015 at $16,094 a tonne and $6,283 a tonne respectively.

China, which last year reported the slowest economic growth in more than two decades, is being buffeted by the twin headwinds of a property slump and excess industrial capacity. Meanwhile a preliminary Purchasing Managers’ Index from HSBC/Markit fell to an 11-month low of 49.2 in March. With Premier Li Keqiang setting the lowest GDP growth target in more than 15 years, growth in base metal demand from China is likely to remain “dormant” over the next few years.

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Source: ABN Amro h/t @CasperBurgering

Related article: Why are aluminium prices falling?

Related article: Seasonal price trends in steel and base metals

What is commodity risk?

Whether it is a farmer deciding what crop to plant for the next harvest, a manufacturer deciding whether now is the best time to purchase the commodities it needs, or an investor taking a position in coffee futures in anticipation of a drought in Brazil, all these decisions consists of dealing with the future.

And as it’s difficult to make predictions, especially about the future dealing with risk is essential.

Commodity market risk comes in many forms and can mean different things to different people.

The main risk is price. Whether you buy, sell or trade commodities the risk foremost in most minds is that the price moves against your position resulting in a loss.

Second, there is a supply risk if the commodities don’t arrive on time and to the condition expected. This may mean price is a secondary thought, especially if the perceived or actual risk of a disruption to supply is high.

Third, career risk (or not having skin in the game) is another factor. A manager may not care much about gains, especially those in which they won’t share in, but may be afraid of losses that could cost him or her their job.

Fourth, a lack of liquidity or cash flow could mean that an investor or physical trader can’t take a position or pay for a hedge that they might otherwise make. This means opportunities are missed and / or risk, that could have been insured against is not meaning risk could actually increase.

Finally, there is a reputational risk. Ensuring the supply of commodities is from a sustainable source (i.e. environmentally or socially) is essential to avoid the risk of bad publicity but also the risk that factors outside your control disrupts supplies.

Price volatility is often used as a measure of risk, a catchall for everything from the risk of supply disruptions to inventories being damaged to there being an unexpected surge in demand.

Long periods of low volatility (much like the last few years) can lead market participants to believe that risk is low. This can inadvertently lead to behaviour that actually increases risk, perhaps by taking on too much leverage in expectation that prices will stay within a tight band or never fall below a certain level.

But as ever it is impossible to boil anything down to one metric and risk and commodity price volatility is no different. Risk exists only in the future and it’s impossible to know for sure what it will hold.

Go back a few years, investors and commodity buyers were fearful that the commodity super cycle was in full flow and prices would continue to rise. Now, the same people may be concerned about missing the bottom but also being wary about catching a falling knife. Here our attitudes to and calculation of risk become blurred by emotion and psychology.

Properly understanding and controlling for risk can be summarised by two quotes. The first “Risk means more things can happen than will happen” and second “Pigs get fat, hogs get slaughtered”.

Or always think in terms of risk and return (or loss) and never get too greedy.

Related article: Top 8 mistakes in commodity buying and risk management

Related article: 6 ways manufacturing companies can manage commodity price risk

Platinum faces major headwinds as price hits 5 1/2 year low

Last year’s five-month strike in South Africa was expected to deplete reserves so much that prices would soar. In reality prices were broadly stable during the strike at around $1450 per ounce with above-ground stocks held by producers and the trade (estimated at 2.8 million ounces at the end of 2014) comfortably making up for the shortfall.

Related article: Global stockpile weighs on platinum prices despite strike

Global platinum output fell to 5.2 million ounces in 2014 with the strike in South Africa responsible for the bulk of the 655 kilo ounce reduction. The strike left the global platinum market in deficit to the tune of 700 kilo ounces in 2014, according to the World Platinum Investment Council, up 25 kilo ounces from 2013 (see report).

Despite the deficit platinum prices fell from $1450 per ounce in mid-2014 to around $1100 per ounce currently. As with most other commodities the strengthening in the US dollar since then providing a major head wind. So what are the prospects for platinum prices going forward?

A slowdown in China is equally important factor when considering demand from the automotive sector (41% of platinum demand in 2014) for use in catalytic converters (Chart 1). Car sales in China are suffering and further signs of adjustment to a new normal are starting to become clear. China’s official China Daily reported that “all officials below ministerial level will no longer be provided with a car and driver”. With 38% of platinum demand coming from jewelry in 2014, a slowdown in China (responsible for ~20 kilo ounces in 2014) could also see reduced demand.

Finally, demand for platinum as an investment dropped to just 1% of overall platinum demand in 2014, down from 11% in 2013 as demand from investors dried up with prices for all precious metals weakening. With the US dollar likely to remain strong investment demand could remain weak in 2015.

Related article: The end of the beginning for commodity price slump?

Chart 1: Platinum end use shares
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Source: SFA (Oxford)

On the supply side HSBC forecast that South African platinum output will recover strongly during 2015, with global output eventually rebounding to almost 6 million ounces by 2018, close to levels last seen in 2011 (Chart 2).

Chart 2: Global platinum production
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Source: HSBC

With rising supply and a slowdown in demand the prospects for platinum prices don’t appear great in the short term. In the longer term HSBC expects demand to recover with platinum prices potentially exceeding $1,700/ounce by 2016/17. Given the prospects of further headwinds – the strength of the dollar and a slowdown in China – and ample above ground stocks this forecast still feels way too optimistic.