Global commodity indices have remained range-bound since the beginning of 2017. This can largely be attributed to softness in the crude prices during the first half of 2017, which has pulled down overall indices. On the other hand, the non-ferrous metal segment has seen a sharp appreciation in prices in the last few months, due to macroeconomic improvements as well as certain sector-specific factors. The prices of commodities such as copper and aluminium were supported by supply-related reforms and disruptions in the industry, stable demand and a weakening dollar.
Copper prices have sharply appreciated throughout the second quarter of CY2017. Year to date, the prices have moved up by 16%. On an annual basis, the average copper prices for the first seven months in 2017 stood at $5,810 per tonne, marking an increase of 23% year-on-year. Aluminium prices have appreciated gradually during the first quarter of 2017, with year-to-date price appreciation of 14%. On an annual basis, the average LME aluminium prices for the first seven months of 2017 stood at $1,890 per tonne, marking an increase of 21% year-on-year.
The GSCI (Goldman Sachs Commodity Index), LME (London Metal Exchange) and GSCI Industrial Metals Index have appreciated by 29.2%, 36.5% and 35.9%, respectively, since January 2016. However, during 2017, GSCI and GSCI Energy Index declined by 5.5% and 10.2%, respectively, due to the decline in energy index.
Improved global business cycle
Globally, manufacturing activity is gaining strength since the second half of 2016. The latest global manufacturing Purchasing Managers’ Index (PMI) rose by 0.1 point to 52.7 in July 2017, marking the 10th consecutive month that PMI remained in upper 52 levels. The eurozone manufacturing activity has been buoyant through first half of the year. The eurozone consumer confidence in July this year surged to the highest level since June 2007. Strong growth outlook is projected for Germany (the biggest economy in Europe) at 1.8% and 2.0% for 2017 and 2018, respectively, (up from 1.5% and 1.8%, previously).
While positive news is flowing from the other side of the Atlantic too, the US second quarter GDP reading came in at a seasonally-adjusted annual rate of 2.6% quarter-on-quarter, from 1.2% in preceding quarter. The growth was largely broad-based and reflected positive contributions from all components, especially the engine of growth, consumer spending, as well as private investment.
In 2016, the weak global trade growth of 1.3% was partly due to cyclical factors as economic activity slowed. Trade flows have, however, accelerated this year. According to WTO’s World Trade Outlook Indicator (WTOI) report released in August, global merchandise trade growth is expected to continue to strengthen in the third quarter of 2017. The indicator is suggesting sustained momentum for trade growth due to strong performance in air freight, export orders and container shipping. Going forward, the WTO is forecasting that global trade will expand by 2.4% in 2017. The trade growth forecast for 2018 is expected between 2.1% and 4%.
Impact of dollar weakening
A weaker dollar is another factor supporting higher commodity prices. The GSCI and the Dollar Index have an inverse relationship typically, reflecting the opposite impact of risk appetite on these variables and the denomination effect (as commodity prices are expressed in dollars). The relationship has largely played out in the recent past as well. From the beginning of 2016 till date, the dollar has depreciated 4.1%. Since the start of calendar year 2017, the dollar has depreciated around 6.2%. However, from the highest point since November 2016 (103.3) to lowest of July 2017 (92.9), the Dollar Index depreciated around 10%.
China demand not a big driver
Manufacturing activity in China has been consistent since the beginning of CY2017. Chinese economy has demonstrated continued strength, growing by 6.9% during the second quarter of 2017, the same rate as the first quarter—above the government’s target of 6.5% for 2017.
China’s import data shows a mixed picture. Its combined imports of copper products (including anode, refined, alloy and semi-finished copper products) stood at 390KT in June 17. Even though imports of combined copper products have declined on an yearly basis, the month-on-month import data suggests stable demand from China. However, China’s imports of refined copper declined by 24.6% year-on-year in the first half of 2017. Remarkably, this has not been the case with copper scrap imports into China, which has demonstrated increasing trend so far. China’s demand for copper is primarily derived by the electric vehicle market, and growth in grid building, vehicle sales and overall construction which has, so far, helped copper prices stay elevated. Chinese imports of copper scrap had declined since late 2012 until early 2016. Remarkably, the declining trend reversed since the first quarter of 2016. Imports of scrap increased by an average 21.4% year-on-year to cumulative of 1,850KT during the first half of 2017.
Other factors for upward price movement in aluminium are supply reforms arising from China, the US policy focus on infrastructure development and higher coal prices. The sector experienced radical supply reforms on account of environmental concerns, forcing capacity idling during winter months and curbing of capacity without approvals. According to some estimates, the potential for Chinese capacity cuts stands over 6 million tonnes due to these reasons. News reports indicate capacity idling of approximately 2.5 million tonnes of outdated smelter capacity that will be replaced by new capacity.
Further, the Chinese government has announced substantial reduction in coal consumption in electricity generation over the course of the current five-year plan (2016-20) by ceasing production of 150GW of new coal-fired power plants and idling 20GW of obsolete coal-fired production. Chinese aluminium sector mostly utilises power for its smelters via coal (often in captive plants). Reducing of such capacity will further intensify supply-side disruptions, driving aluminium prices upwards.
The supply disruption in copper sector due to threatened strikes at Latin American mines failed to materialise. However, the news from China threatening to ban copper scrap imports by late 2018 added an upward bias to copper prices. It is anticipated that the ban may result in increased demand from China for copper concentrate and refined copper for fulfilling its total requirement. In case the proposed copper scrap ban gets implemented, it could support buoyancy in copper prices.
Analysts’ forecasts suggest that global copper market balance is expected to move from a surplus position in CY2016 to a balanced position in CY2017. Although current projections for aluminium market balance suggest a modest surplus in CY2017, ongoing supply disruptions in China could make this surplus vulnerable. Consumption demand from the US, the EU and China is steady on account of increasing investment and macro growth factors. Considering combined factors like global growth outlook, trade growth and supply disruptions, metal prices are expected to stay at elevated levels. The only major downside risk appears to stem from the ongoing geopolitical risks and their implications for risk appetite in global financial markets.
Udit Kumar & Mangesh Soman
Corporate economists based in Mumbai