Metals Roundup Oct ’23: Bases in 9 month downtrend
TL; DR
For October, the RBA’s Index of Commodity Prices was up 3.3% in SDR terms, across all hard and soft commodities tracked, making it the second month of an uptick.
But it was a mixed bag as usual.
Rural commodities were down. Base metals were down and returned to a 9-month price downtrend after only one month of pedestrian acceleration in September, which was the outlier. The increase was limited to steel making bulks (iron ore and premium hard coking coal) as well as ‘other resources’ like LNG and alumina.
On balance, it feels like higher rates (and USD) for longer and that should continue to repress industrial minerals prices while we wait for China and for unemployment to rise next year and the Fed to cut rates (unless some banks or a recession break in the meantime).
That probably means lower base metal prices well into 2024. That’s my base case, but as we know scenarios assume all other things remain equal, and that hardly ever happens.
Here’s the detail 👇👇👇
1. Industrial commodity prices in October
There are still a few cyclical factors working against those much-anticipated higher industrial mineral/metal prices.
Although the Fed’s recent interest rate pause took some wind out of the USD’s sails, we’re still seeing strength in the dollar which is usually negative for commodity prices.
U.S. rate hikes are biting and getting closer to (and might already be at) peak official rates but that doesn’t mean that the yield curve (or the USD) has peaked, and I’ll come back to that at the end of this roundup.
Closer to home in China, we still have crumbling demand, unresolved property market leverage/stress, and no broad-based stimulus.
And the China malaise is also affecting our other trading partners in ASEAN, Taiwan, Korea and Japan where China accounts for more than 25% of exports out of those countries.
Even with the RBA’s rate hike yesterday (increase of 25bp to 4.35%) interest rates here are still too low and we still have a negative carry trade with the U.S., and a negative real yield of -1.05% 🤔
And what we want to see eventually is a stable real yield of no less than 0.5% and preferably a bit higher and a return to a positive carry with the U.S. to encourage more investment. We’re not there yet.
Notably, the only countries showing positive real yields, a positive carry trade with the U.S. and decent real economic growth of >5% are: (a) India, which still only makes up around 5% of our exports; and (b) Indonesia which is now competing harder with Australia to supply coal and nickel (with cobalt) to China and other buyers.
Indonesia is emerging as a real competitor to Australia in the nickel, cobalt and coal trade, with geopolitics and technology its tailwind. China is also investing in base and battery rocks and minerals in the DRC and African countries.
So, how did these macro and geopolitical factors and expectations impact Australian commodity prices in October?
Well, here’s an update on the RBA’s commodity index, which tracks rural and non-rural commodities alike 👇👇👇
For October, the overall Index was up 3.3% in SDR terms, across all hard and soft commodities tracked, making it the second month of an uptick.
But it was a mixed bag as usual.
Rural commodities were down. Base metals were down.
The increase came from the steel making bulks (iron ore and premium hard coking coal which are firmly back on the menu as the decarbonisation narrative rolls back a little) as well as ‘other resources’.
These ‘others’ include LNG (consistent with Japan’s share of Australian exports rising significantly), crude oil, alumina and copper ores - together contributing to the 3.3% rise in the overall index.
Note the uptick in spot (orange line) for iron ore and coking coal, whereas spot thermal coal for electricity generation was down 👇👇👇
2. Industrial metal prices in October 🏭
Below are NextLevel Corporate’s industrial metal spot price (rate of change) charts for October 2023.
1 Base metals - back to 9-month price downtrend
Last month I wrote that it was still a bear’s picnic for bases in September, with the month-on-month rate of change accelerating for the first time in 8 months, but at 2.4% it was pedestrian and did not materially move the dial.
In October, someone turned that dial in reverse, at a rate of 1.4%, quite a reversal, meaning that we returned to a 9-month downtrend as bases lost their short-lived momentum 👇👇👇
The other interesting thing that happened in October was that the ISM Manufacturing PMI for the U.S. also reversed and returned to a downtrend.
This reestablished economic contraction in the U.S. economy after only one month of expansion in September ‘23.
That’s also notable.
Summary based on ISM Manufacturing PMI, October 2023.
Finally, Chinese investment accelerated development of Arican base metals and battery minerals, and we noticed a lot more activity in coal and nickel/cobalt coming out of China’s new best friend, Indonesia.
2 Bulk minerals - inch by inch 📅👷♂️🏗👷♀️
Whereas October brought a deceleration in base metal spot prices, it also came with a small 2% acceleration in the spot bulks index.
As mentioned, growth was in steel making bulks (coking coal and iron ore).
But there’s still a long way to go 👇👇👇
3. Riding a white tulip bulb 😲
The July 6 price high for LME Lithium Hydroxide CIF was US$46,046.
And in these first few days of November as the Albemarle and SQM share prices are down over 50% in less than a year, hydroxide is down 52% from the high (more rhyming) 👇👇👇
And over the year it’s more like 75% to 80% down.
Lithium processors are clearly finding it tough judging by downward revisions in annual earnings and production cuts by Albermarle (and by association, ASX: IGO).
Capex and opex increases, labour shortages, time and high cost of capital are all supply-side contributors. But China ultimately influences prices of the finished goods (BEV batteries). BEV prices have declined due to lack of domestic buying which in turn has led to Chinese units being exported for sale in Europe at hefty discounts to local offerings.
So why aren’t lithium share prices following suit?
Why have share prices decoupled from product prices?
The reason is cyclical and has everything to do with M&A activity and rumours.
For those of you outside WA, the key actors in our local theatre are Albermarle and SQM (the bidders), Liontown Resources and Azure Minerals (the targets), Gina Rinehart funded entities (the deal spoiler) and China (the cost advantaged leader).
To me, it makes sense that the spoiler would be a bottomless pocket long-term actor. Such an actor that earns $5 billion per annum (from iron ore) can easily withstand cyclical price corrections in a mineral like lithium that they interpret to offer a secular, or multi-generational prize.
Other likely targets, bidders and spoilers are yet to join the show, standby! 🍿🍿🍿
4. Peak interest rates in the U.S should be bullish for commodities, right, well, maybe?
To end this roundup, let’s have a look at when industrial metals might catch a tailwind.
Last Wednesday, despite confirming the continuation of the balance sheet run-off and warning of further interest rate rises, Fed Chair Powell’s rate pause was delivered (and received by markets) in a very dovish manner.
The USD weakened a little against the Euro and some other currencies including ours. A weak USD against other currencies is bullish for commodities because most commodity sales are in USD and a weaker dollar makes metals and minerals more affordable.
But when will inflation, rates and the USD fall enough to be supportive of commodity prices?
Well, I think we’re getting closer, but there are a couple of factors to think about:
(The Fed does not want a repeat of Arthur Burns in the 1970s) If yields on treasuries fall (the yield curve has already moved down since Powell’s dovish speech) and share prices moon too high, the Fed may have to hike again in December. And even if we are or will by the end of the year be at peak official rates in the U.S., rate cuts are still not a 2023 story. This is because the Fed will want to keep rates higher for longer to ensure inflation does not reoffend, like it did under the Burns Fed - which in turn required the successor Volcker Fed to moon interest rates to 20%, twice, before bringing the third wave on inflation under control.
(U.S. financing risk) With just under $2 trillion in U.S. deficit financing and ~$8 trillion in debt refinancing in the next 12 months (in an interest rate environment that’s 500 bp higher than the last refinancing cycle in 2020), either higher coupon long term bonds will need to be offered to make that sort of issuance attractive to investors, or Treasury will have to flood the market with more short term non-coupon paying bills to keep financing costs manageable. And there’s already early evidence from the Fed and in the market (higher longer dated yields) to support both of these strategies.
So, on balance, it feels like higher rates (and USD) for longer and that should continue to repress industrial minerals prices while we wait for China and for unemployment to rise next year and the Fed to cut rates (unless some banks or a recession break in the meantime).
That probably means lower base metal prices well into 2024. That’s my base case, but as we know scenarios assume all other things remain equal, and that hardly ever happens!
Until the next metals roundup in early December, I wish you fortune and wisdom if you’re riding white tulip bulbs.
Mike
Image: Leonid Altman
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