ICG Commodity Update – January 2020
The ICG Commodity Update is our monthly published comment on energy, industrial metals and precious metals market.
China’s commodity industry, the world’s leading consumer of raw materials, is ensnared in chaos as the coronavirus delivers the worst demand shock since the global financial crisis. Trade in almost every major commodity is at risk. Oil demand has plunged 20% and refineries are curbing operations, liquefied-natural-gas buyers are reneging on deals, coal mines are staying shut, copper smelters are mulling output cuts, and crop cargoes are getting stuck at ports. The drop in Chinese oil demand equals about 3 million barrels a day, according to people with inside knowledge of the country’s energy industry. China is the world’s largest oil importer, after surpassing the US in 2016, so any change in consumption has an outsized impact on the global energy market. The country consumes about 14 million barrels a day. The collapse in Chinese oil consumption is starting to reverberate across the global energy market, with sales of some crudes slowing to a crawl and benchmark prices in free-fall. Sales of Latin American oil cargoes to China came to a halt by the end of January, while sales of West African crude are also slower than usual. Sinopec Group, the nation’s biggest refiner, is in the process of reducing runs at its plants by an average of about 13%-15%. Also, independent oil refineries may be cutting rates or shutting completely as storage fills up, according to traders familiar with operations at the plants known as teapots. OPEC and its allies are gathering for an urgent assessment of how Asia’s coronavirus may hurt oil demand, and what measure they could take in response. Technical experts from the OPEC+ coalition will meet at the cartel’s headquarters this week to evaluate the impact. The officials’ assessment may help determine whether the alliance convenes an emergency ministerial meeting later this month to consider new production cuts. Saudi Arabia has been pushing for such a gathering, but has faced some reluctance from Russia. Moscow doesn’t face the same budgetary need for elevated oil prices as most OPEC members. The energy minister had said last week that the country is prepared to meet this month, and intervene if necessary, though it prefers to continue monitoring the situation. Still, the outlook is not all negative. Banks including Citi have flagged the potential for stimulus measures. Goldman Sachs analysts said they see only modest further downside potential as the sell-off has already priced in a larger hit to economic growth than they are expecting.
Investors have deserted raw materials around the world over fears about the economic fallout from the corona virus. More than a dozen Chinese provinces have announced an extension of the New Year holiday by more than a week in a bid to halt the spread of the virus that has killed hundreds of people and sickened thousands. According to analysts, investors are seeking risk-aversion assets. Fears over the effect that’s going to have on demand and supply balances had hammered global prices from copper to iron ore while Chinese market were shut – copper on the LME capped its worst month since 2015. After the 12-day slump, copper jumped on Monday ending its longest sell-off on record. The market moves underscore expectations that China may look to stimulus measures to reduce the economic hit from the virus outbreak that has shut down some of its major cities. Manufacturing typically picks up after the New Year. China reduced rates as it injected cash into the financial system, with the central bank seeking to ensure ample liquidity as markets plunged. Citigroup said the virus outbreak is expected to put Chinese metals demand growth on hold for much of this quarter, although there will be a major rebound in the second half on potential policy easing from the government. Some analysts see the slump in LME prices as excessive, and some downstream consumers are buying to replenish stockpiles. If you look at the fundamentals, years of limited mining capex have made the supply side vulnerable to unexpected production outages. Especially in copper and nickel, analysts see great supply risk. The challenges to copper output are multifaceted (technical, political, social and environmental) and spread across all regions. Nickel is expected to remain in deficit beyond 1% of annual demand in 2020. The story for higher nickel prices is strongly tied to Indonesia’s nickel ore ban. The lack of Indonesian nickel ore is likely to weigh on China’s NPI production toward the end of this year and in 2021. Before the virus hit, most base metals were a 2020 favorite for analysts including those at Goldman Sachs, Jeffries and Citigroup. Easy monetary policies worldwide, the preliminary US-China trade deal and mine supply that is expected to lag behind demand in coming years were among reasons given for the bullishness, and those pieces are still in place should the outbreak prove less severe than feared. Parallel to the slide in metal prices, miners and steelmakers plunged as risk-off sentiment hit equity markets.
In contrast to industrial metals and energy products, gold was boosted as worries mounted over the potential global economic impact of the spread of the coronavirus. Those concerns helped burnish gold’s appeal as a haven as investors shunned risky assets. According to analysts, gold has been in a strong uptrend since early December, largely due to the significant monetary stimulus from central banks around the world. Nonetheless, the shiny metal slipped from a three-week high amid concerns the coronavirus could hurt jewelry sales in China. According to analysts, there’s a risk that Chinese shoppers will buy less gold jewelry, especially if the virus follows a similar path to SARS. Retail coin and jewelry demand in Asia is a negative risk for gold markets, particularly in China where gold premiums have started to soften given GDP downgrades and coronavirus risks. Still, investor demand for bullion as a safe haven could offset weaker Asian consumption, Citigroup said. All virus concerns beside, precious metals remain a story linked to easy monetary policy globally and broad US dollar weakness. Real interest rates, particularly in the US, are an important driver for gold due to the metal’s non-yield-bearing status, the lower real rates go, the better its price outlook. Apart from low US real rates and a weaker US dollar, gold should benefit from any sudden spikes in market volatility due to late-cycle dynamics and ongoing geopolitical noise, especially during the 2020 presidential election.