Most base metals are up as we start 2023. We have identified several potentially bearish items (and a few bullish items) related to slowing demand and lower energy costs.
Metals Factors
Global Supply/Demand (Bullish, Surprise). China’s aluminum output is expected to grow in the coming years as the industry switches more production from coal to hydropower, according to Bloomberg. This expected production growth comes despite a government-mandated capacity cap of 45 million mt/yr. According to Bloomberg estimates, production could hit 43 million mt by 2025, up from 40.21 million mt in 2022. The current 45 million mt/yr capacity cap was set in 2017 as part of a government effort to clamp down on emissions. China’s aluminum production expansion comes as their real estate-related demand is set to increase due to government stimulus measures, according to S&P Global Insights. (Sources: S&P Global Insights, Reuters, Bloomberg)
Last year, global aluminum prices and demand fell mainly due to the pandemic and supply-chain issues. However, aluminum prices could rally this year if China’s demand increases.
Market prices for steel show that mill profitability has eroded, and forward prices don’t look much better. The HRC to busheling scrap spread was last $377/st, based on Argus’s most recent HRC and #1 busheling ferrous scrap price assessments from earlier this week. The price spread between HRC steel and busheling ferrous scrap is often used as a gauge for steel mill profitability. AEGIS notes this spread continues to drop even after the usual seasonal slowdown in November and December, as the spread sat near $424/st in mid-October. We also note that this drop in steel mill profitability comes as some large producers such as Cleveland Cliffs and Nucor are hiking prices on certain products and implementing minimum spot prices for HRC. After reaching a record $1,441/st in September 2021, this spread has steadily dropped throughout 2022 and early 2023. Based on today’s forward curves, this spread averages about $398/st throughout 2023, up slightly from the $390/st average in mid-October. (Source: Argus)
USD/Federal Reserve Policies (Mostly Bullish, Surprise). On December 14, the Federal Reserve raised interest rates by 50 bps, putting the Fed Funds target rate between 4.25% and 4.50%. As for their economic outlook, the Fed believes that the median 2023 GDP will be 0.5%, down from their September projection of 1.2%. They also raised their median 2023 Fed Funds rate projection to 5.1%, up from 4.6% in September.
We note that some US economic data released in recent weeks have come in better than expectations, leading some analysts to believe that further interest hikes could occur. Also, CPI data shows that inflation is slowing; however, commodity prices seem to spike on that news. Is the market creating a vicious cycle?
As for the US Dollar, the USD index has dropped precipitously since early November and is now trading at levels not seen since last June. However, due to the inverse relationship of the DXY and dollar-denominated commodities, the Federal Reserve’s interest rate policy is generally bullish on the DXY, and therefore could to continue to weigh on CME & LME metals prices. As always, we will continue to watch the Federal Reserve’s actions and any hints of future rate hikes.
Energy Costs (Bearish, Equally Priced In/Surprise). Due to lower electricity costs, Aluminium Dunkerque, which owns and operates the EU’s largest aluminum smelter, has started increasing production, according to Bloomberg. The company plans to have output at full capacity by May. The plant, which produced 290,000 mt of aluminum in 2021, cut output by 22% last September as soaring electricity costs made smelting unprofitability. However, French month-ahead power prices have dropped over 80% from the October peak, thereby making aluminum smelting feasible again. According to Bloomberg, Aluminium Dunkerque buys most of its power through a French nuclear-power program known as ARENH. The remainder of its power needs is purchased at market prices. Thus, Aluminium Dunkerque has been able to endure the European power crisis better than other smelters. Throughout most of 2022, electricity prices across Europe surged to record highs because of decreased natural gas flows from Russia. (Source: Bloomberg)
AEGIS has been diligently tracking European smelter curtailments since the start of the Russia-Ukraine conflict. We note that this first announcement of a smelter bringing production back online due to the recent drop in electricity prices. We also note that Aluminium Dunkerque’s announcement comes just as global aluminum seems to be on the upswing. For example, China has just implemented a slew of economic stimulus measures that aim to boost its faltering real estate sector. Those measures, along with continued robust demand in North America, could be supportive of aluminum prices.
CME natural gas prices continue to fall. The March through May ’23 contracts now hover near $3.00/mmBTU, down nearly $2.40/mmBTU from the highs of early- to mid-December. Most summer and fall ’23 contracts are trading near $3.40/mmBTU. Given the recent pullback, this could be a good time for consumers such as aluminum extruders to hedge future natural gas needs. We also note that natural gas prices have been extremely volatile in recent weeks. Please contact AEGIS for specific strategies that fit your operations.
Economic Slowdown (Bearish, Mostly Priced In). Most recent economic data shows that economies throughout the world are slowing. This will likely weigh on metals prices and demand. However, we will keep reading the “tea leaves” for any hints of economic recoveries and predicted ramp-ups in metals demand.
Tariffs/Regulations (Bearish, Priced In). The current Section 232 tariffs on steel and aluminum imports will remain in place, despite opposition from the World Trade Organization (WTO). Last Friday, the Biden administration stated they are “committed to preserving U.S. national security by ensuring the long-term viability of our steel and aluminum industries, and we do not intend to remove the Section 232 duties.” AEGIS notes the Biden administration likely felt obligated to reiterate their stance on these tariffs after the WTO stated the tariffs violated international law earlier in the week. Despite the WTO’s comments, they have little recourse over the Biden administration’s decision. According to an international trade lawyer interviewed by Bloomberg, “the WTO cannot declare that a US law is invalid. All they can do is impose sanctions for not changing it.” (Source: Bloomberg)
Section 232 tariffs are at the discretion of the US executive branch and are allowed for reasons of national security. Current tariffs are 10% on aluminum imports and 25% on steel imports. These tariffs were meant to reduce the flow of metals imports, thereby preventing foreign exporters from dumping cheap aluminum onto the US market. AEGIS notes the cost of the tariffs has supported the MWP. Reducing or eliminating those tariffs would likely reduce costs and perhaps prices in the US, as these tariffs are based on aluminum prices, and are built into the MWP.
The current Section 232 tariffs have been in place since 2017, thus AEGIS believes that keeping the “status quo” in place will likely have no impact on MWP or HRC steel.
Raw Materials (Bullish, Mostly Priced In). Tin is the best-performing LME metal in 2023, soaring over 22% so far this year. AEGIS believes the recent price action could be due to Chinese buying as their economy reopens or speculation that Chinese restocking will continue its brisk pace in 2023. China imported 31,115 mt of refined tin last year, up nearly 535% from the 4,900 mt imported in 2021. Last year’s import volumes were also the highest since 2012. According to Reuters, Chinese tin demand was down last year due to the pandemic, thus, the recent significant jump in imports “suggests a major restocking exercise.”
We also note that the recent jump in tin prices could also be due to Minsur’s tin mine closure in Southern Peru. Since early December, Southern Peru has been rocked by violent political protests, forcing Minsur to cease operations at its San Rafael tin mine earlier this month. According to Minsur’s website, the San Rafael operation is the leading Tin producing mine in South America and the third largest in the world. (Sources: Reuters, International Tin Association, Minsur)
China’s aluminum production expansion comes as its producers tap Indonesia for more alumina. Two Chinese metals producers, Tsingshan Group and Nanshan Group are building alumina smelters in Indonesia that will add approximately 750,000 mt to the country’s annual production capacity. Bloomberg expects Indonesia’s alumina output will hit 4 million mt this year, up 37% from 2022. (Source: Bloomberg)
Protests throughout Peru have worsened in recent weeks, potentially restricting access to the country’s copper supply, according to Bloomberg. The Las Bambas mine, which is responsible for approximately 2% of the world’s copper mine supply, has seen transport of copper concentrates impacted by road blockades, according to Reuters. Last Friday, Glencore announced that they had suspended operations at the Antapaccay copper mine after the 3rd attack on the facility in a month. Moreover, transport officials recently told Reuters that protestors have blocked roads in 18 of 25 of the country’s regions. The ongoing protests began in early December when then-President Pedro Castillo was impeached and arrested on corruption charges. At 2.2 million mt, Peru was the world’s second-largest copper miner in 2021, according to USGS data. (Source: Reuters, Bloomberg, USGS)