AEGIS Factor Matrices: Most important variables affecting metals prices

April 7, 2021April 9th, 2021
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Base metal prices continue their upward trajectory. Meanwhile, we have identified several potentially bullish items (and a few bearish items) related to growing demand and rising supply-chain costs.

Metals Factors

Global Supply / Demand. Wood Mackenzie is expecting Chinese primary aluminum consumption to grow by 2.7 percent in 2021. They assess the 2021 aluminum market in a 1.8-million-ton surplus. In copper, Citibank predicts the copper market to move into a deficit in the second half of the year with a minor surplus overall for 2021, followed by deficits in 2022 and 2023. Macquarie Bank expects a copper deficit of 226kt in 2021, down from their previous estimate of 247kt surplus. Morgan Stanley expects Nickel to move into a deficit in 2021 of 18,000 tons.

Calendar Spreads. Aluminum spreads have firmed up with Cash to 3m pricing at $26 contango. The return to significant contango in Cash to 3m spread makes aluminum inventory financing more attractive and is bullish premiums and LME. The aluminum curve has flattened for longer-dated maturity, a sign of producer selling with less consumer buying.  As copper prices have backed off from recent highs, backwardation in that forward curve has been reduced with Cash to 3m indicated at $5 backwardation. Lower copper prices continue through 2022 with Dec ’21 to Dec ’22 copper pricing at $150 backwardation. The backwardation is attractive for investors looking to roll forward long positions. The forward curve in Nickel remains in contango, with Cash to 3m increasing to $50 contango. Mar ’21 to Apr ’21 CME HRC Steel contracts have increased to $80 contango. The backwardation beyond April continues to ease with Apr’ 21 to Jul ’21 backwardation at $49 short ton, making buying forward less attractive to consumers compared to recent weeks.

China Demand. The IMF expects the Chinese economy to grow at a pace of 8.1 percent in 2021, after being the only major economy to grow in 2020. Global growth is expected to rebound to 5.5 percent this year. While China’s growth still has a material impact on markets, we note that Chinese growth is not expected to reach pre-pandemic levels, and growth had already begun to slow before Covid.

Interest Rates. The U.S. Federal Reserve’s commitment to zero or low interest rates for an extended period continues to support capital investments. Meanwhile, the yield curve has continued to steepen, with 10-year Treasury yields climbing above 1.75% briefly last week. Metals prices continue to be supported by very low short-term rates, and Federal Reserve Chair Powell has not backed off his commitment to low rates to support the economy.  The Fed is waiting for growth and inflation rather than forecasted growth and inflation before tightening policy at all.

U.S. Stimulus. Deficit spending has supported consumer demand and incentivized employment, therefore supporting manufacturing. The $1.9T stimulus includes $10B for Infrastructure with individuals also receiving checks.  Further infrastructure bills are on the horizon.

USD. A weaker USD generally contributes to stronger pricing for internationally traded commodities. The dollar has recovered somewhat over the last few weeks, currently at 92.50 as of the time of writing without significant impact on metals prices. The recovering economy and pace of vaccinations in the U.S. have helped support the greenback over the past few weeks.  However, if the dollar returns to weakening, base metals prices should benefit.

Supply Chain Logistics. Supply chain complications and JIT manufacturing have led to back-order and out-of-stock conditions for Covid related consumer choices. Many fabricators are having difficulty buying spot metal to meet customer demand and are paying a significant premium as a result. Most physical metals markets remain tight. Earlier in the month, a fire in an automotive chip factory in Japan provided a further shock to auto manufacturers’ production plans.  The Suez Canal was recently blocked by a container ship, adding to international freight and supply chain woes in general.

ESG (Environmental, Social, Governance). Aluminum producers with access to hydroelectric power are eager to push for standards around green aluminum premiums. They believe consumers prefer green products and will be willing to pay a premium for “low carbon” aluminum. Meanwhile, China seems poised to address pollution and global warming by setting a cap on aluminum production and pushing green energy initiatives.  If China’s efforts come to fruition, ESG will have a much larger impact on metals prices than it has in the past. E.V.’s continue to drive narratives as the push for carbon neutrality globally gains steam which should stand to benefit copper and nickel prices.

Aluminum Relative Performance. Despite prices rising by close to 40% in the past year, aluminum remains a laggard to other LME base metals. Oversupply has dampened aluminum performance relative to copper and Nickel. The oft watched copper/aluminum ratio stood at 4.06 this week after averaging 3.71 for the past year. Switch traders may look at selling copper and buying aluminum with the ratio above 4. If that occurs, it could give aluminum some boost relative to other base metals.

Pandemic Shutdowns. As cases, hospitalizations, and death continue to decrease, we see the possibility of new pandemic shutdowns as low. However, an unexpected change to this outlook could bring reduced economic activity and we have kept this category in the factor matrix but moved it further into surprise/bearish territory.

Inflation. Higher inflation expectations continue to garner media attention with rising long term interest rates also pointing in that direction. There has been significant asset price appreciation in equities, housing, and commodities over recent months, but these increases have yet to materialize across the full spectrum of consumer goods.  The Federal Reserve seems content that they can address inflation pressures when needed.

Raw Materials/Energy. Energy prices have recovered in earnest and are no longer a drag on base metals pricing. The recovery in oil prices has been from supply cutbacks rather than bullish demand. Natural gas levels have been trading near the $2.50 level for the April contract but remain a laggard to oil pricing. Gas prices are pushing $3.00 a gallon for nationwide average, well above summer levels that had dipped below $2.00.

Tariffs. Section 232’s 25% tariff on steel and 10% tariff on aluminum have remained in place with the new Presidential Administration. Department of Commerce Chair, Giana Raimondo, indicated in a recent speech that “the data show those (Sections 232) tariffs have been effective.” Producers and consumers are lobbying their offsetting position on tariffs with the new administration.  As duty unpaid prices increase for imports, the impact of tariff increases on a pure total cost basis.

AEGIS provides financial hedging strategy and execution for base metals, but also oil, natural gas, refined products, and interest rates.

Adam Jackson

Michael Garruto

Questions or comments? Please contact us at [email protected].

Commodity Interest Trading involves risk and, therefore, is not appropriate for all persons; failure to manage commercial risk by engaging in some form of hedging also involves risk. Past performance is not necessarily indicative of future results. There is no guarantee that hedge program objectives will be achieved. Certain information contained in this research may constitute forward-looking terminology, such as “edge,” “advantage,” ‘opportunity,” “believe,” or other variations thereon or comparable terminology. Such statements and opinions are not guarantees of future performance or activities. Neither this trading advisor nor any of its trading principals offer a trading program to clients, nor do they propose guiding or directing a commodity interest account for any client based on any such trading program.

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