Copper hits 2-year lows as metals demand outlook dims
(Repeats Monday’s column with no changes to text. The opinions expressed here are those of the author, a columnist for Reuters.)
* Fund positioning on CME copper: tmsnrt.rs/2Myafvs
* LME Index vs China PMI: tmsnrt.rs/2YnPVnD
* Global Vehicle Production: tmsnrt.rs/2YqBKy7
By Andy Home
LONDON, Aug 5 (Reuters) – If you believe that “Doctor Copper” is a sensitive gauge of the health of the global economy, then you should be worried.
London Metal Exchange (LME) copper fell through the year’s low of $5,725 per tonne on Friday and hit a 26-month low of $5,640 early on Monday.
The trigger for the slump was the latest escalation of the trade stand-off between the United States and China, President Trump announcing the imposition of more tariffs on Chinese goods effective the beginning of next month.
Copper has been used as a proxy for trading the on-off trade talks for some time and funds had amassed a significant short position on the CME copper contract even before Friday’s break-down.
However, what’s troubling Doctor Copper and just about every other LME-traded base metal, with the single exception of nickel, is the accumulating evidence of a global manufacturing downturn.
Quite evidently, an escalation of trade tensions between the world’s two biggest economies is not going to help an already fragile industrial economy.
THE TRUMP TRADE AND THE BIG SHORT
Funds have for many months been expressing their views on the likely success of the trade talks via the CME copper contract.
When a positive outcome looked possible around the end of the first quarter, fund positioning switched to net long. But since then bears have amassed short positions as the prospects of a breakthrough have receded.
The latest Commitments of Traders Report shows money managers holding a net short position of 40,372 contracts.
Outright short positions totalled 86,841 contracts. That’s less than the record 101,593 contracts accumulated at the start of June but the latest report only covers positioning as of last Tuesday. The big short has almost certainly got bigger still, given the price action towards the end of last week.
Long positioning has been largely unchanged since the unwind of previous exuberance in April and May.
THE GLOBAL RECESSION TRADE
It’s not just copper that is being punished by speculators. LME aluminium, zinc, lead and tin are all now trading below year-start levels.
Only nickel is defying this broader trend, with investors keeping faith with nickel’s bull narrative of a lift in demand from the electric vehicle battery sector. It is the only LME metal still showing a net speculative long position, according to LME broker Marex Spectron.
What’s depressing the rest of the LME base metals complex is the deterioration in global manufacturing activity as shown by falling purchasing managers indices (PMI) the world over.
“For the first time in recent history we now have the majority of global manufacturing PMIs in contraction,” said BMO Capital Markets. (“Metals Brief”, Aug. 2, 2019).
The metal markets are particularly sensitive to the health of China’s massive industrial economy, which is struggling, according to both the official and Caixin PMIs. Both indices edged up in July but both, critically, remained below the expansion-contraction threshold.
Other key metals economies such as South Korea, Japan and Taiwan are also suffering.
Manufacturing activity in the euro zone goes from bad to worse, contracting at the fastest pace in July since late 2012.
The United States remains a rare bright spot, but even here activity is slowing fast. The Institute for Supply Management’s July index fell to 51.2 in July, the weakest growth rate in nearly three years.
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AUTOMOTIVE PAIN
The automotive sector is a particular source of metals demand weakness.
World motor vehicle production fell last year for the first time since the financial crisis, according to the International Organization of Motor Vehicle Manufacturers.
Car markets are being hit both by the broader cyclical downturn and the structural challenge of transitioning from the internal combustion engine to electric vehicles.
This double whammy is particularly acute in China, the world’s largest car market and the one that is rolling out electric vehicles faster than anyone else.
Chinese vehicle sales have fallen year-on-year for 12 straight months, with expectations that car demand will slide some 5% this year after a 2.8% fall last year to 28.1 million units – the first decline since the 1990s.
Transport is an important end-use sector for metals such as aluminium, so look no further to understand why China’s exports of semi-manufactured aluminium products are booming even as national aluminium output flat-lines.
Exports of “semis” rose 8% in the first half of 2019 despite the proliferation of trade barriers and anti-dumping duties on Chinese products.
BACK TO SUPPLY
A breakthrough in U.S.-China trade talks could lift some of the manufacturing gloom but the prospects appear to be dimming after the most recent escalation of threatened tariffs by U.S. President Donald Trump.
Beijing, meanwhile, is working hard just to maintain economic stability by using targeted stimulus.
Hopes for a shock-and-awe metals-intensive stimulus package such as that seen in 2009-2010 and again in 2015-2016 have faded.
Beijing has made it quite clear it doesn’t want to repeat the mistakes of the past. The current stimulus pulse is largely bypassing the residential construction sector, another key end-use area for many base metals. Infrastructure spend, meanwhile, also appears to be bypassing the copper- and aluminium-intensive power grid.
With China’s manufacturing sector treading water and other countries’ activity rapidly decelerating, there is no reason for heavyweight fund managers to allocate money to the base metals sector, again with the possible exception of nickel.
Analysts such as those at BMO are looking for some improvement after the seasonal slowdown months of northern hemisphere summer and as destocking through the manufacturing chain comes to an end.
But, until there is “evidence of improvement (…) supply cuts may offer more hope for price upside” in the base metals complex.
That says as much as anything else about the state of global metals demand.
Editing by Louise Heavens
LONDON – If indications of disappointing economic growth in the eurozone are confirmed, the European Central Bank will loosen monetary policy further in September. Last week, outgoing ECB President Mario Draghi signaled a further likely cut in the ECB’s rate on commercial banks’ overnight deposits with the central bank, which is already -0.4%. In addition, the ECB is discussing a new program of asset purchases.
Economic stimulus is clearly needed. Annual inflation is well below the ECB’s target of “close to, but below 2%,” and financial markets expect it to remain so for years. What’s more, the eurozone has grown more slowly than the US economy since the 2008 global financial crisis. Growth has flagged since peaking in the third quarter of 2017, and slowed again in the second quarter of this year.
It is also clear that national governments in the eurozone are reluctant to provide a coordinated fiscal stimulus, despite the urgings of the ECB and many economists. Willingly or not, the ECB remains the only game in town.
The question is whether monetary policy alone can help to improve real growth and the inflation outlook in the eurozone. Monetary policy can be a powerful tool. The key to President Franklin D. Roosevelt’s successful effort to revive the US economy in the 1930s was not deficit spending, but rather the large monetary stimulus resulting from America leaving the gold standard before continental European countries did. Today, the ECB needs to engineer something similar with different tools.
In principle, taking the ECB deposit rate further into negative territory should remove the restriction on future expected short-term interest rates turning negative, and therefore flatten the forward yield curve. A rate cut should also put downward pressure on the euro’s exchange rate, potentially making eurozone exporters more competitive.
But such a move would be controversial, in particular because it would dent the profitability of banks that cannot pass on negative ECB deposit rates to their customers. Such policies have heterogeneous effects across banks, and mitigating action, although feasible, requires complex engineering.
According to an analysis by the ECB’s staff, “strong” eurozone banks are able to pass on negative rates to their corporate clients; “weak” banks cannot.
The ECB is therefore considering ways to mitigate this – in particular by granting very favorable conditions on the special loans that it will offer under the TLTRO III program, which are likely to be taken by the “weak” banks. In addition, a tiering system is being considered in which reserves below a certain threshold would not be subject to negative rates. But this is likely to benefit the strongest banks of stronger core eurozone countries such as Germany, France, and the Netherlands, which together hold about one-third of total deposits at the ECB.
Beyond these technical considerations, policymakers must grapple with two root causes of excess demand for central-bank reserves among strong eurozone banks. One is very high demand for safe assets in general – and banks in core eurozone countries have little incentive to hold their own governments’ debt when the interest rate is below the ECB deposit rate. Another cause is the segmentation of the eurozone’s interbank market, which, if the ECB implemented tiering, would prevent strong banks from benefiting from arbitrage opportunities by lending to weak banks at a rate above -0.4%. Both causes are the result of the eurozone’s dysfunctional banking system, in which demand for safe assets involves both a “home bias” and a strong demand for core countries’ sovereign debt.
In these circumstances, the ECB will not find it easy to implement a policy that would remove the constraint of the zero lower bound on interest rates, while ensuring that the policy’s distributional effects on banks and EU member states are neutral. Doing so will involve many instruments and complex design, far from the simple one-tool-for-one-target framework that was best practice before the financial crisis.
Moreover, negative rates become less effective over time and, if protracted, may have undesirable effects – for example, by inducing savers to de-risk, thereby potentially generating asset-price bubbles and increasing financial disintermediation. The positive stimulus from the depreciation of the euro’s exchange rate could offset these effects, but only if other central banks – and in particular the US Federal Reserve – do not ease at the same time. And on July 31, the Fed announced a widely expected quarter-percentage-point cut in its benchmark interest rate, while further future cuts cannot be excluded.
But the main problem is that neither negative rates nor quantitative easing can by themselves address the pervasive risk aversion holding back the eurozone economy. The ECB is trying to discourage demand for safe assets by making them more expensive to hold, but it cannot address the causes of the increase in such demand. This is a global trend driven by several factors, including demographic changes, widespread uncertainty linked to technological transformation, and political risks such as trade wars and nationalism. But in the eurozone they are exacerbated by the lack of reform of the single currency.
More than ten years after the financial crisis, the eurozone’s financial markets are still fragmented, and the supply of safe assets is limited by the conservative fiscal policy of northern European countries, particularly Germany. Eurozone policymakers must, therefore, find the political will to design a comprehensive package of financial and fiscal measures aimed at injecting new energy into the European project. Such a combined approach is essential to address the deep-rooted risk aversion sapping growth across the eurozone.
In the 1930s, America’s key stimulus was monetary rather than fiscal, but a vital ingredient of success was a comprehensive set of reforms coupled with a strong message capable of unifying the country. Today, Europe needs a twenty-first-century version of that policy.