While most metals prices saw sharp falls through February and March amid global economic uncertainty, in China demand conditions started to recover towards the end of the month as the Covid-19 epidemic came under control and economic activity started to lift strongly. According to our survey work, economic activity started to improve in mid-March in the coastal provinces, and by early April activity levels were normalizing nationwide as even Hubei province emerged from lockdown.
We believe that for most metals, demand was more delayed during the extended CNY and lockdown period, rather than ultimately lost. Consequently, we expect demand for metals to rise strongly through the second quarter and into midyear, as we see pent up demand coming through quickly in what is already a seasonally strong time of year. On top of this, the economic support measures such as cheaper liquidity, infrastructure stimulus and cheaper energy prices, should all help to provide an even more conducive demand environment within China.
However as the pandemic disruption continues to spread outside of China in early April, even sentiment in China is becoming more negative again as people worry about the knock on impact from weaker export markets. Indeed, there is clearly a “two speed” China emerging in terms of demand, with domestically focused sectors such as housing and infrastructure construction clearly accelerating, while demand from sectors which are more exposed to exports such as electronics, appliances and machinery factories remains more subdued.
High inventory was a worry across the metals space throughout March following the pause in demand. However as prices made multi-year lows for most metals, further supply cuts were seen amid negative margins especially in aluminium, copper and zinc. As demand has recovered, inventory of most metals has started to draw, and we expect this draw to accelerate through April and May until prices recover to a level which encourages smelters to raise output to meet the improving demand.
Aluminium smelters in particular are heavily loss making, so supply will not come back without a sharp increase in prices. Chinese aluminium smelters have gone from being very profitable at the turn of the year (with average margins of as high as RMB1,400/t) and looking to raise output, to being heavily loss making now (average losses over RMB1000/t in early April), despite sharp falls in alumina prices. We estimate that as of the second week of April, only 30% of Chinese aluminium smelters saw positive operating margins.
Given the extreme losses, most producers have postponed new capacity ramp ups (we originally expected 2.97mt of new capacity due onstream in China in 2020) and many have already announced production cuts. While the priceis at extreme low levels, the inventory build in aluminium is not unusually high by recent historical standards, so as demand recovers, we expect aluminium to lead the nonferrous price recovery in the short term. Aluminium has also seen significant short interest on the Shanghai Futures Exchange and LME, while cheap liquidity globally and the presence of consumer hedging through the forward curve have already led to a return of the financing carry trade in aluminium, which should provide further support to aluminium prices in the near term.
On alumina meanwhile, prices moved higher after the CNY holiday as 4.6mt of refineries in inland provinces were heavily disrupted by trucking bans which caused a temporary shortage of alumina at a number of smelters. However, given there is no structural shortage of alumina capacity in China, indeed we have another 6.2mt of new refineries due on stream this year, production recovered quickly once restrictions were lifted. As this coincided with smelters cutting production, it caused a sharp drop in alumina prices globally, to as low as $230/t in mid April. That is a price level which we believe undercuts many domestic refineries, and as seen in 2H19, we’d expect traders and smelters to start looking at alumina imports again despite the abundance of domestic supply, and as domestic alumina refineries consequently cut output in the weeks ahead, alumina prices should soon find a floor.
While we expect to see a near-term recovery in aluminium prices, we continue to see few, if any, capacity bottlenecks across the aluminium supply chain in China over the next 1-3 years. Consequently, the ultimate upside to prices will be limited and we struggle to see prices rising beyond marginal cost levels in China for a number of years ahead. The base metal which continues to look the most attractive on any timeframe remains copper. While there has been a clear compression in the global mining cost curve this year given weaker energy prices and a stronger USD against most producer currencies, we still expect copper prices to recover strongly by mid year given the terrible economics at Chinese smelters.
Indeed, Chinese smelters were cutting output at the start of the year even before the virus-related disruption, due to poor economics given the contract treatment and refining charges for concentrates were set so low at $60. Combined with the record low sulphuric acid prices in most regions of China, many smelters were not making money even with prices near RMB50,000/t at the start of the year. We believe these poor smelter economics will require copper prices to recover back above January highs in order to stimulate smelter restarts as copper consumption bounces back in 2Q.
One further supportive factor for copper prices in the near-term is the increasing disruption levels to China’s overseas suppliers of copper units. China relies on imports for nearly 80% of its copper unit supply, and its not just mine supply from countries such as Peru and Chile which is being hampered, but also scrap supply from countries such as Malaysia. The one commodity which has reacted most significantly to the news of global mine closures is the copper concentrates market, with the SMM Copper Concentrates Index falling from $71.5 in mid March to $61 by mid April, only just above the annual settlement level.
Many Chinese market players are indeed worried about potential shortages of copper given the increasing disruption levels ex-China, and this has already led to some domestic stockpiling of refined copper by end users and traders. Copper inventory onshore is starting to decline and physical premiums have risen to their highest levels so far this year as of mid-April, which should provide support to higher exchange copper prices in the weeks ahead.
Medium term, we continue to see a lack of structural growth in raw materials, both in mined concentrates and scrap, to meet the expected demand growth for copper in China, which will be driven by expansion in markets for electronic vehicles, infrastructure and consumer sectors such as 5G telecommunications. With metals prices once again back at multi-year lows, it is likely that capex and exploration spending will again be cut in the months and potentially years ahead, which will only further tighten the medium- and longer-term outlook for copper.
One other metal which has seen a more surprising drop in Treatment Charges (TCs) in response to global mine supply disruptions is zinc. In February Chinese zinc smelter output was heavily impacted by the epidemic control measures given the location of many smelters in inland regions where transportation restrictions were most severe. This came after a strong rise in zinc smelter output in 2H19 on the back of strong smelter margins and rising smelter capacity.
While zinc concentrates were significantly oversupplied last year, Chinese mine disruptions in February have been followed by a number of global mining and export restrictions which have raised concern over seaborne imports of zinc concentrate into China from major supply countries such as Spain and Peru. This has led to a sharp drop in spot zinc TCs for imports into China, and domestic TCs are now following these lower. These falls in TCs combined with the sharp drop in zinc prices has sharply reduced zinc smelter margins, which had previously held up better than for copper and aluminium. While we are bullish on near-term price recovery for both aluminium and copper, given widespread smelter cuts and inventory which is starting to draw on the back of the domestic demand recovery story, we are less bullish on the short-term price outlook for zinc. First, zinc smelter output has not been cut significantly given that margins have only recently come under pressure, indeed March 2020 output was still up 2.7% YoY on our numbers. Second, zinc demand is heavily leveraged into the automotive sector, with two thirds of zinc being consumed by galvanisers, and two thirds of that ultimately ending up in the auto sector. Given that global auto supply chains continue to be heavily disrupted and Chinese consumer buying is only just starting to recover, we expect this demand sector to be a laggard in coming weeks compared to other sectors such as construction and infrastructure.
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