Bipolar Base Metals

Wall St continues to bask in the love of the FOMC, with lots of soothing comments to warm the cockles of trader's hearts and bring on the bids.

I've still got some real concerns about the US economy as the year wears on, but maybe all this stock market joy turns things around. Some rapidly deteriorating economic readings will need continued attention though.

While the US-China trade dispute isn't settled, the two sides are talking and it sounds like the next round of tariffs will be delayed, perhaps indefinitely. That, plus signs of bottoming in the Chinese economy has brightened the mood for base metals.

This issue's editorial is mainly about base metals markets. I give my view on copper, zinc, lead, nickel, uranium as well as more general comments on "minor metals". Most of them should have decent years, notwithstanding my concerns about the US which is not, after all, the main user,

Gold moved to $1350 and is consolidating now. It's still trading well against currencies and I still think its got a good shot at a breakout. We're only days away from the next MIF in Toronto, followed by the PDAC. We should know soon enough if we're due for yet another year of "PDAC curse" for the juniors of if we dodge that particular bullet this year.

Eric Coffin
February 27, 2019

Bipolar Base Metals

There seem to suddenly be a lot of base metal bulls suddenly. It's not chart based, at least for most base metals. Prices look better than they did a couple of months ago. I wouldn't call most base metals charts bullish just yet, though I'd say copper is the exception.

Some of this is fundamentals, for sure. There are good reasons to believe the "main" base metal-copper-should have some good years ahead of it. But there are still potential stumbling blocks in the short term.

The US-China trade war is the headline issue, but China's economy itself, and slowdowns elsewhere are the most important ones. Longer term, things look good for several metals. But you should be prepared for some short-term price swings is you're buying now.

Economic readings were quite weak from China heading into the start of 2019. Q1 numbers are always tricky because of the huge impact Lunar New Year holidays have on the entire economy, but things seem to be stabilizing again. There has been a notable turn around in both new lending and capital investment, both key readings for China.

A turnaround is also reflected in China's stock market. The Shanghai index was among the worst performing Global indexes through 2018, dropping 30%. Things have turned around dramatically since the start of this year, with the CSE Composite Index entering a bull market again when the tariff increase was postponed. You can see both the credit growth and CSI index charts below. Credit conditions started improving in Q4, which should bode well for an uptick in China's GDP growth. It's certainly needed, as that measure is still at a multi-year low.

Going forward, we'll be watching for signs of agreement in the US-China trade dispute, and China's manufacturing sector. The US just put off implementation of higher and broader tariffs as the two sides are still meeting. The recent jump in both copper and the Shanghai index are directly related to optimism that there will be a trade deal.

The jump in credit growth implies we'll see increased construction activity in China, a major consumer of all base metals. Things still look shaky in the manufacturing sector though. Purchasing Managers Indexes have been diving for the past few months, right along with exports to the US. For all of Beijing's attempts at bravado, China really needs that trade deal.

The chart below shows the longer-term relationship between copper prices and China manufacturing indexes. They are far from perfectly correlated but the relationship is clear. Note that the NBS Index, which covers larger companies had a slight bounce in January, which the Caixin index, which includes more smaller companies, dove even harder.

Seeing gains in both these indexes in the next couple of months would go a long way to confirming the demand side of the recent copper price move. That said, metal prices have moved ahead of China manufacturing indexes during other large moves, like 2016.

Things look considerably brighter on the supply side for copper. Whatever the short-term outcome of the trade war, the supply/demand balance for copper is getting increasingly bullish. While we need to be wary of sudden negative turns in the economy and political landscape, that doesn't seem to be any way to avoid increasing copper supply deficits going forward.

The chart above shows a widening supply deficit for copper out to 2022. While there are a couple of new large producers, notably Cobre Panama, several other major developments have been pushed back. Development of underground block cave operations at the giant Grasberg, Chuquicamata and Oyu Tolgoi are all moving slower than expected. Production guidance for Grasberg and Chuqi have both been severely reduced for the next 2-3 years. That alone takes a few hundred thousand tonnes out of supply and more than offsets new Cobre Panama production.

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