London, 30 October 2017
This article was first published in the Financial Times.
London’s annual gathering of the global metal markets community is in full swing. This year, the backdrop is a strong, synchronised and commodity-friendly economic recovery that has given a shot in the arm for many metals and other commodities. Now investors need to learn to stop worrying about where growth will come from, and focus more on individual commodity fundamentals.
From what we called the “wrong kind of world economy” in 2015, the China-led recovery in 2016 has flourished into the right kind of world economy for metals in 2017. Global economic growth has been strong - we estimate 2Q saw a pace of over 4% annualised, the best since 2011. It has been synchronised - September was the first time no major manufacturing PMI survey showed a contraction since 2009. And it has been commodity-friendly - manufacturing, a big demand source, has been expanding at 5% annualised. A weaker dollar hasn’t harmed either.
Perhaps most importantly this recovery seems robust. High-frequency data suggests momentum was maintained into the fourth quarter, and while it will be hard pushed to keep accelerating - many surveys are at levels which historically have been peaks and China could struggle as the housing market cools - all the signs are the slowdown will be modest. As such global growth is expected to remain above average – and thereby supportive of metals – through 2018.
A more benign economic outlook is also likely to mean more divergence in pricing. Through the 1990s and 2000s the rise of China, the increased financial sophistication of commodities and then a succession of severe macro shocks saw metal and other commodity prices increasingly rising and falling together. But our analysis finds that from 2012 this trend - interrupted but not reversed by the 2015 Chinese slowdown - has gone into reverse.
What should investors look out for instead? In addition to the usual array of specific supply and demand issues that affect individual commodities, there are two broader developments which have a clear potential to see prices head in different directions.
Commodity supply-side reform in China
Widespread scepticism about the Chinese government’s willingness to change things has given way to an impressed acceptance as various measures have transformed global steel markets, rescued aluminium, and installed the “Beijing put” for coal. There’s more to come. With a new government in place we expect reform to be even more prominent, front and centre. For many commodities this will continue to push prices higher as excess capacity is shut. But for others, such as coal, lower output downstream will mean weaker demand.
The revolution in motor vehicle technology
For over one hundred years many commodities’ fortunes have been tied to cars, for example steel, and in particular the internal-combustion engine (ICE), the dominant consumer of oil and platinum-group metals. Battery-powered electric vehicles (EV) threaten to up-end these relationships, while at the same time creating new ones for metals such as cobalt, lithium, nickel and even copper. We recently upgraded our forecasts for EV market share out to 2022 on the back of booming sales and government targets.
The difficulty for an investor is timing. An overly zealous Chinese government could take reform too far, hurting the wider economy through higher prices or lower output; a classic case of the micro tail wagging the macro. And on EVs, even with an estimated 40% growth in sales this year we forecast they will command only 1.5% of vehicles sold in 2017. Furthermore battery technology remains in a state of flux. This means even for metals we are most confident will be needed - for example lithium due to its irreplaceable role in batteries - investors need to weigh the transformative potential future against the here and now reality of rapidly expanding supply. The cautious will note that the two metals most dependent on current car engine technology, and which are entirely absent from EVs: palladium and rhodium - are two of the strongest gainers in price this year.
Macro themes are never going to go away entirely as a topic of discussion, especially in key commodity-sectors such as Chinese property. But for now, more than has been the case for many years, commodity investors can stop worrying about the world economy and focus on the fundamentals.
Matthew Turner is Senior Commodities Analyst and European Economist at Macquarie Group