The View from London: Have we seen the peak in metals prices?

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The short answer is yes. As the second quarter ends and the third quarter is underway – slower summer months associated with a dip in industrial activity – the peak in metals prices has passed for this year. Credit growth and infrastructure spending in China has peaked and economic growth is slowing, while central banks are talking about slowly tightening monetary policy and looking to reduce liquidity in financial markets on heightened inflation fears. Asset classes including metals have risen partly due to ample liquidity provided by central banks in the aftermath of the Covid-19 pandemic. The exceptional price strength shown in the chart of the 12-month price change (even stronger measured trough to peak) alone, argues for prices to mean revert. Metals demand growth is slowing as supply constraints ease. The likelihood of higher taxes is another potential dampener.

Source: World Bank, LME, MMSteelClub

Metal prices have increased sharply this year

China is talking down high metals prices with varying success and releasing metal from strategic reserves to back up its talk. It’s not just China though as policymakers are also fixated about whether current inflation rises are transitory and if so, for how long. The recent upturn in headline inflation rates reflects the recovery of oil and other commodity prices, a surge in shipping costs, the normalisation of prices in hard-hit sectors as restraints are eased and one-off factors such as tax changes and should ease in the near term. If upward pressure on prices persists and, as a consequence, expectations of rising interest rates increase, financial markets including commodities could be in for a bumpy ride. The big question around how long inflation sticks around, and how pronounced it proves to be, will take months to answer. It could be the end of the year before we know.

The Covid-19 pandemic prompted a sharp decline in metals prices, mainly as a result of a collapse in global economic growth and metals demand. The pandemic led to a global demand drop at the start of 2020, followed by a faster-than-expected recovery at the end of 2020. Pent-up demand caused by lockdowns in the first half of 2020, shifts in consumption patterns towards durable goods, and government income support all strengthened demand for goods when transportation services were still limited. Supply was also severely disrupted by mine, smelter/refinery closures and a wave of capital spending cuts in the mining sector.

Supply and demand mismatches

Strong metals demand, led by a rapid rebound in China, coupled with supply shortfalls have sharply boosted metals prices. Unprecedented levels of government stimulus and central bank liquidity have boosted metals demand growth whilst supply has struggled to keep pace due to mine closures and/or logistical delays (lack of shipping containers). Global industrial production has continued to strengthen this year and global trade in goods has surpassed pre-pandemic levels, helped by a recovery in investment. Base effects are a key factor – weaker pre-pandemic prices at the beginning of 2020 than pre-GFC prices in 2008 also made it comparatively easier for prices to recover as strongly as they have.

In terms of disrupted supply, zinc and copper were the worst hit in South America, with Peru imposing the longest government-enforced mine closures. The other metals were comparatively less affected by stoppages and restrictions globally. The mine closures caused a small and temporary impact on short-term supply but have had a bigger impact on longer-term supply. Project pipelines were hit by challenging financing conditions and difficulties in accessing and working at mine sites, delaying project development, according to S&P Global Market Intelligence.

Metals demand growth slowing as pent-up demand is exhausted…

Higher metals intensity in China means that demand growth in the RoW (US, Europe, and Asia ex-China), would be unlikely to fully compensate for a China slowdown. China’s metals intensity is falling as progress in rebalancing the economy from industrial production and investment to services and private consumption should resume as the vaccination rollout gains pace and confidence improves. The PBoC said it would reduce the Reserve Requirement Ratio (RRR), the amount of cash banks have to hold in reserve, by 0.5%, equivalent to the release of a trillion yuan ($154bn) into the economy. An RRR cut was the first since April 2020 when the economy was jolted by the Covid-19 pandemic,
and came as a surprise, as most investors expected a gradual tightening of policy at a time when other major central banks are talking about rate hikes and the taper timetable. This surprise could be read as a negative signal about how the economy is doing. The RRR cut stokes concerns about a slowing economy following a peak in the credit cycle. June PMI data for both manufacturing and services point to a growth slowdown, and industrial power demand now appears to have flatlined on a trend basis in the last 12 months after an initial sharp rebound in Q220.

In other major economies, as consumption rebalances, the rotation of consumer demand from durables to services and, as pent-up demand is exhausted, will also lessen metals demand growth. Supply shortages in the semiconductor sector due to the exceptionally strong demand for IT equipment during the pandemic, and temporary disruptions to the output of some major producers, are now beginning to constrain output in some industries, particularly car production. The risk of lasting costs from the pandemic also remains high, with the global economy remaining below its pre-pandemic growth path and global output projected to remain weaker at the end of 2022 than expected prior to the pandemic, the OECD noted in its most recent Economic Outlook report. 

…As supply constraints ease – tin is an outlier

Meanwhile, as lockdowns ease metals output will continue rebounding as some supply constraints ease. As a result, we expect industrial metals prices to have peaked or will peak soon, before easing in the second half, the price adjustments depending upon the fundamentals for each metal. The one exception is likely to be tin, where the supply shortfall will not be alleviated amid structural deficits. That said, we expect metals prices to remain elevated and above historical norms for the rest of the year barring a serious inflation shock or Delta variant curveball. The green transition and the objective of decarbonisation will continue to support metals demand over the longer-term as stimulus tapers off and supply continues to lag.

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