- Base metals fall 8.14% in Q2 erasing most of the gains from Q1- The sector is just 1.69% higher over the first six months of 2019
- An escalation of the trade dispute between the US and China weighed on the prices of LME metals in Q2
- Zinc was the best performer in Q1 and was the worst in Q2 with an over 14% decline
- Nickel was the best-performer with an only 3.13% decline
- The Baltic Dry Index moves higher on seasonal factors while iron ore gains on supply concerns from Brazil
Base metal prices fell by 23.43% in 2015, but in 2016 they appreciated by 26.77%. In 2017, the sector of nonferrous industrial metals was the best-performing commodities sector posting a 21.99% for the year. In 2018, the industrial commodities shed 15.78% of their value.
The base metals sector dropped 8.14% in Q2 after a 10.77% rise in Q1 for this year. After the first six months of 2019, the six LME metals were 1.69% higher from the closing level at the end of December 2018. The best performing commodity in the base metals sector in Q2 was nickel, which fell by 3.13%. Zinc dropped by 14.41%, and tin suffered a 12.15% loss over the three months. COMEX copper futures declined by 7.85% while the LME three-month forward copper contract moved 7.64% lower in Q2. The price of aluminum shed 6.27% of its value for the quarter.
Meanwhile, the price of iron ore moved 30.72% higher in Q2, and the Baltic Dry Index rose by 93.64% over the past three months. So far in 2019, nickel leads the pack with an 18.96% gain over the first six months followed by COMEX copper, which was 2.95% higher and zinc which moved 1.84% to the upside compared to its closing level at the end of last year. LME copper was virtually unchanged from its closing level at the end of 2018 as it was just 0.02% higher. Lead, aluminum, and tin are all down over the first half of the year with respective losses of 4.56%, 2.87%, and 3.22%.
Base metal prices moved lower on the escalation in the trade dispute, but the weakness in the U.S. dollar index which moved 1.22% lower in Q2 and was down 0.07% higher over the first six months of this year likely tempered the selling. Optimism over a trade deal with China turned to pessimism in May and weighed heavily on the price of the LME metals as China is the most influential market participant when it comes to the metals that are the building blocks for infrastructure. Additionally, the divisions within the US branches of government make it unlikely that any infrastructure legislation will get off the ground any time soon.
China is the demand side of the fundamental equation in the commodities asset class because of their massive population and economic growth. The trade dispute escalated on May 10 when US President Trump became frustrated with Chinese backtracking in trade negotiations and slapped new protectionist measures on China. The Chinese retaliated on May 13 upping the ante and turning the market’s optimism that a deal was on the horizon into the pessimism that sent LME metals prices lower. The summit between Presidents Trump and Xi at the G20 meeting in Osaka, Japan on June 28 and 29 was an attempt to get the negotiations back on track, and time will tell if talks between the two leaders will turn the market’s sentiment back to optimism which would likely lift the prices of the metals. The initial indications from the meeting were that negotiations will resume.
Tariffs distort supply and demand fundamentals in all commodities, and the industrial sector of the market is a focal point. As we head into Q3, the trade issues and path of least resistance of the U.S. dollar are likely to continue to provide direction for these industrial commodities that are the building blocks for infrastructure around the globe. A trade deal between the US and China is in the best interest of both nations. China needs a deal from an economic perspective as its economy is suffering the most in the current environment of protectionism. However, with the 2020 election on the horizon, a trade deal would be a political victory for President Trump as it would fulfill a campaign promise from the 2016 election where he pledged to level the playing field on trade with the Chinese. Even if a deal moved the needle slightly in the direction of the US, the President could claim victory as he campaigns for reelection in what is looking like a hostile political environment. I continue to believe that the worst in the trade dispute is behind us when it comes to the increase in protectionist policies that hit the markets in May. However, time will tell if the Chinese and US administration can reach common ground and achieve a deal. Meanwhile, the US Fed’s pivot towards accommodative monetary policy at their June meeting could be supportive of the base metals sector as lower interest rates lower the cost of carrying inventories.
The Invesco DB Base Metals product (DBB) reflects the price action in copper, zinc, and aluminum on the London Metals Exchange. The base metals tend to move together when it comes to macroeconomic issues like trade.
The red metal posted a gain of just over 18% gain on the COMEX and 17.4% gain on the LME in 2016. In 2017, COMEX and LME copper gained 31.57% and 30.25% respectively. Copper was trading at the highest price since 2014 at the end of 2017. Copper on the COMEX futures market moved 20.38% lower in 2018. LME copper three-month forwards lost 16.83% last year. In Q1, COMEX copper futures rebounded by 11.7% while LME forwards moved 8.3% higher over the first three months of 2019. In Q2, copper continued to decline as it lost 7.85% on COMEX and 7.64% on the LME. Over the first half of 2019, the red metal was 2.95% higher in the futures market in the US and 0.02% higher on the three-month forward market at the LME in London.
Copper rose to the highest level since January 2014 when COMEX futures traded $3.3220 per pound on December 28, 2017. Copper started 2019 on a bearish note as it dropped to a new low at $2.5430 per pound on the second trading session of the year on January 3. Copper did not move below that bottom during the second quarter.
As the weekly chart highlights, copper ‘s move to the downside was over early in 2019 as the price moved higher for seven straight weeks, reaching a peak at $2.9780 in late February. The move to the upside came on the back of optimism that the US and China were coming close to an agreement that would end the trade dispute. After consolidating between $2.8335 and just below $3, copper went the other way, and the price posted losses for seven consecutive weeks reaching a low at $2.5995 in early June. Copper was in oversold territory on the weekly chart at the end of Q2.
As the daily chart shows, the now active month September COMEX copper futures contract was attempting to rally after consolidating throughout June.
As the monthly chart illustrates, copper remained closer to the bottom end of its recent trading range at the end of Q2. From a technical perspective, volume and open interest have been steady as copper faces trade issues and lower interest rates.
Open interest in the COMEX futures market moved from 249,520 contracts at the end of Q1 to 244,928 contracts at the end of Q2, a decline of 4,592 contracts or 1.8% over the three-month period. The path of least resistance will depend on the Chinese economy, which hinges on the trade dispute with the United States.
A significant indicator of the short-term price direction of the base metal tends to be the level of LME stocks. LME stocks rose to a high at over 388,000 tons in March 2018. At the end of 2018, they stood at the 130,025-ton level. After falling to a low at 111,175 tons in mid-March, stocks moved higher as metal came into LME warehouses and rose to 168,525 tons at the end of Q1.
At the end of Q2, they stood at 241,400 tons a rise of 72,875 tons or 43.2% on a quarter-to-quarter basis. The rising stockpiles are likely weighing on the price of the red metal as they are a sign of economic weakness in China, the world’s leading consumer of copper.
Meanwhile, stocks on COMEX were at the 43,562 tons at the end of Q1 and fell to 33,415 tons at the end of Q2, a decline of 10,147 tons or 23.3% which does not make up for the increase in LME inventories.
At their March meeting, the US Fed transformed from a monetary hawk to a dove as they canceled short-term rate hikes for 2019, lowered their projection for 2020 to one 25 basis point rate hike, and told markets their program of balance sheet normalization or QT would end in September 2019. The Fed cited slower economic growth and weaker data for the change in policy. At the most recent June meeting, the Fed told the market that economic data supports a 50-basis point decline in the Fed Funds rate by the end of 2019. While the Fed did not lower rates at the June meeting, the guidance was supportive of the price of commodities, and copper is no exception. However, the reason for the pivot when it comes to monetary policy is the trade dispute, which is causing problems with the global economy when it comes to China. Economic conditions in Europe continue to support more stimulus from the ECB, which puts pressure on US rates.
The move by the Fed is likely supportive of commodities prices when it comes to lower rates, which decrease the cost of carrying long positions or inventories. It should also cap rallies in the US dollar, which made a higher high in Q2. Given the inverse relationship between the dollar and commodities prices, a weaker dollar could be bullish for the price of copper. However, slower GDP growth could limit demand. Therefore, the pivot by the Fed is bullish, while the reason for the move provides a rationale for caution.
The European Central Bank remains highly accommodative when it comes to monetary policy. Short-term rates at negative forty basis points are stimulative, and while QE ended in 2018, the sluggish economic growth and data mean that rates will remain low and the balance sheet at an elevated level for as far as the eye can see on the other side of the Atlantic.
Brexit continues to be an issue dividing the UK and EU. The deadline of March 29 moved to the end of June as Prime Minister May could not get the Parliament to agree on the deal she made with the leadership of the union. In Q2, the deadline moved to October 31, and the lack of progress caused Prime Minister May to resign. It now looks like Boris Johnson will become the next Prime Minister, but divisions within the Parliament could lead to a new general election before the deadline. At the end of Q2, the uncertainty of the UK’s future within or outside of the EU is at the same level as it was three years ago when the nation votes to exit the union.
Copper traded to lows of under $1.25 in 2008 in the wake of the world financial crisis. In 2000, the price of the red metal was 85 cents per pound. Before the mid-2000s, copper never traded above $1.60 per pound. Copper traded to a low of $1.9355 in January 2016 and had not looked back until Q3 of 2018. The technical resistance level for the red metal is now at $3.00 as we move into Q3, and then at $3.3220 on the continuous COMEX futures contract, the December 2017 high. Critical support is at $2.5430, the early January 2019 low. Nothing has changed from a long-term technical perspective since the end of Q1, but the path of least resistance for the price of the red metal continues to hinge on whether protectionism continues.
Copper was in a bear market from 2011 through the beginning of 2016. After ten months of consolidation, the metal broke out to the upside and the bear of past years had turned into a raging bull in 2017. The first half of 2018 had been a year of consolidation, but during Q3 copper broke to the downside, and the price fell to a marginally lower low early in Q1 2019. Copper reversed higher over the first quarter of this year but ran into selling at just under the $3 per pound level. As stocks on the LME rose and trade remains an issue, Q2 came to an end with less optimism than at the end of Q1, but the meeting between Presidents Trump and Xi at the G20 meeting injected some confidence back into the copper market.
Copper Prospects for Q3 2019
Copper’s bull market that commenced in January 2016 had been almost picture-perfect as it has never violated a technical support level on the weekly chart. The pattern held over the first six months of 2018, but in Q3 the price fell significantly destroying the bullish trend from a technical perspective. In Q4 2018 and Q1 2019, copper worked its way to a marginal new low which triggered a relief rally on the back of optimism over a trade agreement between the US and China. In Q2, the red metal remained above the Q1 low.
The path of least resistance for copper will demand on trade in Q3 as the red metal is one of the leading barometers for the negotiations between the US and China. Copper moved lower after the trade dispute escalated on May 10 and 13 as the US and Chinese exchanged new protectionist measures. Volatility will likely increase if the optimism and pessimism over an agreement swing back and forth over the coming weeks. The meeting between the leaders of the US and China was a positive event, but significant issues continue to cause a divide that stands in front of a trade agreement. From an economic perspective, the Chinese economy needs a trade deal with the US. From a political perspective, President Trump needs a victory that he can carry into his 2020 reelection campaign. On the campaign trail in 2016, he pledged to level the playing field on trade and moving the needle, even slightly, would amount to a win for the US President. A trade deal has the potential to launch copper and take the price back over the $3 per pound level during the coming three months. However, disappointment and frustration would likely take the nonferrous metal the other way and could send it towards the $2 per pound level as the global economy suffers the effects of a prolonged trade war. The meeting at the end of Q2 was a significant event, but the bottom line is that a trade agreement is the most critical factor facing the copper market. Lower interest rates in the US and a weaker dollar would be bullish for the price of the metal. However, rising inventories and the price action are bearish. Trade between the US and China will be the deciding factor when it comes to the price direction.
Copper traded in a range from $5785 to $6532 per ton on the LME over the first six months of 2019 and finished the quarter closer to the low than the high at $5,981 per ton. However, the low was a double bottom from June 7 and June 17. On COMEX, the nearby futures contract settled at $2.7055 per pound on June 28, 2019.
I will be keeping my eyes on the dollar, LME and COMEX stocks, and progress on stocks which are the variables for an equation that will contribute to the path of least resistance for the price of the nonferrous metal. However, it will be trade and the Chinese economy that determines the price direction of copper in the third quarter. Given the ups and downs of the trade issue, we could be in for a rocky road in the copper market, which is a leader for all of the nonferrous metals that trade on the London Metals Exchange.
The price of aluminum moved 12.43% higher in 2016 after falling by 18.35% in 2015. In 2017, aluminum moved 32.33% higher, but the base metal fell by 17.99% in 2018. In Q1, the price of aluminum rose by just 3.63%. In Q2, aluminum moved to the downside with the other members of the base metals sector as it posted a decline of 6.27%. Three-month LME aluminum forwards was 2.87% lower over the first six months of 2019.
The new USMCA that replaced NAFTA removed the 10% tariffs on aluminum and steel imports into the United States from Canada and Mexico in Q2. Mexico and Canada approved the new trade agreement, but it still awaits ratification by the US Congress. While the price of the metal declined in Q2, aluminum premiums in the US and other parts of the world have been moving higher as mills have increased prices for consumers. The higher premiums reflect a tighter market for the metal despite the ongoing trade dispute between the US and China. Aside from rising premiums, stockpiles on the LME continued to decline in Q2.
Aluminum inventories on the London Metals Exchange fell from 1,129,175 metric tons at the end of Q1 to 996,725 tons at the end of Q2, a drop of 132,450 tons or 11.7%. So far in 2019, aluminum stockpiles fell from 1,267,125 tons at the end of 2018 for a total of 270,400 tons or 21.3%.
As the one-year chart highlights, aluminum stocks are once again approaching the lows, which accounts for some of the tightness in the market. While LME prices fell because of concerns over the global economy, premiums for physical metal reflect the tight conditions.
Shares of Alcoa (AA) almost doubled in value in 2017. In Q4, the lower price of aluminum, trade issues, and a weak stock market pushed the stock from its Q3 closing level at $40.40, to $26.58, down 34.21% over the final three months of 2018. In Q1, AA stock recovered marginally with the stock market and the price of aluminum and closed on March 29, 2019, at $28.16 per share, just 5.9% higher. In Q2, AA shares closed on June 28 at $23.41 or 16.9% lower over the past three months. AA underperformed both the price action in aluminum and the overall stock market in Q2.
Aluminum Prospects for Q3 2019
The decline in production from China as the country moves to clean the air and environment and sanctions on Russia did little ignite the price of aluminum in 2018 or so far in 2019.
In the last quarterly report, I wrote, “Politics will continue to play a significant role in the path of least resistance for aluminum in 2019. The tariffs issue has placed the aluminum market on the front lines. A trade war could cause wild swings in the price of the metal, but it could also result in a risk-off period in markets across all asset classes. During risk-off periods, the prices of all assets decline, and aluminum is likely to be no exception. I believe that an eventual trade deal with China will ignite economic growth around the world, and any sell-off in the aluminum market on the back of new deals and compromise will be a buying opportunity. It is likely that we will continue to see lots of volatility in the price of aluminum in 2019.” My view has not changed as we head into Q3. Now that the protectionist pressures are off Mexico and Canada, China is the critical issue as we head into the second half of 2019.
As the chart shows, aluminum stocks on the LME declined significantly over the past five years, which is a supportive factor for the price of the metal. I believe that the downside is limited in the aluminum market, and the potential for a rally on the back of a trade deal is high as we head into Q3. Falling interest rates in the US and low rates around the world are supportive of the price of the nonferrous metal. Three-month aluminum forwards on the LME traded in a range from $1751 to $1944 during the first half of the year, and it closed near the lows. I would be a buyer of aluminum on dips. A trade deal with China could ignite the price of aluminum and shares of aluminum producers like AA, which was trading at a very low level at the end of Q2.
As the chart shows, AA shares are at a level that is in the buying zone for those who believe that the price of aluminum will rebound and a trade deal between the US and China is on the horizon before the 2020 election in the US.
The price of three-month LME nickel, a highly volatile metal, plunged by an astonishing 42.57% in 2015 and then rallied by 15.98% in 2016. In 2017, nickel posted a gain of 21.90%. Nickel posted a 13.17% loss in 2018. In Q1, nickel was the best-performing base metal as it appreciated by 22.8%. In Q2, was again the leading performer as it only fell 3.13% and was 18.96% higher over the first six months of 2019.
Russia is a major producer of the metal, but China is the world’s leader in nickel production. The trend towards electric automobiles underpins the nickel market and could provide support over the coming years.
On the LME, nickel stocks fell from 207,924 tons at the end of Q4 to 182,574 tons on March 29, down 25,350 tons or 12.2% in Q1. Nickel inventories continued to decline in Q2 and were at the 164,718-ton level on June 28, down 9.8% for the quarter. Nickel stocks were 20.8% lower over the first six months of this year. In 2018, LME stocks fell by over 150,000 metric tons, and the trend continued over the past two quarters. At the end of 2018, I wrote, “The significant move lower in inventories did not stem the price slide in the nickel market during the second half of 2018. While ore supply will likely increase because of supplies from Indonesia, rising demand from electric vehicle batteries is a reason for the drawdown in stocks. Exchange stocks of nickel tend to be a higher grade suitable for battery production, while nickel for steelmaking requires a lower grade. These days, only around 5% of annual nickel production goes into batteries while 1% is required for EV power plants, but that percentage is likely to rise, particularly with the increase in the price of crude oil and petroleum-based fuels.” The stock declines did not help support the price of the nonferrous metal in Q2.
When it comes to nickel, keep an eye on iron ore and steel demand over the months ahead. Nickel is likely to be highly sensitive to changes in global economic conditions. Russia is a major producer of the metal, and sanctions against the Putin government are likely to continue to cause some dislocations in the nickel market in coming months. Nickel is a very volatile metal, and we could see a wide price range for the metal during the second half of 2019. Three-month nickel forwards closed Q2 at $12,705 per ton. A continuation of demand from electric cars is supportive of the price of the nonferrous metal and should prevent the price from sliding below $10,000 per ton, but a continuation of economic weakness in China would weigh on the price of nickel.
Nickel Prospects for Q3 2019
Nickel tends to be one of the most volatile metals that trade on the London Metals Exchange. Over 2017, nickel ran into selling each time the price moved above the $12,000 per ton level which had been critical technical resistance for the base metal. $12,000 was critical resistance, but in 2018 it had made great strides above that level. Nickel broke down below that level during the final three months of last year, but it moved back above the price, which is a pivot point in Q1. The price closed at over that level in Q2 as it remains a significant pivot point for the nickel market.
In the late 1980s, Russian delivery and production problems caused the price of nickel to move higher; it ran to north of $20,000 per ton violently. Any rally in nickel will likely occur in the nearby forward contracts, and a large backwardation where nearby prices move quickly higher and deferred nickel contracts remain lower will develop. At the end of Q2, the cash to three-month nickel prices was at a contango of around $45 per ton which was down $60 from the end of Q1 indicating that while demand is robust, there is no significant supply shortage in the nickel market.
Dislocation in steel and other industrial metals could increase price volatility in the nickel market. Keep an eye on those nickel stocks on the LME. At the end of Q4 I wrote, “While falling inventories did not provide support in Q4, a further decline in 2019 could cause buying and upward pressure on the price of the nonferrous metal that trades with limited liquidity.” Stocks supported the price in Q1 as did optimism over a trade agreement between the US and China. As the optimism turned to pessimism in Q2, the price of nickel fell along with the other members of the nonferrous metals sector. Any further declined in stocks could lead to supply concerns in the nickel market on the LME. A word of caution about stocks is that dominant market participants like well-capitalized trading companies and the Chinese, the world’s leading producer and consumer of the metal, often manipulate stockpile data. Since a Chinese entity now owns the LME never underestimate the ability for some to manipulate stocks to create fundamental illusions and cause prices to move in the desired direction.
LME nickel traded from lows of $10,525 to highs of $13,650 per ton over the first six months of the year and did not move outside of that range established in Q1 during the second quarter. A trade deal with China could send the price of nickel higher, and an escalation of the dispute would likely weigh on the price of the base metal.
Lead, the worst performing nonferrous metal in 2014, falling by 17.65 % and then it was the best performing nonferrous metal in 2015, declining by only 3.36% in 2015. In 2016 lead gained 11.14%. Lead appreciated by an incredible 25.31% in 2017. The price of lead fell 19.32% in 2018. Lead was the worst-performing base metal in Q1 as it only gained 0.74% for the quarter. In Q2, lead dropped by 5.27% in Q2. Lead was 4.56% lower through the first six months of 2019. Three-month LME lead closed on June 28, 2018, at $1,925 per ton.
Lead is a thinly-traded metal, and it is always a possibility that there are both price and stockpile manipulation in the lead market. Lead stocks on the LME were at 78,750 tons, down 28,725 tons on a quarter-by-quarter basis in Q1. Inventories were at 66,175 tons at the end of Q2, down another 12,575 tons or 16%. The stocks have declined by 38.4% so far in 2019. Demand for batteries around the world is supportive of the price of the toxic base metal. China is, by far, the world’s largest producer and consumer of lead and the biggest player in the market which lends the price of the metal to price manipulation. The Chinese anti-pollution policies have increased the demand for electric automobiles, which is supportive of the price of lead. There is some degree of correlation between the price of oil and lead as higher oil prices increase the demand for electric vehicles and falling oil prices do the opposite. Economic weakness in China on the back of the trade dispute and escalation of protectionist policies in May was bearish for the price of the metal. On a longer-term basis, lead is a promising metal because of its consumption in batteries, a global market that continues to grow.
Lead Prospects for Q3 2019
Given the growth in the battery market around the world, and China’s intention to increase the number of electric automobiles, I believe the prospects for an increase in the price of lead are high once economic conditions improve. A trade deal with China could cause a rebound in the price of the metal. My target for the toxic nonferrous metal remains at $2800 per ton despite the poor performance, which is over 45% above the current price of the metal. I am friendly to the price of lead as it is likely that increasing demand will cause stocks to continue to decline, providing fundamental support. However, any risk-off periods in markets because of trade issues could trigger selling in all base metals as we witnessed in Q2. Trade was a risk-off issue for the base metals sector during the second half of 2018 and the second quarter of this year. Lead traded in a range from $1787.50 to $2164 over the first half of this year, and it settled at the end Q2 near the middle of the range.
Liquidity in the lead market is thin, but the metal has an expanding addressable market, which may limit the downside when it comes to the price of the metal in Q3. However, lead is likely to continue to reflect the ups and downs of the Chinese economy.
The price of zinc dropped by 25.8% lower in 2015. Zinc was the best performing metal on the LME in 2016, gaining 59.53%. Zinc added to those gains as it rallied by 27.54% in 2017. Zinc moved 25.49% lower in 2018, making it the worst performing base metal of the year. In Q1, the price of zinc rose by 18.98%. In Q2, the nonferrous metal gave back almost all of its gains as the price dropped 14.41% making zinc the worst-performing base metal for the quarter. The price of zinc gained 1.84% over the first six months of this year. Three-month zinc forwards on the LME closed at $2,495 per ton on June 28, 2019. After achieving a multiyear high in February 2018, the price of zinc plunged in Q2 and Q3 of 2018 on a combination of increasing stockpiles, and weak Chinese demand. Supplies of zinc concentrates have been rising because of high prices last year, and that trend is likely to continue. New production from China and Peru weighed on the price of zinc, and lower demand because of escalating trade tensions had sent prices significantly lower. The zinc market had been tight because of depleted mine supply, but higher prices brought new production to the market, and the $2500 per ton level which has become a significant pivot point for the metal. In Q1, the price climbed back above the pivot point, in Q2, it was just below that level. LME stocks moved higher in Q2 as new supplies added to inventories. LME inventories jumped from 52,325 on March 29 to 97,000 tons on June 28, an increase of over 85%. However, zinc inventories have still declined significantly over the past two years, so the metal still has to catch up when it comes to supply levels. The fundamentals for zinc have shifted with new production at higher prices, and we have witnessed a shift in the production and pricing cycles in the zinc market. The price of zinc is likely to follow the stock level and trade issues over the second half of 2019.
Zinc Prospects for Q3 2019
As the production cycle for the zinc market shifted because of higher prices, more zinc concentrates have come onto the market which has depressed the price of the metal. We witnessed the first significant increases in stockpiles in Q2 as they almost doubled in the on a quarter-to-quarter basis. $2500 per ton continues to be a pivot point for the zinc market on the LME, and the price closed not far below that level. Zinc traded in a range from $2395 to $2948 over the first half of the year and did not move outside the Q1 range in Q2. A trade deal with China could send the price higher, but increased supplies could put a cap on any rallies. Meanwhile, an escalation of the trade dispute between the US and China would likely weigh on the demand for galvanized steel and zinc.
Tin is the most volatile and illiquid metal traded on the LME. Tin declined 25.13% in 2015. In 2016, tin was the second best performing base metal, rising by 44.10%. In 2017, tin was the only loser in the base metals sector posting a 5.4% loss. Tin fell 1.89% in 2018, making it the best performer of the six base metals that trade on the LME. In Q1, the price of tin rose by 10.17%, and in Q2 it gave that all back and more as the price dropped by 12.15% leaving the tin market 3.22% lower over the first six months of 2019.
China is the world’s largest producer and consumer of tin. The global tin market should move into a slight surplus based on current production and consumption levels in 2019. Indonesian output is on the decline, but in other areas of the world, it has risen. Above $20,000 per ton, things got dicey for tin throughout 2017, but economic growth in China provided stability and support for the price. The $20,000 had become the pivot point for the price of three-month tin forwards. Stocks on the LME exploded higher in Q2 which weighed on the price as they were at the 6,390-ton level, up 5,390 tons as of June 28. Three-month tin forwards on the LME closed at $18,800 per ton on June 28. Tin traded in a range from $18,800 to $21,900 over the first six months of 2019 and settled on the low as the weight of significantly higher stocks weighed on the price of the illiquid metal.
Tin Prospects for Q3 2019
Tin is a thin market which makes the metal susceptible to wide price swings. When it comes to tin, it tends to move on supply and demand fundamentals because of the lack of speculative interest. Tin is in contango when it comes to cash to three-month forwards on the LME. I suggest monitoring the supply and demand situation in the tin market by watching and paying close attention to the tin spreads. Tin can swing back and forth between contango and backwardation, and those moves tend to impact the path of least resistance for three-month prices. Tin often rallies when the market moves towards backwardation and corrects when the spreads move to contango. At the end of Q1, I wrote, “Watch the level of stocks on the LME which are at a dangerously low level as we move into Q2.” The sudden increase in stockpiles in June smells like price manipulation by a market player. Time will tell if the Chinese dumped tin into LME warehouses to force the price lower in late Q2.
The bottom line: Outlook for Q3 2019
Base metals and industrial commodities are battling bullish and bearish factors as we head into the second half of 2019. Lower interest rates in the US, a continuation of stimulus in Europe, and Chinese devaluation of the yuan are all bullish for the prices of the industrial metals and ores. If lower US rates cause the dollar index to decline, that would add another supportive factor to the picture. However, the reason for stimulus is protectionist trade policies. Since China is the demand side of the equation for the base metals, a slowdown in the Chinese economy is a bearish factor for the sector, which sent prices of all of the metals lower during Q2. A trade deal would likely light a bullish fuse, as would a rise in inflation. However, economic weakness is bearish for the sector. With bullish and bearish factors pulling at the LME metals, we could see an increase in price variance over the coming days, weeks, and perhaps months.
Any risk-off period that comes from a disappointing result to trade negotiations or a rising risk of a recession could cause a continuation of selling in this sector of the commodities market. The prices of the base metals reflect the disappointment over trade in Q2.
When it comes to fundamentals, keep track of LME stock movements as the trend in inventories can be the best guide for the path of least resistance of prices. In Q2, we witnessed many examples where stocks pushed prices around. However, always view inventories with a grain of salt as they can create a mirage when it comes to the path of least resistance of prices.
Each non-ferrous metal traded on the London Metal Exchange has different supply and demand fundamentals. Some of the metals are in deficit, and some have surplus inventories. On a macroeconomic basis, these strategic metals are all essential building blocks of infrastructure, and as such, China is the number one consumer across the board. Meanwhile, the prospects for infrastructure building in the United States, if the administration and the new Democratic majority in the House of Representatives can come together in a bipartisan effort on a piece of infrastructure rebuilding legislation, would provide additional demand for the sector which could support prices gains. However, the current environment of political divisiveness makes that scenario unlikely in 2019. The upcoming Presidential election could mean that the two parties continue to oppose any initiatives from the other side of the political spectrum. Any bipartisan efforts on infrastructure seemed to go up in smoke during Q2.
The price of iron ore, the main ingredient in steel moved 3.55% lower in 2018, after a 10.02% loss in 2017. In Q1, iron ore exploded 24.81% higher on the back of a production problem in Brazil where a dam collapsed and stopped output at one of the world’s leading iron ore mines. In Q2, supply concerns continued to cause the price to rally as it gained another 30.72% and was 63.15% higher at the end of the first half of 2019. Nearby iron ore futures finished Q2 at $112.90 per ton. Iron ore is the primary ingredient in the production of steel. We could see lots of price volatility in the steel market in 2019 as the commodity is ground zero for protectionist policies. U.S. Steel (NYSE: X) stock was trading at $15.31 per share compared to $19.49 at the end Q1; the stock was down $4.18 or 21.4% per share in Q2 despite gains in the stock market. Weaker economic conditions in China weighed on the price of steel. On a quarterly basis, the tariffs have done nothing to bolster the price of X shares which tanked in Q4, experienced a small rebound in Q1, and tanked again in Q2. X trades at a very low 2.36 P/E ratio making it a cheap stock. X call options limit the risk of the volatile stock.
The Baltic Dry Index moved 42.14% higher in 2017. In 2018, the BDI experienced a 6.95% loss compared to its closing price at the end of 2017. In Q1, which is a seasonally weak time of the year for shipping, the index fell by 45.55%. In Q2, the BDI rose by 93.64% and was 5.43% higher over the first six months of this year. The index that represents the freight rates for shipping dry bulk commodities around the world is often a sign of demand for commodities. China is the most influential factor when it comes to moves in the BDI as it is the 800-pound gorilla when it comes to the demand side of the fundamental equation in the raw materials market. The BDI closed Q2 at the 1,340level. The BDI could be highly sensitive to the trade issues over the coming months. Keep an eye on the BDI for clues as it is a metric that follows commodities from production to consumption sites around the world. The BDI tends to decline during the winter months as seaborne cargo shipments slow in the northern hemisphere. The move to the upside was likely a result of seasonal factors.
Many issues face the industrial commodities sector of the raw material market that could cause lots of price volatility in Q3 and the second half of 2019. The dollar, interest rates, and most of all, trade with China will determine the path of least resistance of prices. A recessionary environment would weigh on the prices of industrial commodities. While economic growth in the U.S. is a supportive factor, China is slowing, and growth in Europe is sluggish, at best. The most significant variable continues to be the trade issue as we head into the coming three-month period. The news cycle will have lots of influence on LME metals and other industrial commodities, along with markets across all asset classes. I continue to believe that the US and China will compromise on a trade deal. China needs one for economic reasons, and President Trump needs a political victory going into the 2020 election season.
DBB is the ETF product that tracks the base metals sector. DBB moved from $17.04 at the end of Q1 to $15.50 at the end of Q1. DBB fell by 9%, so it kept pace with the price action in the base metals sector. DBB does not list lead or nickel LME forwards in its top holdings, and the prospectus says, “The index Commodities consists of aluminum, zinc, and copper-Grade A.”
Expect a continuation of price volatility in the industrial commodities in Q3. The dollar, trade issues with China, and global economic growth will determine the path of least resistance for the commodities in this sector over the second half of 2019. I continue to favor a move to the upside when the US and China agree to end their trade dispute.
Any investment involves substantial risks, including, but not limited to, pricing volatility, inadequate liquidity, and the potential complete loss of principal. This document does not in any way constitute an offer or solicitation of an offer to buy or sell any investment, security, or commodity discussed herein, or any security in any jurisdiction in which such an offer would be unlawful under the securities laws of such jurisdiction.