Metal prices take a knock

HAS THE COMMODITY CYCLE TURNED? PART-I

Curbing bank lending by China raises fears of a commodity cycle reversal.

In 2003, the Chinese economy accounted for half the global consumption of cement, 36 per cent of the world's steel and 30 per cent of global coal.

Its red-hot economy, growing at a prodigious rate, has been consuming huge quantities of raw materials such as nickel, copper, zinc, aluminium and other metals, pushing up commodity prices through the roof.

Commodity producers around the world benefited from the boom, and even shipping rates surged dramatically as there weren't enough ships to carry raw materials to China.

Early this year, however, the Chinese authorities felt that the country's double-digit rate of growth could not be sustained, and took steps to cool the economy by curbing bank lending, particularly to the overheated steel and the cement and construction industries. These measures have raised fears of a reversal of the commodity cycle, and prices have tumbled.

Metal prices, especially prices of steel and copper, have fallen sharply on the London Metal Exchange (LME) between February and April this year, before inching up in May and tumbling again in June.

Nickel prices fell by 17.7 per cent between February and April, but recovered by 9.7 per cent in May. Similarly, copper prices dropped by 7.7 per cent in the same three-month period, but moved up by 2.7 per cent in May.

Aluminium prices, too, fell by 2.8 per cent in the three months, but edged up 1.5 per cent in May. But LME prices of aluminium, copper, tin, zinc and lead declined by 3-5 per cent during the week ended June 5.

In early May, Chinese Premier Wen Jiabao described the Chinese economy as a speeding Mercedes to which the brakes had to be lightly applied. Predictably, the downslide in steel prices (they had falled by 3.2 per cent in the three months before May) continued, dropping further by 2.6 per cent in May.

The drop in metal prices had major consequences for Indian companies. China accounted for one-third of India's steel exports of approximately 5.3 million tonnes in 2003-2004 and any slowdown in the demand for steel in China, would send ripples through the Indian steel industry.

That's already happened. In India, hot rolled coil (HRC "" 2.5 mm) prices peaked in April at Rs 28,200 and Rs 27,700 a tonne, and have been almost stagnant since then (Rs 27,400 in Delhi and Rs 27, 800 in Mumbai). Steel companies have not announced that they are raising prices in June.

Ditto with cold rolled coils (CRC "" 0.63 mm). In April, CRC prices were Rs 30,800 per tonne in Delhi and Rs 31,900 per tonne in Mumbai, but have been almost steady at Rs 30,900 and Rs 31,700 per tonne, respectively.

The landed price of imported steel too is back to its January levels of Rs 24,324 (duty paid) for HRC (2mm) and Rs 28,965 for CRC, after peaking in April at Rs 27,210 and Rs 31,610 per tonne, respectively.

On the Multi Commodity Exchange of India (MCX), the July 15 futures contract for flat steel was traded at Rs 28,550 per tonne on March 12, and fell to Rs 19,700 on June 3, down 30.99 per cent.

"The margins of metal companies that have a higher exposure to the Chinese markets, will be under pressure as they will not be able to command as high a premium on products anymore," notes a portfolio manager at a foreign broking firm.

That has not happened as yet. Tata Steel's net profit rose by 60 per cent in the fourth quarter of the last financial year, from Rs 628.88 crore in the comparable period the previous year. Hindustan Aluminium's fourth quarter profits rose by 1,033 per cent to Rs 222.2 crore. National Aluminium's net profit in the fourth quarter jumped by 50 per cent to Rs 263 crore.

The big question is if profits will dip in the months ahead. The share prices of companies that operate in the metal industry have started sagging, though the fall could also be linked to the overall volatility in the stock market.

The prices of the Hindustan Aluminium, Sterlite Industries, National Aluminium and Hindustan Copper scrips have declined by over 40 per cent from their 52-week highs in February 2004.

For example, the price of the Hindalco stock declined from its 52-week high of Rs 1,599 to close at Rs 952 on June 4. The National Aluminium scrip's price moved down by 42.5 per cent to Rs 119.65 on June 4 from its 52-week high of Rs 208.

The Sterlite Industries share price fell by 48 per cent to Rs 425 from its 52-week high of Rs 815. Jamshed J. Irani, chairman of the Indian Steel Alliance (ISA), which represents the interests of major Indian steel manufacturers, believes that Indian steel prices will not climb any further. On the contrary, they could even tumble "" although the annual demand for steel (30 million tonnes) is expected to climb by 7 per cent this year.

"Prices won't go up any further. They should stabilise at current levels. I won't even be surprised if they come down, as prices are softening globally because of fears about the slowdown in China," says Irani.

That apprehension is reflected in steel company boardrooms. Essar Steel, for example, is keeping its prices unchanged till the end of June. "We will take a decision on this only in July," says PR Dhariwal, Essar's commercial director.

Such positions are remarkable. Some months ago, the ISA had said that India's steel industry would remain unscathed by the slowdown in demand in China.

The exception to the metal price drop rule is bullion. Bullion prices did slide in the past few months riding on fears that interest rates in the US would firm up. But world bullion prices have moved up again. Also, the prolonged rally in oil prices could spur inflation, boosting the allure of bullion as a hedge.

A Refco Commodities report says, "the long-term outlook for gold is bullish. Over the last month-and-a-half, both gold and silver prices have undergone corrections after peaking in January and February. But the US non-farm payroll data that came out on June 4, showed that prices were unaffected and were still going up."

Bullion prices in India tend to follow the global pattern since India imports 98 per cent of its requirements of gold and silver.

However, not everyone considers the high global metal prices saga has come to an end. An ANZ Bank report says the LME cash copper price will average $1.25 a pound in 2004, or $2,755.75 a tonne "" a 54 per cent rise from the 2003 average of $0.81/lb, it notes.

Despite the concerns over the growth of copper consumption in China, the world's largest copper-consuming country, the ANZ Bank report points out that the western world will provide 62 per cent of global demand growth this year, while China will account for only a quarter of that growth.

The report predicts that global copper demand will grow by 5.8 per cent this year to 16.43 million tonne, while global supply will rise 6.7 per cent to 16.26 million tonne, leaving a deficit of 172,000 tonne.

As for aluminum, the report said that this year could mark the first global supply deficit since 2000, which should see prices continue to move up.

It predicts that China's past consumption rates are sustainable, and that the country will consume around 6.1 million tonne of the metal, up 16 per cent from 2003's 5.3 million tonne. The ANZ Bank report points out that global demand for aluminium is expected to rise by 6.4 per cent, while raw material shortage, mainly of alumina, should continue to rein in production growth.

"In China, 32 producers have been forced to close, with capacity cuts totaling almost 500,000 tons a year," it said. ANZ forecasts that LME cash aluminum price will average $0.748/lb this year, or $1,650/tonne. In 2003, the average price was $0.65/lb, or $1,432/tonne, it said.

In a recent report, Enam Securities analyst Jagdishwar Toppo argues, "We believe that the China slowdown concern is overdone as the demand-side equation remains intact, though incremental demand would reduce."

Perhaps, a solution to these contradictory viewpoints lies with Marc Faber, a guru of the global equity markets. Writing in April, Faber pointed out, "China's economy is overheating and will, in my opinion, experience a severe slowdown in the near future, which will lead to a commodity inventory liquidation and depress prices temporarily. Moreover, whereas I am a strong believer that a long-term up-cycle for commodities began in 2001, investors should be aware that for individual commodities, price cycles are of a far shorter duration."