Each Quarter FastMarkets and Sucden Financial produce an analysis and forecast report on the precious and base metals – The Sucden Financial Metals Reports, Jan 2016.
Below is the summary and economic overview of the metals markets, to download a PDF copy of the full report covering all the metals in pdf form click here.
Subscribers have access to these reports before they are published through the research tab in FastMarkets Professional.
The new year has so far been dominated by the fall out in Chinese equities and the consequent short selling of other asset classes as a proxy hedge. The yuan continues to devalue, as does the rouble and the dollar strength continues unabated. Add the euro to the mix, together with emerging market issues from the strong dollar and the result is a recipe for ever weaker metal and oil prices. The outlook is for more of the same until confidence is restored.
Gold – Dollar strength and higher interest rates have proved negative but the outlook for further rate increases is likely to be less than anticipated. Geopolitical influences should underpin safe haven buying and the outlook this quarter is likely to be $1,050 – $1,140.
Silver – Weak on industrial demand and negative investment sentiment, but likely to undergo a short covering rally. Range expected at $13.80 – $14.95.
PGMs – Weakness expected to continue on poor sentiment despite South African issues and auto demand steadying platinum range expected at $800 to $950 and palladium $450 and $570.
Outlook – It may be a new year but the same factors continue to affect global growth, turning markets indecisive and weighing heavily on economic momentum. Despite renewed central bank action in December – the FOMC raised rates and the ECB extended its quantitative easing (QE) programme, the developed nations remain mired in uncertainty and emerging markets (EM) are still at risk. This year started with a strong sell-off across equities, triggered by weakness in China that prompted a fresh devaluation in the yuan – a move that stoked concerns about a renewed downturn in EMs due to their strongly interconnected nature. The easing in global economic momentum while markets acclimatise to a ‘new normal’ where China is no longer able to provide double-digit growth, which has significantly reduced demand, looks set to continue this year. The IMF’s World Economic Outlook highlights this slowdown – in it, the group lowered its global growth expectation for 2015 to 3.1 percent from 3.4 percent in 2014.
US looks increasingly isolated – After much deliberation and discussion last year, the US Federal Reserve lifted the Federal Funds rate from the lower bound in December, the first rise in seven years. The Fed’s forward guidance meant the move was widely expected, reducing its impact when it eventually came. The muted reaction in the dollar reflects this – the dollar index had rallied above 100 ahead of the rate rise from around 80 in mid-2014. The conversation has now shifted from when the Fed will start to raise rates to the number and rate of further increases. To reduce any knock-on effects to the US and global economies, the FOMC has stressed that future rises will be gradual. But the rout in equities at the start of this year has raised concerns that the Fed may have mistimed its move – especially after it cited international factors, which clearly remain unstable, and low domestic inflation, which persists, as reasons for keeping rates at the lower bound in September.
Inflation – the Fed’s dual mandate includes a target of a two-percent rate – remains elusive: the US CPI was flat in November. Although strong falls in energy prices – oil is around $30 per barrel – is probably constraining inflation, the core CPI, which excludes energy and food, rose 0.2 percent in November. The FOMC highlighted this concern in its December meeting minutes. Although all 10 voting members were in favour of raising rates in December, several members felt it was a “close call” due to concerns about downside risks to current inflation forecasts, in particular energy costs and the exchange rate. The Fed again stressed that the speed of future rises remains variable and data dependant. Recent developments in global equity markets have raised speculation that there may not be further rises this year or that the Fed could lower rates should a significant downturn materialise.
The dollar’s comparative strength was another key theme of 2015 and looks likely to be sustained this year. As has been the case several times in the US manufacturing sector, dollar strength has smothered expansion by further eroding the country’s global competitiveness just as momentum starts to pick up. Although a strong dollar makes imports comparatively cheaper, it leads to the US exporting domestic demand and effectively importing deflation, compounding the situation. The official and ISM manufacturing PMIs both attest to this – they have been trending lower since September 2014 when the dollar started its recent appreciation. With safe-haven demand triggered by the recent sell-offs, the dollar may again become a hindrance, especially if a weaker yuan prompts the EMs to devalue their currencies further to remain competitive, which could exacerbate capital outflows from the region.
EMs continue to falter – Weakness in the EMs was a key theme last year amid concerns about their ability to maintain economic momentum given slowing global demand, particularly due to their heavy dependence on commodities and their foreign-debt burdens. With Chinese equities starting this year with a bang – the Shanghai Composite Index (SCI) fell 7.0 percent twice in the first week of the year – fears about China’s faltering economy have jumped back into the limelight. China’s economy continues to falter in the move towards a more consumer-led economy despite several rounds of government stimulus intended to bolster growth in the real economy, hence the continued contraction in its manufacturing sector.
The decision by the People’s Bank of China (PBoC) to weaken the yuan further at the start of the year exacerbated fears about its economy. The move shocked markets – after Beijing’s assurances that it would let the market take a larger role in determining the rate and the yuan’s inclusion in the SDR (Special Drawing Rights) by the IMF last year, the currency was believed to have taken on a more free-floating form. But there is renewed speculation that China’s economy is in a worse state that previously thought, reducing investor confidence. The PBoC’s devaluing of the yuan in August 2015 caused a rout in Chinese equity prices and triggered further devaluations across the EMs. We would expect this renewed weakness to revive fears about further EM devaluations and in turn a repeat of the 1997 Asian crisis, especially because this sell-off is unlikely to be short-lived. Further devaluations should support struggling exporters, fuelling speculation that China is positioning itself to enter a currency war.
The rout in equities was intensified by the circuit-breaker rules introduced at the start of the year – investors feared they would be unable to exit a loss-making position, causing a rush for the exits. After an emergency meeting, the new circuit-breaker rules were abandoned. While this is likely to reduce panic selling, we would expect sustained selling in the near term while confidence returns that Beijing will allow the market to take a bigger hand in determining prices. Although this may mean reduced expectations for Beijing to prop up prices, it should lead to a more stable and efficient market in the long term, especially because external investors are more likely to invest where regulators are perceived to have a lighter touch. Only time will tell if Beijing can swallow this bitter medicine. But there are already signals that the government’s role will be less active. China’s foreign exchange reserves fell by a record $108 billion in December to $3.3 trillion, highlighting strong capital outflows while the central bank looks to prop up the yuan by selling dollars for its reserves to support the exchange rate. Although China’s reserves remain considerable, this large decrease follows a reduction of $87 billion in reserves in November, raising concerns about how much longer the central bank can play such a role. The PBOC said it was comfortable with the yuan’s depreciation against the dollar due to its position against several other currencies; perhaps the bank will loosen its grip on the tiller, raising the potential for further devaluations.
Europe still treading water – Despite weathering the Grexit saga that rocked the bloc last year, threatening at one point to unravel the currency union, Europe is not yet out of the woods. This sustained uncertainty in the strength of the region and its ability to maintain economic momentum are underlined by the ECB extending in December its €1.2-trillion QE programme by six months to March 2017 while growth and inflation rates remain below expectations across much of the region. This reflects decreased confidence in the bloc achieving escape velocity by September this year. This factor was highlighted in December when the ECB maintained its projection for lower GDP growth this year of 1.7 percent and of 1.9 percent in 2017.
Another factor in the ECB’s decision to extend its monthly purchases of €60 billion of public and private assets is the continued struggle to lift inflation towards its target of two percent – the bank sees CPI inflation in the eurozone at just 0.1 percent in 2015. This is a theme across all the developed economies while low energy prices weigh heavily on inflation creation. With the January CPI flash estimate at 0.2 percent suggesting a reduced rate of inflation, this issue appears to have persisted, raising the possibility that the EU could again slip back into deflation as it did in September last year. The ECB is therefore more likely to expand its asset purchases – a six-month extension alone may not be enough to provide sufficient momentum to reach escape velocity. This is especially the case given the worrying signal that Germany – largely seen as the engine of Europe – has fallen back into deflation: its January preliminary CPI reading was -0.1 percent. ECB president Mario Draghi has shown repeatedly that he prefers to keep some of his powder dry to allow him to get the greatest effect from the ECB’s forward guidance and actions, which also makes an expansion of QE likely. The dollar’s lack of a renewed appreciation following the FOMC’s decision to raise rates in December should also be a factor – Europe would have gained from a strong dollar through a comparative easing in the euro, which would have boosted its global competitiveness.
Overall – Despite significant action by central banks, the global economy continues to struggle, so another year of reduced growth and investor uncertainty is on the cards. With inflation subdued due to weak energy prices and monetary policy now diverging in key economies, we would expect the same themes that weighed on markets last year to remain in place this year, particularly while China continues to slow, as market confidence falters. Although metal prices appeared to have bottomed out last year after several key producers announced output cuts, markets are transfixed on the weak demand outlook. Further downside in metal prices would delay the recovery that had been expected this year. Still, tighter supply could eventually turn sentiment around.