Metals: Hard truths

Global commodity markets are currently being driven by a host of factors, both positive and negative. Growth signals as indicated by macroeconomic data, contrasting monetary policies adopted by different countries, high crude prices, weakening dollar and inflation expectations are impacting the commodity market in different ways.

In the last many months, most of the leading indicators have continued to signal a positive trend in global growth. From a regional perspective, growth in Asia continues to be robust, with China leading the consumption surge, followed at a distance by India.

Disaggregated data point to two-speed growth that is taking place globally. While the developed economies under the lead of the US continue to maintain hesitant or halting growth with high levels of unemployment, developing countries continue to register robust growth rates with inflation catching up rapidly.

Contrasting policies

No wonder, the monetary policies adopted by developed and developing countries are contrasting. While the industrialised economies or OECD countries follow what can be termed as ‘loose money policy' — this is true especially for the US — the emerging markets such as China and India are on a credit tightening spree. In the last four or five quarters, the two countries have tightened bank credit as many as six or more times, with no prospect of a let-up in sight.

High and rising crude prices are menacing and gradually cause inflationary pressures across the world. This has implications for commodity markets and prices. The dollar, the benchmark currency for most trades, has turned substantially weaker vis-à-vis the euro, resulting in commodities priced in dollars so much more expensive.

The big question now is the timing of the end of the easy money policy. It is believed rising inflation expectations will force the US to review its monetary policy and infuse a sense of discipline; but the timing is as yet uncertain. The general view going around the market is that such a review could happen sometime during end-third quarter or beginning of fourth quarter, that is, September or October 2011.

At the crossroads

Within this larger picture, the global metals market seems to be at the crossroads. The twin shocks of geopolitical instabilities in the MENA (Middle-East and North Africa) region and natural calamity in Japan have raised the downside risk to global growth, and in turn to metals demand and prices. We need more clarity on the situation at this point of time, although one can assert that metals demand in Japan will pick up once the reconstruction activity starts. Also, it is unclear how policymakers will respond to rising inflation pressures.

With commodities having become an accepted asset class, investment in commodities has been rising relentlessly. In 2010, asset under management was an estimated $376 billion globally, rising by about $100 billion from the previous year. Clearly, investor appetite is high.

A significant part of investment is, of course, in precious metals such as gold and silver. The question that everyone seeks answer to is whether the investment demand will sustain through 2011. Of course, it has, so far.

For the global metals market, China is a wild card. Even as the Asian giant continually tightens monetary policy, metals demand is still robust. To be sure, China's demand numbers are not transparent. Will there be a slowdown in China? While concerns are being expressed, no one is certain. Another uncertainty is geopolitics. How the ongoing instabilities in MENA region will pan out eventually – escalate or subside – is hard to tell.

It is such a complex environment that one must examine the global market covering precious and base metals. Currently, gold and silver prices have escalated to unprecedented levels with the support of a host of favourable factors, including geopolitics, weak dollar, rising crude, weak equity markets, inflation fears and so on.

OUTLOOK ON METALS

Yet, the combined strength of these supportive factors has not benefited gold much. Of course, investor interest is the key and at the bourses, speculative interest in bullion is at a record high. The day investors see opportunities elsewhere, they will desert gold and silver. If equities market starts to improve, there will be rapid liquidation of long positions in gold and silver, and prices will witness a sharp correction.

Silver, in particular, is more vulnerable than gold. The market fundamentals are weak, with an estimated 5,000 tonnes surplus for 2011. In the event of a correction, prices are vulnerable to a strong downside risk and steep decline.

As for base metals, in the short-term, Japan's closure of copper and zinc production and weak usage will affect prices. However, in the medium-term, reconstruction work is set to boost demand. Lead can rise quickly due to demand for generators and batteries. Copper demand is set to expand because power utilities need to repair damaged transmission lines.

World steel production is on course to record a new high of 1,500 million tonnes in 2011. Consumption is rising not only in Asia, but also in Europe and US. Indian steel production and consumption numbers also look healthy. But the country is currently facing a ‘steel dilemma'. Will India have enough iron ore to meet its future steel production needs?

New projections for steel suggest India will have a steel capacity of about 295 million tonnes by 2019-20. To service this capacity, over 470 million tonnes of iron ore are required 1.6 tonnes of iron ore are necessary to produce one tonne of steel.

Currently estimated at 2,500 million tonnes, the domestic iron ore resources may soon be exhausted and the country may not have enough indigenous ore to meet its future needs.

Iron ore exports have become highly debatable, but are continuing. Tariff restrictions are in place. The government will have to quickly come up with policies that seek to address short-term, medium-term and long-term requirements for healthy development of the steel industry which is an integral part of the country's growth story.