October 23, 2008
CRU predicts that the fall in commodity prices will not invalidate the Super-cycle theory
or “Super-cycle suffers flat tyre but will re-emerge to race again.”
All commodity booms in recent times have faltered because of an unexpected weakening of demand. The current commodity crisis is no different, except that the financial crisis has been a catalyst for forces that were already at work. What might have taken months or even years to happen has been compressed into a few weeks.
Given that this commodity crash will be driven by a demand shock, CRU has a number of observations on the impact of the financial crisis on commodity markets.
1. The market today is still under-estimating the extent of the imminent downturn in consumption.
- In the West the media is only just turning its attention to the coming recession, looming job losses, falling consumption, and the impact on the economy outside the financial sector. The crisis so far has been a 'phoney war', largely confined to the financial sector and investors in sub-prime mortgages. But consumers are now beginning to adjust; retail sales are falling, consumers are starting to pay off their credit card debts and we expect to see an increase in personal savings rates. Demand for manufactured goods, and therefore metals, will get worse. In addition, the impact on demand is being felt across the world, including China, the Middle East, South America and other regions that were supposedly economically independent of the US or European economies.
- The slowdown in demand is likely to continue for the remainder of 2008. All players will be minimising stock levels to ensure they are not exposed to falling prices. Financial participants in commodity markets are likely to liquidate long positions.
- Markets are forecasting that Chinese GDP will grow more slowly, but the consensus is still that GDP will grow at 8-9% in the next two years. Despite the recent stimulus package, we believe that the deceleration in demand for metals could be sharper. Our view is based upon: significantly less foreign direct investment into China; a major slowdown in exports; cautious consumer spending among China’s new middle class (who were good savers even before the crisis); and a decline in private sector construction because of falling property prices. Public sector spending on infrastructure will only partially offset these factors.
2. In the short term, falls in prices may be much bigger than the market is currently forecasting.
- Operating costs of metal producers do not provide a floor close to current prices. Operating costs are now falling, and will continue to fall. Downward pressure is now being felt on all inputs into production processes. It is transmitted through energy costs, freight costs, labour costs and the prices of other raw materials.
- History tells us that prices in a recession can fall well below the level where high cost producers fail to cover their costs. Producers have to decide to curtail production, in order to bring a market back to balance. This response tends to be delayed for a host of reasons: producers may believe that the downturn will be short or shallow; they may first seek to reduce the prices of materials bought from suppliers; some may rely on forward hedges to protect margins; some may stubbornly wait for competitors to cut production first, and thus avoid the cost and pain of closures.
- The fall in metal prices is likely to be made more severe this time as we witness a combination of contraction in demand, a slow response from producers, and the unwinding of financial investments in metal markets. We should remember that many of the commodity price indices, exchange traded funds, hedge funds and similar instruments or vehicles did not exist or were not significant at the time of previous crashes.
3. However, in the medium term, the commodity sector could witness a recovery in prices that would make the 2003-2008 commodity boom pale by comparison.
The world’s response to the credit crunch and economic downturn is also sowing the seeds of the next commodity boom.
- Global monetary policy has been loosened, and will be loosened more. This will not immediately have its normal effect, because of the global liquidity trap. An economic recovery will also need a number of fiscal stimulus packages, and a sufficient rebuilding of confidence to encourage consumers to spend rather than save any incremental income. As this confidence returns, re-stocking adds to demand, which can grow as rapidly as it slowed as global supply chains are replenished.
- Infrastructure spending by developing economies will continue or even increase, as a result of local political pressures and sound economic reasoning: if it made sense to invest in infrastructure at all-time high prices, surely it makes sense to do so when raw material and construction costs have fallen by over 25%.
- Financial constraints already curtailing projects that would add to supply. All projects are finding it difficult to obtain loan funding. Refinancing is substantially more expensive and junior miners in particular, who rely on equity finance, are suffering. As a result, projects under development are being slowed down, postponed or even cancelled.
- Therefore CRU predicts that when demand recovers, as it will, the market will find itself short of capacity again and will enter commodity boom part 2, which may make part 1 (2003-2008 RIP) look modest by comparison. The severity of the current cyclical downturn will add to the strength of the next upturn.
4. A great opportunity will come for counter-cyclical investments.
For companies with sound projects, enough free cash, available skilled workforce, suitable risk appetite and risk tolerance, this could be the ideal time to invest in new assets in the sector. Previous examples in the aluminium smelting industry include Becancour (1983), Hillside (1992-3) and the Alouette expansion (2002-3). All were projects built cheaply in a downturn which hit the market in the upswing - a highly profitable strategy for those with the confidence to pursue it.
There are also players in the metals industry that will see a downturn as a buying opportunity. There will be some interesting and unexpected consolidation deals over the coming months. These are also the times when business are refocusing on controlling price exposure and capturing margins through prudent Price Risk Management (PRM) and proven PRM methods.
The current downturn will be an opportunity, as well as a threat.
The CRU Group is uniquely positioned to help the metals industry to manage its business through the current market turmoil, and benefit as the market turns and consumer confidence returns. Our dedicated analysts across the world produce a portfolio of world class products to supply managers with the data and market opinions they need; our consultancy team (CRU Strategies) provides client-specific services, based on experience and insight gained from assisting clients during previous downturns. Our CRU Price Risk Management experts have first hand experience helping you to control your price exposure.
If you would like to speak to a member of CRU’s management team please contact:
United Kingdom
Phil Newman, phil.newman@crugroup.com
Tel: +44 20 7903 2105
Asia
John Johnson, john.johnson@crugroup.com
Tel: +86 10 6210 2208
North America
Jim Southwood, jim.southwood@crugroup.com
Tel: +1 724 940 7100
Or visit us at www.crugroup.com
4 August 2008 – for immediate release
First ever US steel futures contract will be settled against price assessments from CRU Indices Ltd.
In a move that brings steel into the realm of US financial trading for the first time, CRU Indices Ltd’s assessments of steel market prices have been licensed by the New York Mercantile Exchange, Inc. (NYMEX) to settle a new futures contract. The contract (“HRC”) is based on prevailing market prices, researched by CRU Indices Ltd, for hot-rolled steel coil in the US Midwest; it will be launched towards the end of 2008.
The use of index-based pricing programmes by steel sheet producers in the USA has grown dramatically in recent years, in tandem with the increase in steel price volatility. In 2004, very few physical market transactions were index-based, according to CRU. In 2008, 25-30% of transactions will reference an independent assessment of market prices, the majority using CRU. This widespread acceptance of the CRU assessments was a key factor in the NYMEX licensing decision.
“The NYMEX decision to license CRU Indices Ltd’s price assessments is yet a further endorsement of their accuracy, and of the robustness of our research procedures,” said CRU Group Chairman, Robert Perlman. “Wherever steel is traded, from physical transactions to futures, we believe our price assessments give all participants the truest picture of the market”.
NYMEX Chairman Richard Schaeffer said, "NYMEX expansion into the steel market is a natural extension of our risk management business and we are pleased to offer a steel futures contract to serve the North American market. Managing price volatility has become a necessity for everyone involved along the steel supply chain and these contracts will assist the US manufacturing industry in dealing with this issue”.
Ends
Further information
Paul Scott, Managing Consultant – CRU Indices Ltd, on +44 (0) 20 7903 2185,
Paul.Scott@crugroup.com.
Notes for editors
About CRU Group
CRU is an independent business analysis and consultancy group focused on the mining, metals, power, cables, fertilizer and chemical sectors. Founded in the late 1960s, the group employs more than 200 experts in London, Beijing, Santiago, Sydney, and key centres within the United States. CRU Indices Ltd. is a member of the CRU Group of companies. CRU’s Steel Group provides in-depth analysis and information on commercial and economic aspects of the global steel industry, from raw materials through to distribution and end-use sectors.
About the New York Mercantile Exchange, Inc.
The New York Mercantile Exchange, a subsidiary of NYMEX Holdings, Inc. (NYSE: NMX), is the world’s largest physical commodities exchange, offering futures and options trading in energy and metals contracts and clearing services for more than 400 off-exchange energy contracts. Through a hybrid model of open outcry floor trading and electronic trading on CME Globex® and NYMEX ClearPort®, NYMEX offers crude oil, petroleum products, natural gas, coal, electricity, gold, silver, copper, aluminum, platinum group metals, emissions, and soft commodities contracts for trading and clearing virtually 24 hours each day.
Note: the word “assessment” is synonymous with “index”, the more commonly used term in the US.