Which metals prices fell last week? Almost all of them. Copper, the most active metal on the London Metal Exchange, was among the biggest fallers. From its lows in 2003, the price of copper had surged 113% to hit a 15-year high at the beginning of last week, only to fall 17% on Wednesday and Thursday, its biggest one-day fall in 14 years. Other notable fallers included lead, which had surged 135% before plunging 15%; nickel, which had jumped 130% before tumbling 24%; zinc, which was up 55% before falling 15%; and aluminium, which was up 44% before dipping 8%.
Why did prices fall?
Most analysts blame the falls on speculative trading by hedge funds, rather than any change in sentiment in the industry. The clue was in the timing. Last Tuesday night was the annual dinner to mark Metals week, a huge industry shindig that brings together all the miners and brokers that deal on the London Metals Exchange. Metals prices had soared in the run-up to this gathering, as hedge funds speculated that news of further supply bottlenecks would emerge to drive up prices. In the event, there was little news to justify the run-up in prices and thus the sell-off on Wednesday and Thursday. This theory gains further credibility when you consider that it affected all base metals, which means the sell-off cannot have been triggered by worries about excessive supply of copper or any other metal.
So all remains well in the metals market?
Not necessarily. Some analysts claim that last week’s sell-off was triggered by fears for the global economy. If the global economy was to slow, it is likely that demand for metals would fall. Given that there was no specific news on Wednesday to justify such a change of view, this explanation seems unlikely. Indeed, markets have only recently stopped worrying about a hard landing in the booming Chinese economy. Nonetheless, it would be wrong to dismiss macro-economic fears entirely. It is clear that brokers are starting to downgrade their forecasts for growth next year in the face of rising oil prices. Stephen Roach of Morgan Stanley, for instance, has cut his estimate for global growth from 3.9% to 3.6%. China is unlikely to be immune from this global slowdown.
How might this affect metals?
Soaring Chinese demand has driven the bull market in metals prices and any suggestion that demand might slow down is enough to unsettle markets. China accounts for about 20% of the world’s consumption of copper and aluminium. Some analysts blamed last week’s sell-off on a report that Chinese imports of copper grew 22% in the year to September – the lowest level for two years – adding to fears the economy is slowing down. Morgan Stanley predicts China’s economic growth will slow from 9.5% this year to 7% next – hardly a hard landing, but enough to spook investors at a time when China accounts for a third of global economic growth. Yet it is not so much a slowdown in Chinese growth that traders fear as a revaluation of China’s currency, the yuan.
Is a yuan revaluation likely?
China is clearly coming under international pressure to revalue its currency, but there is little reason to expect any change in the near future. One problem is the rickety state of many of China’s banks. Any move to make the yuan fully convertible could lead to a run on the banks as people tried to get their money out of the country. This could cause the yuan to fall, interest rates to rise and the Chinese boom to come to an abrupt halt, which is in nobody’s interest. Moreover, for all the public criticism of China’s fixed-exchange rate from the US, the current set-up suits America very well. China and other Asian countries whose currencies are pegged to the dollar are obliged to defend their exchange rates by buying US assets, thus underwriting the vast US trade deficit. The risk is that any currency realignment could lead to a collapse in the dollar as demand for US government bonds dried up, leading to higher inflation, higher interest rates and a possible recession. Yuan revaluation is inevitable at some point, but not right now.
How does this affect the outlook for mining shares?
Even after last week’s falls, no one disputes that commodity prices are high and that, in the short term, further falls are possible. Nonetheless, barring a massive shock to the global economy, the long-term prognosis for the mining industry remains intact: supply is failing to keep pace with demand. It is likely to be several years before new production of most base metals comes on stream, which should provide a floor to prices. Besides, prices would have to fall much further before they upset the outlook for mining companies, since industry profit forecasts have been calculated on metal prices well below their current levels.