The August 2011 OECD Composite Leading Indicators (CLIs) make pretty dismal reading. Of note is that the Euro Area, the major 5 Asian economies (excluding Japan), China, Brazil and India are all below the threshold 100.0 “pointing strongly to a slowdown in economic activity below long term trend”. Germany is close to that threshold; Canada and the UK are below it. As for the USA, that venerable institute ECRI, which correctly forecast the beginning and the end of the last recession and over the past 15 years has gotten all of its recession calls right while issuing no false alarms, states, “If the USA isn’t already in a recession now it is about to enter one.” If ECRI is right then where the USA goes so the rest of the world will follow.
The world is becoming an ever more confusing place, as much economically as geopolitically. We are sitting on a precipice and it is difficult to judge whether we fall off that cliff. Amidst confusion it pays to be reminded of the picture because it is the picture which will ultimately give us the answer to today’s confusion.
Professor Kenneth Rogoff told Der Spiegel that what began in New York was not a normal recession, albeit somewhat more severe than usual, but a ‘great contraction’ of the sort that happens only once every 75 years in global economic history. This circumstance has not been recognised to this day. In his view, this is why Europe’s crisis, which began as a crisis of confidence, turned into a debt and liquidity crisis and finally led to multiple solvency crises, is not ending. The current policy is to act as if a liquidity crisis could be overcome and as if all it took were to hand out enough loans to jump start growth once. But it’s the wrong diagnosis.
“We have a solvency crisis and we have European countries and regions that are fundamentally bankrupt. No loan in the world, no matter how , will save Greece, nor will it save Portugal and probably not Ireland, either, and Italy is very worrisome.” The second leg of the global credit crisis is coming. The only question is whether it will be in the next few months or in about a year’s time.
This leads us into the copper industry. Our take is quite simple: global growth is slowing fast with a high risk of a recession in 2012; and China is in no position to save the global economy as it did in 2008. If central banks attempt to float the world on a sea of credit all that will be done will be to delay what is inevitable by a year or so, but it will encourage another round of speculative flows into commodities. The crash when it comes will then be just that much more brutal.
What struck us most was the overt dichotomy of views between fabricators on the one side and producers with their analyst/consultant groups on the other side. One could, perhaps, summarise this dichotomy by saying it is reality versus the optimistic mantra. In general, fabricators are seeing a sharp fall in order books in Europe, across Asia, excluding Japan, and in many sectors in China, especially magnet and electrical wires. Their worries are such that they will be reducing their contracted requirements from producers from around 70% to between 40-50% for 2012.
Talk of fabricators in China rebuilding inventory seems somewhat strange when money is not only very tight but expensive. Most cathode imports into China are being used as a financing instrument and not destined for furnaces because the overall level of business is not good.
Producers, in public anyway, remain optimistic: this is just a mid-life slowdown. Demand remains strong, supplies constrained and costs are rising rapidly. On the other hand, to take one example, copper production in the Congo is forecast to increase from 498kt in 2010 to over 1.6MT in 2015. Yet, producers reduced premiums to Europe by 9% to $90! Premiums are high in Shanghai giving the appearance of a tight market, but this is more a reflection of holders of metal being unwilling sellers at these prices than a fundamentally tight market. There are also stories of large scrap stocks sitting at the ports.
Credit availability is getting tighter for the trade so that one side of the banks is becoming more concerned. Yet, with large margin calls overhanging the market, the banks came into supporting the market aggressively at $6800; that level appears to be a crucial price level for them. We should expect more support at around that price. Whether or not they succeed will depend on the overall financial system with, for the short term, much depending on how events unfold in Europe. At this stage the result is in doubt with many rumours, leaks etc. circulating.
A further support to prices will be the continued withdrawal of stocks out of the exchanges. This is probably not a reflection of real “demand” but of producers delivering material ex the exchanges to their customers in place of their own metal. It is a price supportive measure. Thus, once more, reported stocks will be shown to be falling but unreported inventories will be rising.
The “game” continues as it has done since 2004; it will go on until we enter the second part of the global credit crisis which will either be very soon or postponed by about a year. If we had to guess - and it is no more than that - what emerges in Europe will disappoint markets by year-end thus putting more price pressure on copper later this year. Under this scenario it will be very difficult for banks to hold the $6800 line.
(A longer version of this analysis by Simon Hunt was posted on Mineweb.com)