Chinese demand drives metals prices

Scotiabank's Commodity Price Index, having lost steam in late 2013, is expected to bottom out this spring and rally in the second half of 2014 on stronger global growth, Scotiabank Vice President, Economics Patricia M. Mohr told an overflow crowd attending the 2014 Nunavut Mining Symposium in April.

Mohr, a commodities market specialist at the Toronto-based international bank, again opened the 17th annual gathering, held April 7-10 in Iqaluit, NU, the northern territory's capital.

She said growth in the global manufacturing sector in late 2013 posted its best performance since the second quarter of 2011, led by an improvement in the economies of the G7 (excepting France and Canada). The gain in the United States was particularly notable.

However, a slowdown in manufacturing in China in early 2014, recent lackluster economic indicators in the United States - largely due to severe weather - and pressure on some 'emerging-market' currencies - once more called into question the outlook for global growth in early 2014.

"Nevertheless, we are of the opinion that China's growth will remain over 7 percent in 2014, only slightly slower than the 7.7 percent of both 2013 and 2012. U.S. growth should also pick up again, as 2014 unfolds. Global industrial activity will be lifted by a new record high in metal and gasoline-intensive global auto sales & production and the beginning of a recovery in G7 construction activity," Mohr explained.

Scotiabank GBM is the No. 1 mining and metals lender in Canada and the country's most international bank with operations in 11 Asian countries and Canadian banking's the largest network in mainland China.

A commodity market specialist at the Toronto-based financial institution, Mohr developed the Scotiabank Commodity Price Index, which is the first index designed to measure price trends for Canadian commodities in export. The CPI is a trade-weighted U.S. dollar-based index of principal Canadian commodity exports, including oil & gas (39.9 percent weight), metals & minerals (30.1 percent weight), forest products (14.66 percent weight) and agricultural commodities (15.35 percent weight).

Giving an overview titled, "Metal Prices, Currencies & Global Growth - Outlook 2014-15," Mohr told the Nunavut gathering that "the All Items Index edged up through May 2013, but then lost steam through late last year.

The correction since April 2011 - linked to austerity-led recession in the southern Eurozone, a sub-par U.S. economic recovery, new mine supply started in a slowly growing world economy and unusually wide discounts on Western Canadian Select Heavy oil - should be largely over in first-half of 2014." She also cited a strong rally in oil and gas in early 2014 on severe winter weather and the TSX has started to discount a recovery (especially in gold & materials - potash & uranium).

Mohr said the economic outlook for China is vital to prospects for the global commodities market as emerging markets remain supportive for prices, with the "bull run" returning.

Global consumption of copper, zinc, nickel and aluminum in China, for example, exceeded 45 percent in 2013. That compares with roughly 10 percent for the United States.

With new leadership in place, and the government's focus on urbanization and market-driven initiatives along with its willingness to apply fiscal stimulus when growth slows, China will play an important role in the strength of commodity prices in the near and medium term, Mohr said.

"China's potential GDP growth is slowing - in 2012: 8.5 percent, 2015-20: 7.0 percent per annum, 2025-30: 5 percent p.a. with less under-utilized labor and much slower capital formation (less build-out of manufacturing, in view of emerging excess capacity in some sectors in China)," she explained.

China will continue to be the main driver of global auto sales (accounting for more than 60 percent of the world total in 2013). Passenger vehicle sales roared past 16 million units in 2013 and will climb to 18 million in 2014, she predicted. Automakers will introduce 200 new or upgraded models in China in 2014, compared with less than 70 new models in United States.

Moreover, with a population of 1.354 billion people, China has huge potential for oil and metal-intensive motor vehicle sales.

In the United States, strong auto assemblies have buoyed industrial activity and employment has picked up moderately. U.S. employment recovery has, until recently, been five times less than normal. In March U.S. payrolls advanced by 192,000 jobs and year-over-year employment climbed by 2,246,000 positions.

North American motor vehicle assemblies advanced by about 4.4 percent in 2013 to 16.5 million units (the highest level since 2005) and will climb to 17.2 million in 2014, likely approaching the previous 17.7 million peak of 2000 by mid-decade, Mohr predicted.

"U.S. household balance sheets are the healthiest in a decade, and last year was the 'Year of the Truck & Cross-Over Utility' in both Canada and the United States," she said.

A stronger U.S. dollar, supported by widening and increasingly attractive growth and interest rate differential, is expected in 2014-15, which will support dollar-denominated commodity prices. However, a softer Canadian dollar has hugely increased the competitiveness of Canadian resource producers and manufacturers in U.S. and overseas markets, Mohr said.

She also noted that the Canadian dollar was weakened by large price discounts on Western

Canadian heavy crude in late 2013; and the Bank of Canada is expected to lag tightening Federal Reserve monetary policy in 2015, which should keep the Canadian dollar competitive.

Gold outlook

While investors shifted from gold to U.S. equities in 2013, S&P and TSX gold equities picked up again in early 2014

"In view of a weak performance by gold equities - as measured by the 'Toronto Stock Exchange - Gold Index' - and shareholders' demand for higher earnings, gold producers adopted tighter cost control and more disciplined capital spending programs in fall 2013, deferring higher-cost new mine development," Mohr said. "This likely sets the stage for tighter mine supply in the second half of the decade."

Some 20 percent of the world's existing gold mines had "all-in sustaining cash costs" that exceeded US$1,175 per ounce in 2013 (a forecasted US$1,090 in 2014).

"The US$1,180 mark for gold prices in late June 2013 was likely the 'bottom', because lower prices of US$1,050-1,100 - if sustained - would trigger substantial mine production shutdowns. Gold has caught a bid as a 'safe-haven' in early 2014, in view of pressure on some emerging-market currencies and Crimean developments," Mohr said.

As of April 4, gold prices were down 16.1 percent from a year ago.

Copper prices

Copper prices are expected to ease alongside mine expansion going forward.

In 2012-13, global supply and demand conditions shifted from "deficit" into a modest "surplus", though global consumption grew faster than output in 2013, given ongoing strength in Chinese demand.

LME copper prices started 2014 on a positive note, boosted by a rumor that China's SRB (expecting 2014 to be the cyclical bottom) may increase its copper stocks by 300,000 metric tons (a move which would wipe out this year's projected world 'surplus') and a modest increase in copper's weighting in two commodity indices used as investment benchmarks. Indonesia will apparently allow the continued export of copper, lead and zinc concentrates until 2017; but possibly with stepped-up export taxes. The export ban on unprocessed nickel-containing ore and bauxite has gone ahead.

In 2013, global copper demand held up better than expected (+5.5 percent), as China's consumption performed well (up almost 12 percent) and a shortage of scrap lifted cathode demand.

Visible exchange inventories on the LME, COMEX & SHFE fell 39 percent in the second half of 2013.

China likely holds the bulk of overall global stocks (away from bonded warehouses at semis plants).

This has contributed to tight 'physical' markets outside of China and lucrative premia.

While new mine supply ramped up by 8 percent in 2013 - with expansion or improved output at Escondida, Grasberg & Collahuasi as well as new mine start-ups at Oyu Tolgoi, Antapaccay & Salobo - the global 'surplus' actually narrowed.

Despite concern over potentially slower GDP growth in China, strong underlying demand and tight scrap supplies boosted refined copper consumption by almost 12 percent in 2013. Expansion of the electricity grid, high-speed railway development and socially assisted housing construction lifted demand for copper cable, building wire and household goods.

Scotiabank forecast an average price of US$3.32 for copper in 2013; US$3.08 in 2014 and US$3.00 in 2015.

"In 2014-15, the world 'surplus' will likely widen again; this development has already been discounted in recent weeks, with further declines expected to be modest, as copper approaches a cyclical bottom. Later in the decade, copper prices should rebound to a lucrative US$3.50, given substantial capital costs for new mine development (requiring "high 'incentive prices') and solid demand growth in 'emerging markets'," Mohr predicted.

Zinc outlook

Describing zinc as "the next big base metal play", Mohr said demand for the metal will be boosted mid-decade by a recovery in G7 construction activity, and zinc prices could climb as high as US$1.50 in 2016-17.

Gains in world mine production over the next four to five years will likely fall behind global demand growth (4.7 percent p. a.), given unusually high depletion at major mines in the face of tighter capital availability for new mine development; lack of equity capital for junior miners will take a toll on development, despite some pick-up in private equity interest; Century in Australia will close one year early in mid-2015 (515,000 metric tons) and Lisheen will shut in 2016 (172,000 metric tons), following closures in 2013 at Brunswick (190,000 metric tons) and Perseverance (125,000 metric tons) in Canada.

In addition, the major end uses of primary zinc in galvanized steel are picking up - particularly in motor vehicle production and construction. World vehicle sales reached a record high in 2013 of more than 81 million units and an even bigger record is forecast for 2014 at almost 86 million (+5 percent). China's passenger car & cross-over utility sales jumped by

23.6 percent in 2013, surpassing U.S. sales last year, and should advance by 12.5 percent in 2014.

U.S. nonresidential construction, a sector which has struggled since 2008, also appears to be turning around (office buildings). Construction also has edged up in Europe.

Scotiabank's outlook is for zinc prices to average US87 cents per pound in 2013 (actual) and US$95 cents/lb. in 2014 and US$1.25/lb. in 2015.

Competitive iron

Iron ore demand was robust in China in 2013. China's imports of iron ore rose to a record

819.4 metric tons in 2013 - up 10.2 percent over 2012. This partly reflects import displacement of higher-cost domestic production as well as strong steel output.

China's steel production rose 7.5 percent year-over-year in 2013 and accounted for an extraordinary 48.5 percent of the world total.

Steel output in Germany and Japan was strong in December and edged up in the

United States, but ROW production was subdued in 2013 as a whole.

Turning to iron ore, huge mine expansion in Western Australia and Brazil (+10 percent in 2014), amid slower steel mill capacity expansion in China in the next several years, points to lower iron ore prices through 2016-17; cost control is vital for new mine development.

The Mary River project in northern Baffin Island - with lump and fines destined for European markets - derives its competitiveness from the high quality of the ore.

Baffinland Iron Mines Ltd. pared the size of its Mary River iron ore project in 2013 to initial production of 3.5 million metric tons annually, down from the 18 million metric tons in annual production originally planned, and is currently ramping up construction at the remote mine site. Scotiabank's price outlook is for iron ore averaged US$135 per metric ton in 2013, US122/metric ton in 2014, and US$115 cents/metric ton in 2015 - moving towards US$100/metric ton by 2016-17.

Soft uranium

Spot uranium prices remain at low ebb in March 2014 - at US$34.00/lb. - well below the US$66/lb. average just prior to the Fukushima-Daiichi incident in Japan several years ago.

A further pullback in prices in 2013 reflected a delay in re-starting Japan's 48 nuclear reactors (the world's third-biggest fleet). Utilities are now seeking approval to restart 16 reactors from Japan's Nuclear Regulatory Authority; three could be re-commissioned in the second quarter of 2014 (Kyushu EPC's Sendai 1 & 2 and Shikoku EPC's Ikata 2), with the Nuclear Regulatory Agency fast-tracking some approvals. Ten could be restarted by late 2014 and 30-35 by 2017. Japanese utilities have deferred delivery of some U3O8. The HEU Agreement between the United States and Russia ended in December, removing 24 million lbs. of U3O8 from Western markets.

However, a pro-nuclear governor has been elected in Tokyo, and China remains the world's key growth market, with 30 reactors under construction of a total 70 worldwide (300 planned).

Price recovery is likely to be slow in 2014-15, given limited, uncovered utility needs, but prices should move up over US$60 in late decade.

Scotiabank's spot price forecast: Uranium will average US$38.50/lb. in 2013, US$39/lb. in 2014, and US$40-45/lb. in 2015.

High oil prices

Expect oil prices to continue their current trend in 2014-15, Mohr said.

"World petroleum consumption should pick up slightly in 2014 (+1.5 percent), with better economic growth; 'geopolitical supply risks' will likely remain high," she said.

Brent oil prices jumped as high as US$116.61 in late August 2013 on 'geopolitical supply risks' surrounding Syria and civil unrest in Libya. Strong global refinery demand linked to new refinery capacity in 'non-OECD' countries also boosted crude prices.

While Brent lost ground in October and early November, given a high level of refinery maintenance worldwide and well-supplied global markets, prices regained ground seasonally to US$111.77 in late December (currently US$106). Saudi Arabia and Kuwait cut output by 420,000 b/d, given an end to summer 'direct crude burn' and significant outages have recurred in Libya.

International oil prices are expected to remain high in 2014-15, though North American 'light' oil prices (WTI, LLS, Edmonton Par crude) could ease back over the next 18-24 months due to the remarkable development of 'light, tight' oil in the North Dakota Bakken and Permian & Eagle Ford Basins in Texas, Mohr said The U.S. crude oil export ban may persist (the only country to which shipments are effectively exempted is Canada)."

Overall U.S. oil production is expected to climb by another 935,000 barrels per day in 2014 and 775,000 b/d in 2015.

"Saudi Arabia may have to reprise its role as 'swing producer', given the U.S. 'shale revolution', which has largely backed out U.S. light oil imports from West & North Africa and may start to back out Middle East supplies in 2015," Mohr observed.

Scotiabank's spot price forecast (at April 4, 2014): Crude prices will average an estimated US$98 for West Texas Intermediate and US$109 for Brent Oil in 2013; a forecasted US$97 for WTI and US$108 for Brent Oil in 2014 and US$92 for WTI and US$106 for Brent Oil in 2015, reflecting downside risk on U.S. light oil prices over the next 18-24 months.