America’s trade war takes the sheen off base metals

The threat of an escalation in the ongoing trade war, an appreciation in the US dollar, and fears of a global slowdown have been dragging base metals lower in 2018.

The Bloomberg Base Metal Index is down 11.73 per cent since January 2018. This is in sharp contrast to the rally witnessed in 2016 and 2017 when the index had surged 21 and 27 per cent, respectively. Zinc, lead, copper and aluminium have lost more than 10 per cent this calendar year, leading to concerns about a cyclical reversal in these metals.

The draggers

It all started with the US imposing a 10 per cent and 25 per cent tariff on aluminium and steel imports in March. The fall intensified in June as the trade war rhetoric began to get louder.

“Stress is developing in the Chinese economy as industrial activity in the country seems to be slowing down as trade war concerns escalate. Since China is a major consumer of base metals, concerns of a slowdown in its economy are impacting prices”, says Navneet Damani, VP Commodity Research, Motilal Oswal Commodities.

According to experts, the strength of the US dollar is the other factor that has been piling pressure on base metal prices. The US dollar index, which fell to a low of around 88 in the initial part of the year, has reversed sharply higher, surging about 8 per cent since then.

Zinc is the worst-hit among the base metals, with prices on the London Metal Exchange (LME) declining 20 per cent this calendar. “Zinc has fallen the most because of its link with steel. Concerns of a slowdown in the steel industry because of the tariffs is impacting zinc prices,” says Goutam Chakraborty, AVP, Institutional Research (Metals & Mining), Emkay Global Financial Services. About 65 per cent of zinc produced is used in the steel industry.

The rates of copper and lead are down 14 and 15 per cent, respectively, while aluminium has been knocked down 11 per cent. Nickel is the only metal that has withstood the strains of the trade war.

On the domestic front, the weakness in the rupee has helped reduce losses. MCX-Copper, Lead and Aluminium are down 10 per cent, 9 per cent, and 3 per cent, respectively, while MCX-Nickel has surged 18 per cent on the back of a weak rupee. Zinc has suffered a mauling here, too, with the MCX futures contract declining over 14 per cent.

Will the fall sustain

Does the sharp fall in prices this year indicate a turnaround after two years of a strong rally? Experts do not think so. Jayanta Roy, Senior Vice-President, ICRA says: “The price fall is just a correction fuelled by a weaker sentiment because of the trade war. We don’t see prices going down sharply as the fundamental factors, especially for aluminium, are still in favour of the metal.” Experts believe the prices may continue to remain subdued in the short term, and are likely to reverse higher over the long-term.

The recent fall in metal prices is likely to have a short-term impact on corporate earnings. “Primary aluminium producers such as Hindalco, Nalco and Vedanta are already getting hit by rising input costs and carbon prices are to blame. A further fall in aluminium prices will impact their bottomline,” says Emkay’s Chakraborty. Volatility in zinc prices will affect Hindustan Zinc, he adds.

“Weakness in the LME-Copper prices is likely to affect the bottom-line of Hindustan Copper,” says Jayanta. Roy. However, the impact on companies is likely to be short-lived according to experts as they expect the prices to recover.