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Will the party last in key base metals?

Akhil Nallamuthu BL Research Bureau | Updated on August 31, 2021

Base metals have been soaring since the outbreak of the Covid-19 pandemic. Here are insights on the rally and where it is headed

The prices of base metals have been soaring since the outbreak of the Covid-19 pandemic, more than for any other commodity. Among reasons for this is the quick recovery in China, a major user of metals, and disruption in mining operations of almost all metals because of the Covid restrictions. Increase in transportation cost of bulk materials, quarantine curbs and a rebound in fuel prices added to the cost, contributing to the price rise. In addition, a massive amount of stimulus injected by major economies has buoyed asset prices, including that of commodities.

The question now is, will prices continue to remain at elevated levels or will they see a dip? While there are many common factors that influence metal prices, we analyse specific aspects affecting each base metal and give a price forecast based on fundamental and technical analysis.


Gleam may sustain on higher demand

What drove prices?

So far this year, aluminium has been the best performing base metal, gaining about 36 per cent. This gain is despite the 4.5 per cent y-o-y increase in production in the first half of the year to 33.5 million tonnes, according to International Aluminium Institute data. Similarly, it had gained by 11 per cent in 2020 even as the production went up by 2.6 per cent to 65.3 million tonnes.

The primary driver was significant imports by China. Imports in April to December 2020 more than quadrupled to 2.4 million tonnes as against corresponding period of preceding year. Between January and July this year, China imported nearly 1.5 million tonnes of unwrought aluminium and aluminium products — about 21 per cent higher compared to the corresponding period of 2020, as per data of General Administration of Customs, China. Increasing economic activity across the globe too contributed to demand.

As price remained strong, major metal companies in India benefited and their margins expanded. For instance, the aluminium segment of Hindalco Industries’ EBITDA margin in Q1-FY22 stood at 37.5 per cent, highest in the last thirteen years and another major player, Vedanta Limited, recorded an EBITDA margin of 36 per cent, its highest level.

What lies ahead?

Prices may continue to be strong, going forward. US rating agency Fitch Solutions expects demand growth (3.3 per cent) to be higher than output growth (2 per cent) in 2021. Construction, auto and transport contribute to about half of aluminium demand globally. While semiconductor shortage has wreaked havoc on the auto industry, many countries are set to embark on infrastructure spending, which could keep up the expected demand for the metal.

Another key factor that could support prices is stricter emission norms in China, which could hit production . But new, greener capacity is being ramped up quickly. This means that China, the largest producer, which is looking to cap production capacity at 45 million tonnes, could hit this cap next year. Thus, scope for supply increase is limited.

Supply side constraint and simultaneous increase in demand as industrial activity recovers are likely to keep aluminium prices on the higher side for the rest of the year — the price is likely to rule at $2,830 on the LME as the chart suggests. As the outlook for the metal is positive, aluminium majors in India are likely to maintain good performance at least for the next couple of quarters.

On the charts

The price of continuous contract of aluminium on the MCX has had a strong base at ₹128 since 2018. However, it was unable to establish a rally until 2020. The attempt to go northwards in April and October 2018 was blocked by resistance at ₹170. But after bouncing off ₹128 in May 2020, the contract built a strong rally and broke out of ₹170 this year. In July, it went past ₹200 mark.

The metal is in an uptrend. As long as futures price stays above ₹180, the major trend will be bullish. But the relative strength index (RSI) and moving average convergence divergence (MACD) on the weekly chart show bearish divergence, implying there could be a correction before the next leg of up-move. The futures has potential to reach ₹225 before end of year. But watch for any price moderation as a break below ₹180 could alter near-term trend to bearish.


Red metal likely to remain range-bound

What drove prices?

Copper was the best performer among base metals in 2020, sporting a return of 26 per cent. The red metal carried forward the performance in 2021 as well and has gained 22 per cent so far this year. On Friday, the metal quoted at $9,424 per tonne on the LME.

The price rise in 2020 was due to demand powered by China, the largest consumer. International Copper Study Group (ICSG) data shows that refined copper deficit was 604kt (604,000 tonnes) in 2020 and it has been steadily increasing since 2018.

But the price has softened after hitting the decade high of $10,729 in May as Chinese demand slowed. From January to July 2021, Chinese imports amounted to 3.2 million tonnes, 11 per cent lower than the same period in 2020. But ICSG expects refined copper demand to grow 7 per cent for world, ex-China.

What lies ahead?

Several worker unions of mines across Chile, the largest producer of copper (about 30 per cent of world’s total), are on strike, triggering the fear of disruption in mining output. However, the union of Escondida, the world’s largest copper mine, has struck a deal with the management, raising hopes that a similar agreement can be reached between other mining companies and their unions.

ICSG expects refined copper production to go up by 3 per cent in 2021 whereas consumption is estimated to remain flat, possibly resulting in small surplus of 80kt. So, price may not see any significant rise during the rest of 2021 unless there is disruption in supply-demand dynamics.

However, the price may not fall as industrial nations like the US, Germany and Japan are seeing increased manufacturing activity — the manufacturing PMI (Purchase Managers’ Index) of these countries shows considerable expansion. Moreover, copper finds its way into various applications like electrical vehicles, renewable power projects and construction; therefore, demand might stay in support of the price. By the end of this year, the price can be expected to be at around $9,600 as per charts.

Because of the increasing trend in copper price since April 2020, Hindustan Copper, an integrated player, was able to achieve an EBIDTA margin of 24.4 per cent in FY21 and 47.1 per cent in Q1-FY22 whereas margin realisation of Hindalco Industries was miniscule as it imports copper concentrate to convert it to metal. Vedanta’s Sterlite Copper plant in Tamil Nadu remains shut. In the next one to two quarters, copper price can be expected to remain at current elevated levels, from which Hindustan Copper can benefit though the likelihood of significant price rise is low.

On the charts

Between the beginning of 2018 and March 2020, copper futures on the MCX was trading in a broad sideways trend, largely between ₹400 and ₹470. While it slipped below ₹400 in March to mark a low of ₹335, it saw a quick revival. The price started to accelerate upwards, eased past ₹470 in July last year and went on to hit a fresh high of ₹813 in May this year.

Copper has been experiencing a slowdown since then; the closing price on Friday was ₹719. The price band of ₹680 and ₹700 offers substantial support and similarly, on the upside, ₹775 acts as a barrier. Until either ₹680 or ₹775 is broken, the next swing in price will remain uncertain. The contract can be expected to end this year within this band.


Polish may not last

What drove prices?

Zinc supply remained surplus to requirements in 2020 as global demand for refined zinc fell by 3.9 per cent to 13.2 million tonnes, International Lead and Zinc Study Group data shows. Despite this, zinc gained 19 per cent last year on the LME due to two reasons: one, global mine production shrank 4.9 per cent and two, increase in demand from China. Usage of refined zinc in China was up by 1.3 per cent. This, coupled with a drop in mine production (including 3.7 per cent decline in China), resulted in the country importing more refined zinc last year.

Even as mine output grew by 11.3 per cent in the first four months of 2021, the consumption of refined zinc shot up by 10.1 per cent during this period with substantial rise in demand in China, according to ILZSG. Notable increase in demand was seen in other countries, including Brazil, India, Japan, South Korea, Taiwan, Thailand and Turkey. This led to contraction in surplus between January and April and the metal gaining 10 per cent year-to-date, supporting the price.

What lies ahead?

ILZSG forecasts the growth of refined zinc usage (4.3 per cent to 13.78 million tonnes) to be higher than production (3.1 per cent to 14.13 million tonnes) in 2021, resulting in contraction in surplus to 353kt as against 501kt in 2020. Consumption is anticipated to be go up by 1.8, 6.9 and 15.4 per cent in China, Europe, and Japan, respectively, which is good for prices. But this might have already been factored in, so there might not be much upside henceforth in 2021.

In addition, demand can be lower because of slowdown in automobile production. More than 50 per cent of the zinc produced is used for galvanising aluminium and steel to prevent corrosion and auto industry is one of the largest consumers of aluminium. That said, demand for galvanised steel can come from infrastructure and consumer durables industry. However, zinc is expected to be at a surplus and there will not be significant impact on prices. Our view is that the price is likely to stay within the band of $2,850 and $3,080 per tonne on the LME by end of this year.

Hindustan Zinc Limited, one of the largest zinc and lead producers in India, saw improvement in revenue and margin as metal prices rose. Revenue went up by nearly 22 per cent and operating margin stood at 52 per cent in FY21. Revenue climbed by nearly 64 per cent y-o-y in Q1FY22 and operating margin was at 54 per cent. However, the price might stay flat or see a minor decline over next couple of quarters, which might pull down company performance.

On the charts

The continuous futures contract of zinc on the MCX was oscillating between ₹162 and ₹232 from the beginning of 2017 until March 2020. After briefly dropping below ₹162 (and hitting a multi-year low of ₹123.6 in March 2020), the contract recovered and headed towards ₹232 in February this year. This time, the futures rallied past ₹232 and marked a high of ₹253.8 last month. However, it seems to be losing steam since March and volume too has subsided the past couple of months. The contract could struggle to continue the uptrend. But it has a strong base in the range of ₹232 and ₹240. These factors indicate the contract could remain within ₹240 and ₹260 by the end of this year.


Grey prospects

What drove prices?

Lead remains the weakest base metal since 2020, underperforming other metals. While it made a modest gain of 3 per cent in 2020, the year-to-date return in 2021 now stands at 14 per cent. Even as all base metals rallied last year, lead could not find its way up as global demand for lead fell faster (6 per cent) than refined lead production (4.1 per cent), creating a surplus of 255kt. About 80 per cent of lead goes into battery making (lead-acid batteries) and as auto sales slumped because of the pandemic, the usage of lead fell considerably. The gain in 2021 so far is largely because of the demand pick-up, which remained higher than production.

According to International Lead and Zinc Study Group (ILZSG) data, the demand growth in the first four months of this year stood at 11.2 per cent against the production growth of 10.8 per cent. The stocks in LME came down by 55 per cent (to nearly 60kt tonnes) compared to the level by the end of last year, putting upward pressure on the prices. But whether this rally can sustain depends on the factors, discussed below.

What lies ahead?

According to ILZSG, the global demand in 2021 is expected to grow by 3.9 per cent to 11.97 million tonnes with usage expected to rise in Europe, India, Japan, and South Korea. On the supply side, despite the closure of a 100kt per year capacity smelter in the US, refined lead production is predicted to rise by 3.3 per cent to 12.07 million tonnes, leaving excess 96kt of lead this year. Refined lead production is also aided by recycling of old batteries due to non-use following lockdown restrictions.

As things stand, the gain of 14 per cent this year is likely to have priced-in the positive factors and going ahead, sober demand because of less production in automobile sector might weigh on the metal price towards the end of the year. Beyond that, considering the pollutive nature of lead, preference of lithium-ion batteries over lead-acid batteries can be a dampener over the medium to long-term prospects of the metal. As countries move ahead with environment-friendly policies, lead might find itself being left behind. On the back of the above factors, we see high possibility of LME price declining to $2,150 per tonne by the end of 2021.

On the charts

The price of lead futures on the MCX was fluctuating within ₹132 and ₹172 between early 2017 and March 2020. Backed by the rally that began off the support at ₹132 in May 2020, the contract steadily gained and moved beyond ₹172 to reach ₹182 in February this year. Since then, it has been losing momentum and made several failed attempts to break out of ₹182. But this level stays valid and the price action on the week chart shows that the price band of ₹172 and ₹182 is likely to be a critical barrier for the contract.

The contract remaining below ₹182 for a prolonged period will only make the resistance at ₹182 stronger, thus reducing the possibility of a fresh rally beyond that price. While the contract is yet to witness a bearish trend reversal, the way the contract has been trading of late hints at that possibility. In price terms, a break below ₹165 could mean that the trend has turned southwards, which is a possibility. The lead futures might slowly correct towards ₹165 towards December end.

Published on August 28, 2021

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