US-China Trade War. Price correction in metals may be short-lived

As the much-anticipated trade talks between the US and China fell through, all stakeholders — from farmers to businessmen — were disappointed. The sentiment dampened further when the renewed tariff impositions were announced.

In response to the increased US tariffs on the $200-billion Chinese exports, China announced that it would raise tariffs on $60-billion worth US goods from 5/10 per cent previously to 10/20/25 per cent from June 1.

It’s not a surprise then that metals became the scapegoat, as most of the goods traded between the US and China are metals or products with metal components, such as machinery, electrical equipment and vehicles.

Prices of metals including zinc, copper, aluminium and nickel have fallen 11-20 per cent from a year ago.

The LMEX (London Metal Exchange Index) (weighted index of all base metal prices) is down nearly 17 per cent from a year ago.

Here, we look at the impact of the trade tensions on the global metal industry, and whether users of the metals should take advantage of the current low prices.

Economic impact

The global metal industry is supported by China’s raging appetite — the country is the top producer as well as the consumer of most metals. It also leads in the production of base metals such as aluminium, zinc, lead and nickel.

Also, the US and China are interdependent. For instance, while the US exports nearly half of its lead concentrate to China (16 per cent of its requirement), China exports a significant number of lead-acid batteries to the US. Thus, the cross tariffs are set to hurt both the economies.

A report by UBS, a Swiss investment banking company, has estimated that the Chinese GDP growth rate would drop 30-40 basis points over the next 12 months. The report also states that if the US imposes 25 per cent additional tariffs on all other Chinese exports to the US, which are estimated to be worth about $300 billion, the GDP growth rate of China will be further reduced by 80-100 basis points, resulting in the growth sliding to below 6 per cent for 2019 as well as 2020.

Ironically, imposition of tariffs by the US in the name of protectionism will also hurt the US economy. For example, a study by NERA Economic Consulting — Impact of Potential Aluminum Tariffs on the US Economy — found that tariffs on aluminium imports would result in lower output, employment and personal income in the rest of the economy, which would significantly offset any gains in the aluminium sector.

If the growth of the world’s two biggest economies slows down, there would be huge repercussions in global trade, lowering the demand for metals and exerting further pressure on commodity prices.

Good buying opportunity

Even though the developments in the US-China trade talks are depressing, fundamentals of most metals remain strong.

The supply-demand dynamics of most metals remain under pressure on the back of closures of multiple smelters and mines, and concerns over drop in prices. For instance, in 2018, while copper usage was up 3 per cent, production increased just 2 per cent year-on-year.

Inventory across all metals in LME, SHFE (Shanghai Futures Exchange) and CME (Chicago Mercantile Exchange) are about 25 per cent lower than last year.

In case of copper, the International Copper Study Group (ICSG) has revised up its deficit forecast for 2019 and 2020.

Thus, with large deficit forecasts for metals this year, the inventory in LME and other exchanges may fall further.

However, the current LME prices are way lower than what is justified by the fundamentals of the metals.

Sandeep Daga, Director of Regsus Consulting, a commodity hedging consultancy, believes an upward trend of LME prices is imminent and that a further drop in prices in case of unfavourable outcome from the G20 summit next month will be short-lived. “From the point of view of the respective fundamentals of each metal, the current prices provide a handsome buying opportunity not only for the rest of 2019 but also for 2020.”

Users of metals can thus lock into the current prices. However, it is recommended that they also hedge an appropriate part of their total exposure.

No big win for India

While, there is a school of thought that the Indian metal industry could seize the opportunity as the 25 per cent tariffs make Chinese products less competitive, experts brush aside this idea saying that the Indian metal industry is small and is currently a net importer of most metals; it will not be able to fill the void China’s absence creates in the global market. Also, demand for metals will be diverted to countries with LME warehouses. As India does not have an LME-registered warehouse, an increase in demand for the Indian metal industry is not on the cards, say some experts

However, small downstream metal players, who purchase metals and sell customised products, could benefit if China exports its surplus primary metal to India at lower prices.

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