2000 Roundtable Coverage—Prepare for Landing

If you can view the 2000 commodity markets as an airplane flight, it’s about the time when the flight attendant tells passengers to fasten their seatbelts and prepare for landing.

To be sure, there’s a lot of talk in business circles about an impending economic landing. Yes, the seemingly inexhaustible U.S. economic juggernaut may finally be slowing, leading optimists to predict a “soft” landing and pessimists to fear a “hard” one.

Only time will tell which, if any, landing occurs, but one thing’s for certain—2000 has brought some significant economic changes that could have negative effects on metal commodities for the remainder of this year as well as 2001. Need proof? Just look at the skyrocketing energy prices, increasing interest rates, turbulent stock market, and ailing euro.

While many metals seem to have solid fundamentals, market participants know that fundamentals can change quickly, especially given the unpredictable behavior of major players such as China. Plus, fundamentals aren’t the only, or even the major, factor driving the metal markets these days. There’s always the wild card of hedge-fund buying that can skew the picture for any metal at any time.

So, though the metal markets entered 2000 unscathed by the Y2K nonevent, they’re now facing other potentially more serious global economic shifts. That helps explain why many speakers at ISRI’s commodity roundtables, held in September in Chicago, offered little more than guarded optimism on the prospects for aluminum, copper, iron and steel, lead, and zinc. Here’s what they had to say.
  
ALUMINUM

Like many industries, aluminum is bracing for the anticipated braking of the robust U.S. economy. Concerns expressed at the aluminum roundtable were wide-ranging, encompassing interest rates, consumer confidence, the supply of raw materials, and rising energy prices.

Tom Akers of Metal Exchange Corp. (St. Louis) asserted that increasing interest rates take their toll eventually, as do increasing energy prices. Gasoline, for instance, is up 60 percent and electricity has jumped as much as 162 percent in California since 1997, he said.

Other important economic indicators are that housing starts are down 50 percent, while automobile production has increased 4 percent, Akers reported.

On the European front, the euro has depreciated almost 30 percent since its debut, bringing “the threat of inflation, and with the threat of inflation there’s an increased expense of buying from the outside,” Akers said. As a result, Europe won’t import much, it’ll export more, interest rates will rise, and a slowdown will occur.

In Japan, stocks of aluminum have risen, and the opinion among analysts is generally neutral, which is better than it’s been for a long time.

Domestically, not only are aluminum mills not buying scrap, they’ve actually become scrap sellers, Akers said, noting that the discount for scrap is at a historically wide level and may go wider.

So, does that mean the sky is falling?

“It sure as heck doesn’t feel like a soft landing, but it’s a big pipeline effect, and the pipeline isn’t just a pipeline that we look at somewhat myopically in the aluminum industry, but it goes all the way to the products on the shelves at the Wal-Mart and the Home Depot,” Akers said.

In his view, aluminum will continue at a level similar to the overall economy, and any slump in the economy will be an aberration. Longer term, “the world economies in general look pretty good,” while the U.S. economy will slow down to an annual growth rate of 4 to 5 percent, he forecast.

Reorganization will continue to be a feature in the aluminum industry, said Akers, pointing out that Wabash Alloys L.L.C. (Wabash, Ind.) and Newco Metal Recycling Inc. (Greenwich, Conn.) have been undergoing reorganization. Companies usually don’t reorganize if everything is well, he noted, adding that the industry is also likely to see more consolidation.

One result of such consolidation, he continued, is that “there are fewer consumers, and they swing bigger sticks. They’re not going to put up with poor scrap quality, and the demands for [quality material] are going to continue to get tougher, not easier.”

Room for Stability? Internationally, there’s reason to be cautiously optimistic regarding aluminum, said John Martin of CRU International Ltd. (London).

“The big question is: Are we going to have a repeat of what happened last year, or is there some reason why we can’t be more optimistic about price this time?” he asked. “We actually believe there really is some reason to be more optimistic, and it has more to do with the industry’s shock absorbers.”

While the LME three-month price has been volatile over the past 12 months, there’s room for stability, he said. According to CRU, world consumption is set to grow more than a million metric tons in 2000 and perhaps 2 million mt by 2001, while the reported inventory cushion has been depleted. Production will be limited, mostly due to power problems in the Pacific Northwest. World smelting capacity, meanwhile, is projected to rise 650,000 mt in 2001—not enough to meet the growing demand.

So, said Martin, growth and primary production prospects are key, and the ingot-scrap differential could widen due to weaker demand prospects in North America. Domestic scrap demand will slow, growing 2 percent in each of the next two years in auto castings, declining 2 percent in can stock, and slipping 3 to 6 percent in extrusions, he forecast.

Prices have been edging up, and they’ll rise as the market moves into deficit in 2001, he said.

“In the last week or so, investment funds have been getting very excited about the industry again,” Martin asserted. At this time last year, prices were around $1,500 per mt. Investment funds became excited that there would be a shortage in January, but Alcoa announced a production agreement adding more capacity, so the investment funds never took flight. Since then, he said, prices have been very volatile, though they have been edging up.

Problems Aplenty for Secondaries. Speaking from a secondary aluminum smelter’s perspective, Stuart Cohn of Behr Metals Inc. (Rockford, Ill.) noted that secondaries continue to grapple with narrow margins, shortfalls in short-term demand, and rising energy costs.

The problem of pricing also plagues the industry. As Cohn explained, “It has become increasingly popular to place sales of ingot on a formula based on a discount of published prices. This discount has gotten greater over time while, at the same time, the price has gotten lower against what I see as our natural selling points. Couple that with spreads that are narrower than normal, and you have your recipe for potential disaster.”

In his view, publications that include price data should give different weight to prices quoted by secondary smelters of different sizes, such as a million-pound producer and a 50 million-pound producer. 

As for the secondary industry’s near-term prospects, Cohn expressed caution, mainly because of the industry’s tie to the overall economy. His company expects prime interest rates to rise to 93/4 percent by 2001, which will have a dampening effect on the economy. He also said that CEO confidence in the economy is down. “I think much of this concern comes from wondering how long you can continue at business levels we’re presently at and how soft the landing will be,” he said.

Confidence is also slowing down in the automotive industry, which accounts for 40 to 50 percent of the demand for aluminum die-castings, Cohn noted. “The year started at its highest confidence level ever, and while the future looks good to very good, it’s still lower than the first quarter,” he said.

Though supplies of Russian ingot have decreased, U.S. secondaries aren’t hurting for adequate raw material supplies, Cohn said. Should the flow of Russian ingot increase, he noted, that would mean less scrap needed by secondaries. Overall, though, the secondary scrap market will remain stable with slight price variations.

An Eye on North America. Though Eivind Hagen of Norsk Hydro AS (Oslo, Norway) was cautious about the market’s direction, he was more confident about his company’s plans to make headway in the North American market.

“Even though we’re primary producers, we’re very well aware that scrap is becoming more and more an important source,” said Hagen, whose company has a production capacity of about 760,000 pounds annually. North America, he noted, is becoming more dependent on imports of raw materials, so his company believes it can do well in that market region.
   
COPPER

 In a review of copper market fundamentals, Craig Tuckman of Chase Manhattan Bank (New York City) initially examined the “implied supply-demand imbalances for refined copper” over the past five years. Following two years of surplus in 1998 and 1999, the global copper market is heading toward a 100,000-mt shortfall this year, he said. This despite second-half demand prospects that are expected to be weaker than first-half demand.

Looking ahead, Tuckman also forecast a growing shortfall of copper concentrate, resulting in a 180,000-mt deficit for refined metal in 2001. The copper market, he maintained, won’t return to surplus until 2002.

In light of these projected deficits, Tuckman’s analysis called for a cash price average of 88 to 90 cents a pound next year as the copper stocks-to-consumption ratio drops to 4.7 weeks of consumption from an expected average of 5.6 weeks this year. Total copper demand, however, is expected to slow from 5.3 percent growth this year to around 3.7 percent next year. Despite this projected slower demand growth, more new supply would be required next year at higher average prices. In addition, any unexpected demand-side shocks could move the supply-demand balance below the critical level of 4.5 weeks of consumption, Tuckman said.

Price volatility will also be a feature next year as producers look to lock in relatively high forward prices, he stated. Hedge funds, he said, tend to view this strategy as a negative signal, thus adding to potential price gyrations.

On the scrap side, Tuckman asserted that domestic recyclers can expect to see wider spreads, reflecting a slowing in order books at copper fabricators. Given the possibility of refined tightness next year, however, spreads for better scrap grades could hold around present levels on average, he concluded.

Death of U.S. Copper Scrap Refining. Also speaking at the copper roundtable, Henry Schweich of Cerro Copper Products Co. (St. Louis) focused on what he called the “unnecessary and pointless destruction” of the U.S. electrolytic copper scrap recycling industry.

To illustrate this trend, he recalled a host of refiners that have closed in the past decade and reminded listeners that only one company—Chemetco Inc. in Hartford, Ill.—is still receiving copper scrap for conversion into copper cathode. And even that company, he noted, is facing potential closure due to ongoing environmental issues with the state of Illinois.

Why this shift away from recycling copper scrap?

 In Schweich’s view, the most significant cause has been what he called “incomplete and poorly constructed environmental legislation, compounded by excessive and unnecessary costly regulation at both the federal and state levels.” The destructive effects of legislation, he said, have been “dramatically compounded” by “arbitrary, capricious, and arrogant bureaucratic implementation.”

Offering an example of the above, Schweich traced the events leading to the closure of Cerro’s refinery in Sauget, Ill., in 1998. As he explained, rising environmental compliance costs drove scrap conversion costs up threefold in less than a decade. As operating costs increased, Cerro was forced to close the refinery and abandon that portion of its business. Taking into account Cerro’s closure and the other domestic consumers that have ceased operations, the domestic copper scrap recycling rate has fallen to about the same rate as at the beginning of the last century.

Going With the Flow. Copper trade flows were examined by Andy Goenka of Steelbro International Co. Inc. (Oyster Bay Cove, N.Y.), who looked at copper trade from the United States as well as the Chinese and Indian markets.

The United States, he said, saw increasing copper imports (mostly cathode) and exports (mostly scrap) through the first six months of this year. Both imports and exports have maintained a steady growth pattern. Domestic mills are busy, with enough orders to run at full capacity. Thus, Goenka stated, the domestic copper market is going to have “steady and gradual growth for the months to come.”

China and other Pacific Rim countries are showing clear signs of recovery this year, with China being the “best bet” in the near term, Goenka said. Prices in China have firmed this year thanks to production cutbacks in Indonesia and the hint of “possible” rationalization among Japanese smelters.

China’s lower domestic supply and higher demand have resulted in higher domestic consumption. According to Goenka, total Chinese consumption is expected to reach 1.8 million mt this year compared with 1.4 million mt last year. Imports, he said, will have to play a significant role in feeding this nearly 30-percent growth rate. The Chinese market offers a “bright outlook,” therefore, for U.S. exporters of copper scrap.