January/February 2005
Most commodities soared in 2004, with many setting records or revisiting previous highs. Will the markets remain aloft in 2005, or will they start returning to earth? While the first half looks good, the forecast becomes less certain later in the year.
By Robert J. Garino
Sometimes the market forecasters get it (mostly) right. Looking back at our 2004 market forecast story, we can now see that many of our sources were on, or close to, the mark with their predictions for the past year—and, boy, were we amazed.
As 2003 ended, most of our contacts as well as published sources were convinced that 2004 would be a positive year. They based their optimism on constructive macroeconomic developments that, they assumed, would favor industrial production, demand, and consumption. They also reasoned that ongoing supply issues for certain nonferrous metals would help support higher prices in 2004.
As it turned out, market fundamentals were generally stronger than expected. Demand for several major base metals far outpaced new supply and, as inventories fell, the average-price forecasts proved understated across the board. In the steel sector, China was—as predicted—the driver behind raw steel production and consumption. That’s not to discount the continued U.S. and global expansion that many predicted for all levels of the economic spectrum.
All industries didn’t excel to the same degree, however. The paper and paperboard industries, for example, didn’t respond as favorably as the metals sector, though the total amount of scrap paper recovered in 2004 set a record. Some analysts also correctly identified potential problems in 2004. To wit, several warned that rising crude oil prices could hinder the global recovery, while others expected a general slowing of the domestic economy (evident in the “soft patch” the U.S. economy experienced in the second quarter last year). Others also questioned whether China’s torrid growth rate would—or could—be sustained. Those concerns, along with the ongoing war in Iraq and escalating Middle East tensions, were viewed as potentially disruptive variables for the global economy in 2004.
In the end, though, last year more than exceeded expectations (except perhaps on Wall Street) for perfectly understandable reasons: For one, the U.S. economy was solid, with GDP growth of 4.5 percent in the first quarter, 3.3 percent in the second quarter, 3.9 percent in the third quarter, and a projected 4-plus percent for the year—a level well above the longer-term U.S. GDP trend.
Global growth was even more impressive, with real GDP growth in 2004 projected to be 5 percent—the highest rate in nearly 30 years, according to the International Monetary Fund (IMF) (Washington, D.C.). Most of the potential negatives for the market—such as energy, inflation, and war—were identified early and factored in, albeit in a relatively conservative fashion. The fact that there were no lasting or profound global shocks to the system helped smooth the way. This was a welcome change from recent years in which the world economy seemed to move in fits and starts.
That Was Then, This Is Now
With 2004’s grand performance now in the past, though, what lies in store for 2005?
Several economists assert that inflation and currency issues will be serious national and international challenges this year. Their worries center on America’s continued expansionary monetary policy, the huge U.S. budget and current-account deficits, rapidly rising commodity prices, slower global economic growth, and the falling value of the dollar. The dollar’s weakness, in fact, “will be a dominant influence in the world economy in 2005,” stated ABN AMRO Bank N.V. (Amsterdam) in December. Some analysts are comparing the current market dynamics to the late 1970s and are troubled that the Federal Reserve may not be paying enough attention to the early warning signs of inflation. For these reasons, ABN AMRO expects slower U.S. and world GDP growth of 3.25 percent and 4 percent, respectively, this year.
IMF is also more cautious about 2005’s prospects. While the group sees continued expansion of the world economy, the balance of risk has “shifted to the downside,” with further oil price volatility and “geopolitical risks becoming the central short-term concerns.” IMF’s inflation-adjusted GDP forecast for this year calls for a U.S. growth rate of 2.9 percent (compared with 3.6 percent expected for last year) and a world growth rate of 4.3 percent.
Offering other 2005 forecasts, Société Générale (Paris) predicts U.S. GDP growth of 3.6 percent and global growth of 4 percent—slightly lower than last year but “a still healthy pace.” Also, the Organization for Economic Cooperation and Development (OECD) (Paris), which represents 30 member countries with market-driven economies, sees U.S. GDP growth of 3.3 percent and GDP growth for all OECD members of 2 percent this year. Though global growth is expected to show a year-on-year decline, the U.S. economy, in contrast, will keep growing “above potential,” said OECD’s chief economist last November.
Regarding U.S. growth, the Manufacturers Alliance/MAPI (Washington, D.C.) recently lowered its forecasts for both 2004 year-end results and 2005. Previously, the group predicted growth of 4.5 percent in 2004 and 3.7 percent in 2005, but it scaled back those numbers to 3.9 percent and 3.4 percent, respectively. The manufacturing sector is, however, expected to outpace the overall economy with a 4.1-percent growth rate this year, according to the group’s chief economist. Adding another view, the National Association for Business Economics (Washington, D.C.) is projecting a 3.7-percent U.S. GDP growth rate in 2005.
And what of China? Several forecasts place China’s GDP growth around 9 to 10 percent in 2004 and 7.5 to 8 percent this year—lower, yes, but still extraordinary. This lower rate, in fact, is largely due to China’s deliberate efforts to slow its economic growth, analysts note. While the Asian Development Bank (Manila, Philippines) agrees with 8-percent growth for China, that rate could slip to 7.2 percent if crude oil stays around $40 a barrel, the group says. Should Chinese industrial production continue to register strong year-on-year increases, the overall outlook for industrial metals “remains extremely robust,” says Barclays Capital (London), which also pegs China’s GDP growth this year at 8 percent.
Overall, market watchers see considerable momentum in the domestic and global economies at the start of 2005, with only modest downside risk through midyear. After that, however, the macroeconomic picture becomes less certain, more conservative.
Last year, our market forecast story included a song verse that seemed to capture the spirit of the consensus outlook: “The future’s so bright, I gotta wear shades.” Will that optimistic chorus be repeated this year, or will a new song prove more prophetic? Some contributors to this story believe the new refrain may include this line from a late-1960s hit tune: “Those were the days, my friend, we thought they’d never end …”
With those nostalgic words in mind, let’s take a closer look at the forecasts for seven major commodities.
Aluminum
In the first five months of last year, the aluminum market was shrouded by uncertainty, with LME prices showing little independent movement. While demand was clearly improving, there were deep concerns that an apparent global overhang of primary metal would inhibit any upward price move.
Sentiment for the light metal changed as the year progressed. Global aluminum demand proved to be stronger than expected, while primary supply was constrained by shortages of alumina and power. Reduced smelter output pushed aluminum into a deficit position, as reported stocks declined more than 700,000 mt in the January-November period. The U.S. market, in fact, was described as “structurally undersupplied.” Even with the high level of production expected this year, aluminum stocks aren’t expected to be restored to a “normal” level, says James King, an independent U.K.-based consultant.
Given these changing market dynamics, forecasts became increasingly bullish, with most assuming that relatively tight primary supply would remain a driving factor through June 2005. After projecting an aluminum deficit of 349,000 mt last year, for instance, BB&T Capital Markets (Richmond, Va.) predicts a 948,000-mt shortfall this year along with an LME cash average of 88 cents a pound. Merrill Lynch & Co. Inc. (New York City), in contrast, sees a smaller deficit of 525,000 mt but a higher average price of 90 cents.
Other aluminum price forecasts for 2005 include 82.5 cents (Société Générale), 81.6 cents (Macquarie Research), 78.9 cents (Barclays Capital), 78.2 cents (Standard Bank), about 76 cents (James King), and 74.8 cents (HSBC).
Copper
In contrast to the muted expectations for aluminum early in 2004, the forecast for copper was far more optimistic. After all, copper’s fundamental picture was looking solid at the end of 2003, with firm global demand prospects and uncertain supply holding out the potential for higher prices.
The 2004 market turned out to be even more bullish than envisioned, with improving global demand, falling inventories, a weaker U.S. dollar, speculative influences, and surging Chinese imports of copper concentrates, refined metal, and scrap. Despite stalling in the second quarter last year, copper’s upward trend was firmly reestablished, driven by both fundamentals and speculative influences. As a result, producers and analysts had to routinely increase their estimates of copper’s global deficit as well as its price prospects.
Last December, Macquarie Research again revised its 2005 price forecast, calling for LME cash to average $1.35 a pound. In its view, supply won’t keep pace with new consumption, yielding a deficit of 250,000 mt this year. Other sources are less convinced of copper’s underlying strength in 2005. To support their positions, these sources point to evidence of destocking of copper, slower economic growth, and improved availability of copper concentrates, all of which should reduce the statistical shortfall as the year progresses.
On balance, though, most believe that the Western World and global copper markets will be in deficit this year, with prices in backwardation through the first quarter. Thus, the differences of opinion center on the actual size of the deficit. Last October, for instance, Standard Bank forecast a 290,000-mt deficit in 2005, while Société Générale sees a shortfall of 300,000 mt and Barclays Capital pegs the total around 337,000 mt.
Copper prices, meanwhile, could show increased volatility based on any unexpected supply-and-demand developments. Barclays Capital forecasts an LME cash average of $1.20 a pound this year and, in fact, sees the potential for prices to challenge the peaks seen in 1988-1989 (in December 1988, for instance, copper averaged nearly $1.60). Likewise, Société Générale predicts that copper prices will remain “historically high through 2005,” projecting an LME average of $1.19. Other forecasts include HSBC’s $1.15 average, Standard Bank’s $1.10 prediction offered last October, and London-based Bloomsbury Minerals Economics’ $1.12 projection in December.
Iron and Steel
The global steel industry was on track to produce more than 1 billion mt of steel last year—an all-time record. According to the Iron and Steel Statistics Bureau (London) last October, global steel output would end 2004 at 1.050 billion mt, up more than 8 percent from 2003, with China setting the pace at more than 260 million mt of production.
As for the United States, its raw steel output in 2004 was expected to be around 100 million mt, also a positive year. Actual domestic steel consumption (total shipments plus net imports) was even more impressive last year, growing at a double-digit rate.
This record-setting production stretched the raw material supply chain, affecting iron ore, coking coal, pig iron, scrap substitutes, and purchased scrap as well as energy and transportation. Overall, global merchant scrap requirements increased 15 million mt last year to 292 million mt, says the International Iron and Steel Institute (IISI) (Brussels, Belgium). MEPS (International) Ltd. (London) places the increase in scrap demand closer to 25 million mt based on its 2004 production forecast of 1.035 billion mt. Either way, unprecedented demand for ferrous scrap resulted in record prices and escalating surcharges on finished steel, as mills sought to recover some of their higher raw material costs.
This year, domestic and global steel demand is expected to be relatively strong, with China again the main focus. IISI, for one, expects crude steel production to increase 6 percent this year to 1.115 billion mt. To meet this production, merchant scrap requirements will increase almost 9 percent, or 26 million mt, the group says. World Steel Dynamics (Englewood Cliffs, N.J.) also sees continued growth this year, with global crude steel production expected to reach 1.071 billion mt, 3.3 percent higher than its 2004 estimated production of 1.043 billion mt.
Overall, IISI anticipates a sustained period of higher global steel production and ongoing tightness in ferrous scrap, which means that “prices for scrap are going to stay high.” By 2010, the group projects, global steel production will total 1.3 billion mt, requiring 388 million mt of merchant scrap—96 million mt more than was needed in 2004.
Lead and Zinc
Lead was energized in 2004, with LME prices briefly visiting 14-year highs last July. The change in market sentiment and outlook can be traced to low supplies of lead concentrates and growing demand for refined lead from China, India, and South Korea, which offset static Western World consumption. The net result was a lead market in deficit and average lead prices at levels last seen in 1980.
Lead’s firm global fundamentals follow a two-year cutback in Western World mine output, CRU notes. As a result, last year’s primary production posted its fifth consecutive year of decline, while Chinese imports of lead concentrates rose steadily. The resulting shortages of ores and concentrates, CRU says, will be enough to keep the lead market in deficit this year as well. According to the International Lead and Zinc Study Group (ILZSG) (London), lead was expected to end 2004 with a 188,000-mt deficit. This year, the group sees a smaller shortfall of 118,000 mt as China, Australia, Canada, and India ramp up production to meet demand.
Overall, lead forecasters see supply and demand trending toward a balance this year based on new primary production and a modest increase in output from secondary smelters. Lead’s price prospects this year are expected to remain at historically high levels, albeit below last year’s final average. Predictions include a high of 40 cents a pound from Macquarie Research to a low of 34 cents from AME Mineral Economics (Sydney, Australia). In between, the price forecasts include 36 cents from both Standard Bank and Société Générale to 36.3 cents from Barclays Capital.
As for zinc, its price fortunes have been limited in recent years by the ready availability of refined slab and LME zinc inventories, which have kept the metal’s supply-and-demand balance in surplus since 1999. In addition, China’s position as a major zinc producer served as a constant threat to the overall market sentiment. Consequently, with Western World consumption showing little or no growth in recent years, zinc prices languished in the mid-to-upper-30s-cents range since mid-2001. Last year, however, the outlook brightened.
Through the first three quarters of 2004, the global deficit of refined zinc totaled 190,000 mt compared with the 147,400-mt surplus in the same 2003 period, ILZSG reports. Global zinc production was reportedly increasing at a rate less than half that of consumption, thereby drawing down inventories. LME stocks, which stood at 740,400 mt at the end of 2003, fell more than 66,000 mt in the January-November 2004 period. Plus, global stocks eased below the 1-million-mt mark for the first time since mid-2003.
Based on these improving fundamentals, Deutsche Bank AG (Frankfurt, Germany) predicts that the global market will be undersupplied this year and next. With available zinc concentrates being depleted as consumption continues to expand, the bank expects a 150,000-mt supply deficit this year along with an average LME cash price of 56 cents a pound. Société Générale also believes that zinc has upside potential this year, with its projected price average of 53.5 cents based on an assumed global deficit of 180,000 mt. Other 2005 price forecasts include 53 cents (Macquarie Research), 52.2 cents (Barclays Capital), 52 cents (Citigroup), and 44.9 cents (Standard Bank).
Nickel and Stainless Steel
The nickel market entered last year on solid footing, with demand driven by strong stainless steel consumption. World demand for stainless was expected to end 2004 at a record 24 million mt, says Markus Moll, managing director of SMR GmbH (Reutte, Austria). Beyond this fundamental demand, speculative nickel buying by both commodity and investment funds led to extreme price volatility for nickel on the LME.
Nickel’s volatility, in turn, had an impact on this year’s outlook. Market participants and analysts assessed the “overbuying” of nickel and stainless steel and its lingering effects last year on the destocking of nickel by consumers and producers, scrap utilization rates, product substitution, and the potential for lower production and consumption by the Chinese in 2005.
These and other related market influences nudged nickel’s global supply-and-demand balance last year from deficit to a more balanced state than in past years. According to the International Nickel Study Group (INSG) (The Hague, Netherlands), global primary nickel output totaled 1.25 million mt last year. Despite lower-than-expected primary nickel consumption, Macquarie Research still expects the global market to post a deficit in 2004 and 2005, albeit lower than in 2003. Global economic recovery continued to be a major driving factor, the firm notes, along with scrap tightness, underinvestment and delays in new supply, and low aboveground nickel stocks.
Last November, Société Générale said that nickel output in 2004 may prove to have been underreported while stainless production may turn out to be less than expected. This, combined with a buildup in unreported nickel stocks, meant the market was in “rough balance” last year and will again be close to balanced this year, the firm says. INSG also forecasts a balanced market this year, with primary nickel output at 1.32 million mt. Meanwhile, stainless steel production this year is expected to reach 25.8 million mt, says the International Stainless Steel Forum (Brussels, Belgium), up 5.7 percent over last year’s estimate of 24.4 million mt.
As for nickel’s price prospects this year, Morgan Stanley (New York City) sees LME cash peaking at $7 a pound based on low LME stocks of primary metal, tight scrap supplies, the return of Chinese buying, and no surge in new primary production. Offering other views, CRU International Ltd. (London) predicts a $6.35 average this year, while Macquarie Research forecasts $6.75, bolstered by a projected supply deficit of 10,000 mt this year. Prices, Macquarie says, should remain firm “especially in the first half of the year.” Nickel’s 2005 price forecasts also include $5.67 (Barclays Capital), $5.35 (Société Générale), and $5.24 (HSBC).
Paper and Recovered Fiber
In contrast to the generally bullish outlook for metals in 2004, the paper-related markets faced more-reserved expectations. Though most anticipated recovery in the domestic market, many looked to China as the principal price driver for both domestic market pulp and recovered fiber.
At the end of 2004, pulp prices were once again on the upswing following a midsummer correction. North American producers of northern bleached softwood kraft (NBSK) were showing a list price of $650 a mt and $640 in Europe. Based on improving fundamentals, Smith Barney (New York City) is forecasting NBSK delivered to Europe at $690 a mt this year. CIBC World Markets (Toronto) also increased its 2005 pulp price forecast by $10 due to what it sees as “exchange-rate induced” changes rather than any significant changes in supply or demand.
In November, however, EMGE & Co. (London) noted that the growth rate in world demand for printing and writing paper is slowing, with the 2005 rate expected to be 5.8 percent. China, the firm said, remains the key, largely due to planned pulp and papermaking capacity additions.
As for recovered paper prices last year, most domestic scrap grades showed little upward inclination after peaking last summer. The national average for all grades tracked by Paper Stock Report, for example, peaked at $147.01 a short ton in August. As 2004 ended, the Midwest market for OCC was $75 to $80 a ton, with ONP about $85 to $90.
Price forecasts offered for 2005 by Resource Information Systems Inc. (Bedford, Mass.) see OCC averaging $105 a ton, picked up, and ONP around $98. As with the market for pulp, export demand will influence any price forecast. Notably, last year proved to be another record year for U.S. scrap paper exports.
Robert J. Garino is director of commodities for ISRI.
Most commodities soared in 2004, with many setting records or revisiting previous highs. Will the markets remain aloft in 2005, or will they start returning to earth? While the first half looks good, the forecast becomes less certain later in the year.