January/February 2006
Last year brought its share of “shocks”—including record energy prices and devastating weather—but nothing could stop the market’s positive momentum for most in the metal industries. That begs the question in 2006: Will the market continue its marathon run, or is it on its last lap?
By Robert J. Garino
It’s common for forecast articles like this one to first take a look back before looking ahead—and why not? With the luxury of hindsight, we can now examine the forecasts for 2005 and see if they were close to the mark.
At the start of 2005, inflation and currency issues loomed as serious national and international concerns. The factors behind those concerns included America’s ongoing expansionary monetary policy, its huge budget and current account deficits, fast-rising commodity prices, the falling value of the dollar, and anticipated slower global economic growth. Some, seeing similarities to the late 1970s, worried that the Federal Reserve Board wasn’t paying enough attention to inflation’s early warning signs.
On the world stage, several financial institutions—as well as scrap processors and consumers—were growing cautious about overall global economic growth in 2005. Though many expected continued expansion, others maintained that the balance of risk was toward the downside. Several saw oil price volatility and geopolitical risks becoming the central short-term concerns. At the time, an inflation-adjusted GDP forecast called for world output growth of 4.3 percent in 2005, with the United States at 2.9 percent compared with a 3.6-percent rate expected in 2004.
China continued to command attention, with its surging economy holding the key to virtually all global economic growth projections. The International Monetary Fund (IMF) (Washington, D.C.) and others placed China’s GDP growth at 9 to 10 percent in 2004 and closer to 7.5 to 8 percent in 2005. The lower rate, most believed, was largely based on the assumption that China would succeed at deliberately slowing its economy.
Reviewing the Results
With 2005 now history, it’s clear that many of the previous macroeconomic issues and concerns did indeed surface but had limited effects. Take inflation. The Fed continued to hike short-term interest rates last year, with most expecting the funds rate to reach 4.5 percent by the time Chairman Alan Greenspan retires in January 2006. The rate increases in 2005 confirmed to most that inflation remains a threat, suggesting that additional rate increases are likely as new Fed Chairman Ben Bernanke steps in. Claymore Advisors L.L.C. (Lisle, Ill.), for one, expects a 5-percent federal funds rate by this May.
And energy? Crude oil and natural gas hit record prices last year. Crude oil was $70.85 a barrel on the New York Mercantile Exchange last August due to the hurricanes that temporarily crippled U.S. refining capacity. Though many expected the energy supply-and-demand balance to be relatively tight in 2005—mostly driven by unprecedented global demand—the Gulf Coast storms exacerbated the tenuous condition.
Though the storms and the subsequent spike in crude oil were shocks to the U.S. system—and, ultimately, threats to the health of the global economy—they did not derail U.S. or global economic growth. Last year’s oil price shocks, in fact, were nothing compared with the crises of 1974 and the early 1980s. Significantly, 2005 brought no other events that materially altered earlier assumptions about the U.S. and global economies. Even the ongoing violence in Iraq had little effect on consumers’ psyches.
Even the second-quarter slowdown in the U.S. market came and went without making a lasting impression. Metal consumption sputtered and commodity prices corrected as a result, but this proved to be a short-lived phenomenon—at least regarding prices. Only Wall Street seemed less than enthused throughout last year despite the positive macroeconomic picture and improved earnings of many companies.
Thus, many of the broad assumptions about last year hit close to their targets. If anything, most underestimated the strength of the global economy and the United States as well as the resilience of the U.S. dollar. No one, however, anticipated the surge in base metal prices at the end of 2005. While overall scrap demand and end-use consumption may have disappointed some compared with 2004—especially for the paper and paperboard industries—last year still offered many opportunities for growth and increased profitability, despite the increased costs of doing business.
The Next Lap
In its World Economic Outlook published last September, IMF asserted that “the expansion remains broadly on track,” with its global forecasts for 2005 and 2006 largely unchanged from its April 2005 report. The group retained its world output forecast at 4.3 percent for 2005, while modestly downgrading its 2006 forecast to 4.2 percent—still above the longer-term growth trend. “All in all,” added Jean-Philippe Cotis, chief economist for the Organization for Economic Cooperation and Development (OECD) (Paris), “global growth has been exceptionally vigorous.”
The Institute for International Economics (Washington, D.C.) also expected global growth of about 4 percent last year, though it projects a 3.5-percent growth rate this year. The institute is convinced that central banks in industrial nations will have more restrictive monetary policies this year that, in turn, could limit GDP and IP growth in the G-7 countries. This certainly looks to be the case in the United States. In the European Union (EU), meanwhile, the European Central Bank (Frankfurt, Germany) raised interest rates 25 basis points in December, much to the dismay of many EU business leaders.
Is that the only worry for 2006? No. Other concerns echo last year, including inflationary pressures, a slowing of global growth, unforeseen geopolitical upheavals, a potential influenza pandemic, and ongoing energy challenges. For these reasons, many are looking closer at gold’s potential to increase in 2006. With bullion above $500 a troy ounce in December, sentiment remains positive that gold can, and will, hold above this price through midyear. Macquarie Research Ltd. (London) has gold peaking this year at more than $550.
As for the United States, OECD forecasts this year’s U.S. growth rate at 3.5 percent, higher than its 3.3-percent projection last May. Claymore Advisors sees U.S. GDP growth of 3.9 percent this year, while H.S. Dent Foundation (Allen, Texas) expects the Dow to reach 14,000 to 15,000 by August.
On balance, however, many business leaders fear that the U.S. economy is slowing, which would naturally affect the country’s industrial output and GDP. Several economists expressed special concern about automotive sales in 2005 and the overall health of the domestic auto industry. According to a survey conducted last August-September by Bank of America Business Capital, executives in the manufacturing sector were less optimistic than in the past several years. The report noted that 58 percent of the CFOs surveyed expect the U.S. economy to expand this year, a dramatic decrease from the 77 percent who expected growth in 2005.
Other concerns in the U.S. business community include the rise in interest rates, higher energy prices, and a slowdown in residential real estate activity and appreciation. Given these factors, the “pattern of slowdown seems to be in order,” stated Bob Doll, chief investment officer of Merrill Lynch & Co. Inc. (New York City), in November.
China’s torrid economy, meanwhile, had GDP growth of 9.4 percent in 2005 and is expected to grow 8.9 percent this year, according to the Chinese Academy of Social Sciences (Beijing). The slower rate reflects an anticipated decrease in China’s exports as the yuan appreciates. Last year, its exports were growing around 25 percent year-on-year, while this year’s export growth is expected to be 12.6 percent. Fixed asset investment, however, is still expected to remain “robust” in 2006, increasing 17.4 percent compared with last year’s growth estimate of 21 percent.
With this macroeconomic picture in mind, here we review the recent performance and future prospects of some key metal commodities and paper. (Please note, the following projections were culled from a number of primary and secondary research sources in the fourth quarter of 2005.)
Aluminum
The sentiment toward aluminum grew increasingly bullish last year as it became more and more evident that new supply might not keep pace with demand. That trend underpinned many 2005 price forecasts, which ranged from the mid-70s to 90 cents a pound, with most closer to an 80-cent average. A July 2005 updated survey by Reuters placed the LME cash average at 82.1 cents compared with 77.8 cents in 2004.
As it turned out, most underestimated aluminum’s strength last year, with the LME cash price averaging around 85 cents year-to-date in November. Prices, in fact, were trading at a 16-year high at the beginning of December. The LME cash settlement average last November was an eye-opening 93 cents a pound.
This year, supply remains the focus. Despite new production, many believe that energy costs and continued tightness in alumina will curb overall supply. Merrill Lynch, for one, claims that more than 3 million mt of global capacity could be at risk for closure due to high costs. Also, China could reduce its primary aluminum exports, further eroding global supply.
Overall, analysts are projecting an LME cash average in the low-to-mid-80s this year, though specific forecasts vary by almost 30 cents a pound. Here, for example, are eight analysts and their 2006 predictions, from low to high: ABN AMRO Bank N.V. (Amsterdam), 77 cents; Commonwealth Bank of Australia (Sydney), 80 cents; JPMorgan Chase & Co. (New York City), 81 cents; Prudential Equity Group L.L.C. (New York City), 83 cents; Natexis Commodity Markets Ltd. (London) and Goldman Sachs JBWere (New York City), 84 cents; Standard Bank (London), 88.8 cents; and Macquarie Research, $1.05.
Copper
As with aluminum, copper’s market story in late 2004 and early 2005 focused on supply uncertainties, even overshadowing assumptions about mediocre consumption prospects in the Western World and global economies (excluding China). Even with copper production set to increase, analysts expected the market to show a deficit in 2005. The only differences of opinion were over the size of the deficit.
Copper supplies experienced some bumps last year in the way of strikes and other disruptions that kept concentrates from being refined and entering the market. Regardless, refined metal supplies still increased faster than consumption in 2005, thereby trimming the global deficit by more than 700,000 mt.
Even so, supplies failed to meet projected production numbers. That fact, coupled with a sharp decrease in visible inventories, boosted prices. Several other factors also supported copper tags, including speculative influences, continued tightness in scrap, confusion over the activities of China’s State Reserve Bureau, and ongoing institutional buying. Though most analysts contacted by ReMA steadily increased their price projections as the year progressed, all understated their forecasts significantly.
Forecasts for 2006 had to take into account LME and Comex prices that were trading at all-time highs in the fourth quarter. The LME three-month price was $1.90 in November and averaged $1.85 for the month. Spot Comex closed November at $2.075, averaging $2.01 for the month.
Those willing to offer a forecast for this year based their outlook on the fundamentals, assuming that primary supply would grow and continue to reduce the deficit gap, even in the face of improving demand. Some—such as the International Copper Study Group (Lisbon)—forecast in November a global cathode surplus of 295,000 mt this year.
Others cautioned that several large international copper producers face labor contract expirations this year, portending possible strikes that could easily tip the market back into a deficit position. Given copper scrap’s tight position, it isn’t expected to offer any relief on the supply side. Still others suggested that primary supply tends to be overestimated while demand tends to be underestimated.
Most 2006 average cash price forecasts seem to be between $1.35 and $1.40 a pound, with some lows and highs thrown in. The price projections include ABN AMRO Bank, $1.15; Natexis, $1.25; Bache Financial Ltd. (London), $1.25 (based on an assumed 450,000-mt Western World surplus); JPMorgan Chase, $1.42; Standard Bank, $1.42 (based on an assumed 263,000-mt global surplus); Commonwealth Bank of Australia, $1.46; Cochilco, Chile’s government copper commission, $1.46 to $1.50; Macquarie Research, $1.60; and—on the high end—Man Financial Ltd. (New York City), $1.76.
Iron and Steel
When steel and ferrous scrap executives looked ahead to 2005, they expected domestic and global demand to be relatively strong, with China again the main focus as a producer, consumer, and potential exporter.
The International Iron and Steel Institute (IISI) (Brussels, Belgium) saw 2005 world crude steel production reaching 1.115 billion mt, an increase of 6 percent over 2004. To meet this forecast, merchant scrap requirements would have to grow almost 9 percent, increasing 26 million mt compared with 15 million mt in 2003. If that forecast proved correct, ferrous scrap prices would get a substantial boost.
World Steel Dynamics (WSD) (Englewood Cliffs, N.J.) also projected continued growth last year, with global crude steel production expected to reach 1.071 billion mt, 3.3 percent above its 2004 estimate of 1.043 billion mt.
Through October 2005, world steel production stood at 915.4 million mt, or about 1.1 billion mt annualized, according to IISI. China’s production through October totaled 286.8 million mt, 26.5 percent ahead of comparable 2004 figures. U.S. steel production, meanwhile, was 77.4 million mt through October, down 6.3 percent compared with last year. The American Iron and Steel Institute (Washington, D.C.), meanwhile, placed U.S. steel shipments through September at 77.3 million net tons, down 9.5 percent compared with the same 2004 period. According to WSD, U.S. shipments would end 2005 at about 106.2 million mt, a decrease of 4.7 percent.
All told, 2005 was a relatively strong year for steel, despite rising costs for iron ore, natural gas, scrap, and coking coal. In 2006, though, the domestic steel industry could find itself on softer footing, with the Midwest hot-rolled spot market entering this year around $535 a net ton. That figure is still well ahead of the global market, with hot-rolled coil at $355 to $425 a mt ($325 to $386 a net ton), f.o.b., port of export, WSD reported. Others placed the December 2005 Southeast Asian market at $450 a mt.
The worry this year is about global overproduction, especially China’s capacity and its ability to export lower-grade products. Various forecasts of China’s crude steel production this year include 350 million mt (WSD), 400 million mt (Macquarie Research), and 385 million mt (China Iron & Steel Association), while China’s steelmaking capacity is figured around 470 million mt.
Apparent global steel demand in 2006, meanwhile, could total 1.040 billion to 1.053 billion mt, an increase of 4 to 5 percent, says IISI. Apparent Chinese demand, meanwhile, is forecast to be 320 million to 330 million mt, up 7 to 10 percent year-on-year.
As for finished steel prices, National Australia Bank Ltd. (Melbourne) sees hot-rolled coil averaging around $450 a mt on the global market, down 15 percent from its 11-month 2005 average of $532 a mt. MEPS (International) Ltd. (Sheffield, England) sees a more balanced global market for flat products by midyear defined by “steady price improvement.” The firm does not see hot-rolled prices falling to the lows of 2003, mainly due to the higher costs that mills now have to absorb, nor do they expect significant raw material shortages developing as was the case in 2004.
The U.S. steel market, meanwhile, will experience weakness by the second quarter, owing to the negative impact of exports on the marketplace, says WSD, adding that this trend could continue into the second quarter as well. Goldman Sachs expects domestic flat-rolled products to stabilize around $550 a net ton in the first quarter before gradually declining in the second half.
The ferrous scrap market, the company says, will be influenced by seasonal winter supply issues and better global demand that could advance prices. GFMS Metals Consulting Ltd. (London) maintains that Midwest shredded scrap will average $227 a gross ton this year, 1 percent above the 2005 estimate of $225. According to Michelle Applebaum Research Inc. (Highland Park, Ill.), however, 2006 will be much more
bullish, with higher iron ore prices driving scrap prices to “new highs.”
Lead and Zinc
Sentiment toward lead turned more positive in the past two years, reflecting previous cutbacks and supply disruptions in 2004 and 2005. Growing demand was also a significant contributing factor, with China surpassing the United States as the world’s largest lead consumer. According to the International Lead and Zinc Study Group (ILZSG) (London), China’s lead consumption was on track to grow 19.8 percent in 2005 compared with the previous year.
Lead’s positive fundamentals pushed LME prices to $1,000 a mt in late 2004 and again in the first half of 2005, briefly visiting a 14-year high last July. Supply responded in kind, with exchange inventories of refined metal growing in the summer and prices trending lower as a result. Nevertheless, ILZSG and others expected the Western World and global markets to end 2005 in a deficit. As 2005 wound down, LME prices were at an all-time high, eclipsing the December 2004 level.
This year, ILZSG again projects a lead deficit despite improving concentrate availability. The group’s October report forecast global output to reach 7.62 million mt this year, up 3.4 percent from 2005, yielding a shortfall of 50,000 mt. Metal Bulletin Research (London), however, sees refined supply continuing to rebound, moving the market back into surplus this year. As stocks build, prices will decline to a 2006 average of 36 cents a pound, almost unchanged from the 2005 consensus forecast from Reuters.
Other price predictions for this year include ABN AMRO Bank and Standard Bank, 34 cents; Natexis, 35 cents; Société Générale (Paris), 36 cents; JPMorgan Chase, 37.6 cents; and Barclays Capital (London), 41 cents.
Zinc’s fundamentals began improving in 2004, leading many analysts to expect the 2005 zinc market to be undersupplied and the LME average cash price to be around the mid-50s cents a pound. Market confidence in zinc was clearly on the upswing.
As of last November, this indeed looked to be the case, though prices paused at midyear following hefty deliveries into LME warehouses and a corresponding slowdown in demand. A protracted strike at Teck Cominco’s Trail facility and the announcement that Big River Zinc Corp. (Sauget, Ill.) would close its 100,000-mt smelter due to lack of concentrates, however, served as positive market influences. In the fourth quarter of last year, ILZSG said Western economies could see a 272,000-mt deficit.
Buoyed by these supply-and-demand fundamentals, LME zinc prices exceeded even the most optimistic forecasts, posting a cash average of 60 cents a pound through November. Zinc was, in fact, trading at a 16-year high as December began, supported by dwindling LME stocks and soaring Chinese net imports of slab.
This year’s supply-and-demand balance will show a 430,000-mt deficit, says ILZSG. Other researchers also see a statistical shortfall, with Société Générale pegging the total at 360,000 mt. Based on its figures, the global zinc deficit will total a million mt in the 2004-2006 period, offsetting the cumulative surplus in 2001-2003. For this reason, the company maintains that zinc will outperform the base metal sector this year. It forecasts a 64.4-cent average for 2006, adding that the mean “will be somewhat higher” than that.
Other average zinc price forecasts range from 56.7 cents from Bache Financial to 80 cents from Macquarie Research, which also predicts a 400,000-mt deficit this year. In between are JPMorgan Chase, 60.5 cents; Metal Bulletin Research and Natexis, 63 cents; GFMS Metals Consulting, 63.5 cents; Mitsui Bussan Commodities Ltd. (London), 67.8 cents; and Standard Bank, 69 cents.
Nickel and Stainless Steel
In 2005, nickel began moving from deficit to surplus—a first in more than two years. Still, nickel prices held surprisingly firm through much of last year, with LME cash averaging $7.18 in the first half and $6.75 through the first 11 months. Global economic recovery continued to be a major driving factor, along with scrap tightness, underinvestment in new nickel production, delays in new supply, and low aboveground stocks.
That said, nickel prices did trend downward based on lower than expected stainless steel demand and production as well as greater than expected scrap availability. Any primary nickel supply disruption was more than matched by announced cutbacks in stainless capacity and, hence, nickel demand. Those cutbacks freed up some 60,000 mt of primary nickel, says CRU Ltd. (London).
Meanwhile, world stainless steel production was expected to end 2005 at 25.8 million mt, up 5.7 percent over 2004, with China producing 3.75 million mt, a 34-percent jump from its 2004 output, according to the International Stainless Steel Forum (ISSF) (Brussels, Belgium). ISSF also envisioned a 5-percent increase in product shipments last year, bringing the total to 26.5 million mt, with Asia—led by China—setting the pace.
This year, global stainless production forecasts include 26 million mt (MEPS), 26.4 million mt (Macquarie Research), and 26.97 million mt (Heinz H. Pariser Alloy Metals & Steel Market Research).
Going forward, nickel’s fate rests with stainless steel and whether earlier mill production cutbacks and a firm-to-robust global economic picture this year will change the market’s direction. Any nickel supply disruption could also have a huge effect on price forecasts for this year.
Metal Bulletin Research sees nickel as “finely balanced” in the new year, with China and India driving demand and potentially pushing LME cash to $15,000 a mt ($6.80 a pound). For the year, the company forecasts an average nickel price of $5.67. Macquarie Research revised its forecast to $5.75, stating that weakness will be most apparent in the first quarter as consumers continue to destock. As demand recovers in the second quarter, “so will prices,” it predicts.
Other price predictions include CRU, $4.68 (offered last November); Commonwealth Bank of Australia, above $5 “until the end of 2006”; ABM AMRO Bank, $5.30; Société Générale, $5.35; Natexis, $5.44; Goldman Sachs, $5.95; and Barclays Bank (London), $6.58 (forecast last October).
Paper and Recovered Fiber
A year ago, most paper industry participants anticipated a domestic paper and paperboard industry in recovery. This positive scenario was based on a cautious view of economic conditions, with end-use demand influenced by industrial nondurable goods production, consumer spending, and commercial printing and advertising activity, among other factors. Many, however, were also looking to China as a principal price driver for both domestic market pulp and recovered fiber.
As it turned out, the industry struggled with generally poor fundamentals in 2005, even in the face of a strengthening domestic economy. Key issues included generally weak paper and paperboard demand, overcapacity, cyclical commodity pricing, and volatile operating costs—principally energy and transportation—all of which conspired to reduce margins and profitability.
Scrap paper packers also found that domestic price weakness more than offset the positives of higher export demand. At the start of last year, Resource Information Systems Inc. (RISI) (Bedford, Mass.) projected the OCC average at $105 a ton, picked up, and ONP at $98. As 2005 ended, however, domestic OCC prices were trending lower even with a 25-percent increase in OCC exports to China through the first nine months. Export prices, in fact, lost more than $20 a ton after peaking in the first quarter of last year.
Virgin pulp prices, meanwhile, were on the upswing as 2005 began. Northern bleached softwood kraft (NBSK) was $650 a mt in North America and $640 in Europe. Based on improving fundamentals, Salomon Smith Barney (New York City) expected NBSK, delivered to Europe, to average $690 a mt in 2005. Canadian Imperial Bank of Commerce World Markets (Toronto) also increased its 2005 pulp price forecast by $10
due to what it saw as “exchange-rate induced” changes as opposed to any significant changes in demand or supply.
While NBSK prices firmed in the first quarter, they maxed out at $680 in North America and $645 in Europe. North American prices bottomed out at $620 last August-September before staging a tentative recovery to $640 in the final quarter.
In the scrap paper market, Hurricane Katrina’s effect on supplies was short-lived and only mildly disruptive in the South and Southwest markets, and it didn’t have a lasting effect on national recovered fiber prices. By December, Midwest OCC had fallen to $40 to $45 a net ton, picked up—quite a slip from the $75 to $80 prices at the beginning of the year.
As for 2006, the potential for weaker economic growth represents “a big downside risk” for recovered paper prices, according to RISI. Conversely, the key to any upside rests with a stronger than expected rebound in the global economy, the firm says.
As a domestic average for this year, RISI sees OCC and ONP in the mid-$80s a ton, Midwest, picked up. Recovered paper prices for most grades, it says, are expected to climb in the first and second quarters “before registering a brief decline later in the year.” RISI also expects U.S. scrap paper exports to reach a record 15 million mt this year.
Robert J. Garino is director of commodities for ISRI.