January/February 2011
Though the U.S. economic recovery is still shaky, growth in manufacturing and consumer spending is giving the economy some confidence, making the outlook for most major scrap commodities cautiously optimistic.
By Joe Pickard
At this time last year, readers of Scrap were treated to what turned out to be an extremely prescient 2010 market forecast from Bob Garino, then ISRI’s director of commodities, titled “The Slow Road to Recovery.” That the U.S. economy had, in fact, entered into a recovery at that point was by no means guaranteed. By the end of 2009 the economy had just one quarter of economic growth under its belt after a “prolonged recession that rattled its economic underpinnings and far surpassed the deep downturns of 1973 and 1981,” in Garino’s words. Today there’s no question that the economic recovery has indeed taken root. We’ve now seen five consecutive quarters of economic expansion, and concerns about a double-dip recession are largely waning.
That the road to recovery also has been slow, unfortunately, is not in doubt. Economic growth hasn’t made a dent in unemployment, which crept up to 9.8 percent in November, the worst reading since April 2010 and higher than during the depths of the recession in 2008 and 2009. The sorry state of the labor market is especially troubling considering how many people have been unemployed for more than six months (more than 6.3 million people, or more than 40 percent of those unemployed) and the fragile state of the U.S. housing market (sales of both new and existing homes plunged by more than 25 percent in October). Unemployment and housing continue to serve as twin drags on the economy.
Fortunately, there is some good news. The economy is getting increasingly solid support from some crucial sectors, notably consumers and manufacturing. Consumer spending, which typically accounts for about 70 percent of total GDP in the United States, is looking up: Retail sales in November jumped 0.8 percent from the previous month and 7.7 percent compared with November 2009, thanks to a healthy start to the holiday shopping season. This follows an 8-percent year-on-year increase in retail sales in October, primarily due to a surge in car buying.
The manufacturing sector, a welcome driver of growth, also experienced its fifth straight month of expansion in November, as manufacturing capacity utilization reached 78.2 percent—its highest level in more than two years, though spare capacity remains. As these economic engines begin to rev up, accompanied by improving labor productivity, restocking of business inventories, falling household debt levels, low inflation (but not deflation), rising stock markets, and accommodative government policies, economists are starting to revisit their projections.
Economists from JPMorgan Chase & Co. (New York), Credit Suisse Group (Zurich), and a host of other companies have raised their forecasts for fourth-quarter GDP growth in the United States from less than 2.5 percent to between 3 percent and 4 percent. That seemingly small shift can have a big impact—it can represent the difference between stagnating and improving unemployment. Not everyone is painting such a rosy scenario for the U.S. economy, however, nor is there agreement that the recovery is now self-sustaining. The International Monetary Fund (Washington, D.C.) is forecasting that U.S. economic growth will drop from 2.6 percent in 2010 to 2.3 percent in 2011 as “consumers face headwinds of high debt and fallen asset values; weak credit growth, despite extraordinarily loose monetary conditions; and persistently high unemployment.”
Though opinions vary sharply on the economic outlook for the United States this year, most economists and commodity analysts can agree on a few points, most notably that the United States no longer solely determines the fate of its own economy or the pace of global commerce. China’s increasingly important role on the world eco nomic stage in general—and for commodities in particular—is nothing new. But it’s hard to overstate the extent to which changes or potential changes in China’s economic policies (interest rates, bank reserve requirements, export tax rebates, infra structure investment, and more) now move markets. If China were to raise its interest rates or take other actions this year to cool its economy and contain inflation, those actions could pose a significant risk not only to commodity demand, but also to the global economic recovery.
This year’s economic risks are not limited to China, however, as the ongoing sovereign debt crisis in Europe demonstrates. Though the widely reported potential for the disintegration of the euro is probably overstated, the dangers posed by increasingly untenable debt levels in the struggling economies on the European periphery and the political risks associated with austerity measures across Europe are not. A sovereign debt default (or its equivalent) in one of these struggling economies in 2011 would send shock waves not just across Europe, but worldwide. The question of how and when to rebalance debt-to-GDP ratios is not solely a European issue, however. It will be a prominent theme across much of the developed world, including in the United States and Japan, as the economic recovery continues this year and beyond.
Despite all these downside risks, the IMF has forecast that real-world economic output will increase at a still-healthy 4.2 percent in 2011 and an even-better 4.5 percent in 2012, including annual growth in China at or above 9.5 percent for both years. In addition, Goldman Sachs Group (New York) has recently forecast that GDP growth in the key BRIC countries (Brazil, Russia, India, and China) will reach 8.6 percent this year. That type of growth typically would bode well for the scrap industry in North America. The ReMA Scrap Index, which tracks a basket of scrap prices, had its second-highest reading of the year in Novem-ber 2010, which seems to confirm this outlook.
Does all this mean that the U.S. economy is ready to get off the slow road to recovery and jump onto the high-speed Autobahn of economic growth? In all likelihood, not yet. If policymakers in the United States follow Federal Reserve Board Chairman Ben Bernanke’s advice not to “ ... take actions this year that will affect this year’s spending and this year’s taxes in a way that will hurt the recovery”—i.e., don’t take away the punch bowl just yet—and barring a complete meltdown in Europe or other large shocks to the global economy, it looks like we’re ready to shift gears and, at the very least, move out of the slow lane. That’s the big picture. Here’s a more detailed outlook for seven key commodities in 2011.
Aluminum
With a global aluminum market beset by overcapacity in recent years, the U.S. aluminum industry faced especially severe challenges during the recession. The Aluminum Association (Arlington, Va.) reported that primary aluminum production in the United States plunged about 35 percent in 2009, to just over 1.7 million mt. The saga continued into 2010, with U.S. primary aluminum production from January to November falling 1 percent below 2009 levels in that period, to less than 1.6 million mt.
Despite that poor performance—due in part to inconsistent demand from the auto industry and, especially, the housing market—2010 was a better year for the aluminum industry in several respects. The average monthly London Metal Exchange price reached nearly $2,400 a mt in November 2010, which was 16 percent higher than November 2009, though prices were somewhat softer as of mid-December. Accompanying the stronger prices were falling inventories: LME aluminum stocks in December 2010 were down about 7 percent from December 2009, as aluminum alloy and NASAAC inventories contracted even more sharply in percentage terms.
The aluminum scrap market is showing signs of life as well, and not just because of the improving price picture. Year-on-year U.S. exports of aluminum scrap, including remelt secondary ingot and used beverage containers, surged 20 percent during the first 10 months of 2010, to more than 1.58 million mt. Market participants believe this trend could continue or even improve in the first quarter of 2011.
Despite these positive trends, most analysts still have modest expectations for the light metal in 2011. As Goldman Sachs analysts put it, “We continue to expect high aluminum stocks and excess capacity for the foreseeable future, with some of the confusion and dislocation that led to tight spot markets thus far in 2010 dissipating with more supply and better matched demand in 2011.” Though LME aluminum stocks have been declining, at nearly 4.3 million mt in mid-December 2010, they remain significant. Many forecasters, therefore, are looking for range-bound aluminum prices in 2011 of $2,200 to $2,500 a mt. On the bright side, with the sharp run-up in 2010’s copper prices, aluminum’s relatively modest price gains will open the door to greater gains from substitution.
Copper
With copper prices repeatedly breaking into record territory in late 2010, reaching dizzying heights, it’s not hard to see why the red metal has been getting more than its fair share of attention lately. In December, refined copper prices surged to well over $9,000 a mt, and LME inventories were down about 28 percent compared with the end of 2009, to just over 360,000 mt.
The fundamentals certainly seem to support the rebound in copper prices, which as recently as December 2008 had fallen to below $3,000 a mt. World demand for copper exceeded supply by more than 360,000 mt through the first eight months of 2010, according to the International Copper Study Group (Lisbon, Portugal), and the group forecast that the global copper deficit would grow to 435,000 mt in 2011. The constraints on copper supply and solid demand from China (the predominant market for refined copper, as it is for so many other commodities) are what support such analyses. China’s rapid pace of economic growth in general, and its high levels of investment in construction, electrification, and a host of other copper-intensive industries, are contributing to a tighter market balance.
That said, the question remains whether market fundamentals or investor demand is really driving the rapid rise in copper prices. The creation of physically backed exchange-traded funds in copper has only exacerbated concerns that it’s the latter. With the launch of a copper ETF by ETF Securities (New York) in December, and with JPMorgan Chase and others planning similar ETF launches this year, market participants have been preoccupied not only with how much the ETFs will contribute to copper price volatility, but also with the potential for a high concentration of copper stocks in just a few hands.
The result of such concerns is an increasingly wide range of copper price forecasts for 2011. At the low end are forecasts ranging from the high $8,000s to the low $9,000s a mt; at the high end are forecasts of $11,000 to $12,000 a mt—an unprecedented $5 a pound or more. A word of caution, however: What goes up must come down.
Iron and Steel
Toward the end of 2010, it seemed as though domestic flat-rolled steel prices were going up nearly $10 a week, with surprisingly little resistance from customers. Ferrous scrap prices also were on the rise and, according to Scrap Price Bulletin, they were on track to end 2010 with all-time high average prices for December. Though steel production statistics were looking up, some market watchers questioned whether end-use demand was sufficiently strong to warrant such price increases.
According to Steel Market Intelligence, crude steel production in China from January to November 2010 had already exceeded total 2009 output. For all of 2010, China’s steel production looked likely to beat the 2009 total by around 50 million mt. In the United States, domestic raw steel production from Jan. 1 to Dec. 11, 2010, was up 39 percent from that period in 2009, approaching 84 million tons, according to the American Iron and Steel Institute (Washington, D.C.). AISI also reported that the industry’s capacity utilization rate jumped from roughly 52 percent for that period in 2009 to 70 percent in 2010.
On the ferrous scrap trade front, the data were less clear. Turkey, the biggest international buyer of U.S. ferrous scrap, increased its imports 17.5 percent in the first 10 months of 2010 compared with that period in 2009, reaching 15.3 million tons, according to Steel Business Briefing. But trade data from the U.S. Census Bureau revealed that overall ferrous scrap exports from the United States were down 9 percent through October. Exports of No. 1 HMS and shredded steel fell by 9 percent and 13 percent, respectively. Looking at the export data, analysts noted the growing importance of ferrous scrap demand from developing countries with minimill capacity.
The run-up in both steel and ferrous scrap prices in late 2010 complicated attempts to forecast 2011 prices. Without evidence of fundamental support for the latest increases, many analysts predict higher prices in the first quarter of 2011 but are wary of potential downturns after that.
Lead and Zinc
Despite the geological connection between lead and zinc, the 2011 forecasts for these “sisters” were moving in different directions. Unlike the other base metals, both lead and zinc LME inventories grew during 2010, with December stocks of each up more than 40 percent compared with December 2009. The supply and demand balances look dour for both metals, so the question might be which one looks less bad.
The refined lead market, again dominated by China, had a surplus of 41,000 mt through September 2010, according to figures from the International Lead and Zinc Study Group (Lisbon, Portugal), and it forecast the surplus will grow to 90,000 mt in 2011. The group’s zinc forecasts are even less supportive. Though it expects the zinc surplus to decline from 233,000 mt in 2010 to 161,000 mt in 2011, the total size of the surplus remains substantial. The U.S. scrap export picture is more positive toward zinc: Lead scrap shipments were down 67 percent year on year in the January-to-October period, but zinc scrap shipments were up 58 percent in that period.
Despite zinc’s more positive export picture, analysts at Macquarie Bank (London) echoed others in being “ ... more bullish on lead, due to the supply-demand balance, than zinc.” The range of price forecasts for both metals remains rather narrow, though. With both lead and zinc trading in the range of $2,300 to $2,500 a mt at the end of 2010, several forecasters expect prices for both metals in the neighborhood of $2,400 to $2,600 a mt in 2011. Notable outliers on the zinc forecast were RBC Capital Markets (London), which predicts a 2011 price of $1,874 a mt, and Goldman Sachs, which gave a 12-month price target of $3,100 a mt.
Nickel and Stainless steel
Though the nickel market has had its share of price volatility, it seemed to be ending 2010 on a firmer note, with LME three-month ask prices up from the November average of $22,990 a mt to between $24,000 and $25,000 a mt in December. Inventory changes also were supportive, with LME stocks in mid-December down more than 15 percent compared with the end of 2009, to around 132,000 mt. But in this challenging market, forecasters see many issues that could reverse these gains: increases in nickel supply, overcapacity in the stainless steel industry, and the impact of nickel pig iron production in China, to name a few.
With Vale-Inco’s increasing nickel output in Canada, and with several new nickel mine projects and expansions also scheduled for this year, market watchers worry about the potential for a “structural oversupply” in the nickel market. In October, the International Nickel Study Group (Lisbon, Portugal) projected that the global nickel market would be “broadly balanced” in 2010, but it expects stocks to grow this year due to world refined nickel use (projected to reach 1.53 million mt) not keeping pace with the increase in global refined nickel production, projected to hit 1.61 million mt. In a recent research note, however, Barclays Capital (New York) declared that concerns about nickel oversupply are overblown. Demand for stainless steel remains strong in utensils, durable goods, and process industries, among others, the report noted. The sharp increase in nickel scrap exports from the United States, which surged 75 percent in the first 10 months of 2010 compared with that period in 2009, would seem to confirm that demand. That said, the world’s leading steel producer, ArcelorMittal (Luxembourg), recently announced that it will spin off its stainless steel division this year, reportedly as a result of rising costs and overcapacity in the stainless industry.
It’s clear that the nickel and stainless industries continue to face a plethora of challenges, including the changing supply picture, the potential for more industry consolidation, and opportunities for heightened investor demand. Less clear is just how those challenges will play out, thus it’s not surprising to find a wide range of nickel price forecasts for 2011, from about $19,000 a mt to closer to $26,000 a mt. The forecasting difficulty underscores the ongoing uncertainty and changing nature of this market.
Paper and Recovered Fiber
As they have for many other commodities, prices for recovered paper have been rebounding from the lows they hit during the worst of the recession in early 2009, when the industry was beset by bankruptcies and reduced capacity. Though the subsequent reduced supply and improved demand have had a positive impact on prices, the boost has not been uniform across all grades, and concerns about the long-term demand prospects persist.
In a recent RISI Viewpoint, Hannah Zhao, a RISI recovered paper economist (Boston), wrote that improved demand in the United States, Europe, Japan, and elsewhere in Asia boosted overall recovered paper demand in 2010 to about 220 million tons. But despite an 11-percent jump in U.S. OCC exports in the January to October period, year on year, total U.S. scrap paper exports were down 2 percent in that period, to 17 million tons, on lighter loadings of mixed paper (down 31 percent) and ONP (down 6 percent). After a solid run, export prices for OCC reportedly were easing in December, though Brook Edwards, publisher of the Brown Sheet, recently noted that with “new paper machines coming online in China in the first quarter of the year, it appears to be a given that the Southern California export market [for OCC] will trade between $220 on the low side with $250 not out of the question” after the Chinese New Year.
It’s very likely that demand from China will remain solid in 2011, given not just the country’s strong economic growth but also the Chinese paper industry’s reliance on recovered paper. What is less certain is whether more attractive recovered-paper price levels will generate sufficient or more-than-sufficient supply to meet growing world demand. As with our general economic outlook, we remain cautiously optimistic.
Joe Pickard is chief economist and director of commodities for ISRI.