May/June 2009
The long run of economic good fortune came to a dramatic end in 2008, with commodity markets suffering an unprecedented economic earthquake of evaporating demand and steep price corrections. By Robert J. Garino and Tom Crane
"2008 was the most difficult year our industry has experienced in recent times," stated Josef Ackermann, chairman of Deutsche Bank's management board and group executive committee, in a shareholder message this March. Ackermann knows whereof he speaks. Deutsche Bank, with 78,000 employees in some 75 countries, posted a 2008 loss of E3.9 billion. His bank was just one victim of last year's global financial earthquake. This temblor, with an epicenter traced to the U.S. subprime housing market debacle, caused an economic tsunami that quickly swept financial destruction around the globe.
The credit crisis actually began in earnest in the second half of 2007. In 2008 it morphed into "a new and more severe phase" that devastated the international financial and banking sectors, a development that affected all business, Ackermann said. He pointed to the collapse of Bear Stearns and Lehman Brothers—two highly respected New York-based investment firms—as the catalyst for that new phase. Those events, he said, triggered a sudden and significant deterioration in market conditions and confidence that ultimately led to acute shortages of liquidity and sharp reductions in interbank lending, which put additional pressure on credit markets. As global equity markets plunged in the final months of 2008, governments and central banks in the major world economies intervened to support both the markets and individual financial institutions.
Though the financial community more than welcomed the support, the actions were, in hindsight, too little and too late to stem the tide that only a few foresaw. Back in April 2008, for instance, the International Monetary Fund (Washington, D.C.) warned that the financial losses from the U.S. mortgage crisis could approach $1 trillion and condemned a "collective failure" to predict the breadth of the crisis. More recent estimates place the final tab closer to $2.98 trillion.
Economists continue to examine, debate, and identify the root causes of this near paralysis and collapse of the global banking system. In 2007's The Black Swan: The Impact of the Highly Improbable, author Nassim Nicholas Taleb argues that the buildup of what he terms "hidden debt" introduced by highly complex and largely unregulated financial derivatives created unsustainable levels of debt. Others contend that the low U.S. interest rate policy of 2002-2005, financial deregulation, and the subsequent unbridled credit expansion encouraged debt and leveraging. In other words, cheap money, lax lending practices, and little regulatory oversight fostered irresponsible lending and equally irresponsible borrowing to the point where it became nearly impossible to assign a value to toxic mortgage-backed securities and other marketable assets tied to credit default swaps and other complex financial instruments. Banks' balance sheets became frozen because no one could figure out who owed what and to whom and whether anyone had the ability to pay. Interbank lending virtually stopped, Ackermann noted, due to lack of trust after years of speculative excess and financial innovations that got out of control. The result was panic deleveraging in both commodities and equities. All this moved the U.S. and the global economies into recessionary environments with mountains of debt that now rest squarely on taxpayers' shoulders.
Quantifying the Damage
So how bad was 2008? Looking first at this nation's output of goods and services, U.S. gross domestic product grew just 1.1 percent in 2008 compared with 2 percent in 2007 and 2.8 percent in 2006, according to the U.S. Department of Commerce's Bureau of Economic Analysis (Washington, D.C.).
Collectively, nations in the Organization for Economic Cooperation and Development (Paris) recorded 0.9 percent combined growth last year compared with 2.7 percent in 2007. Japan and Italy saw their economies post negative numbers in 2008, while China's economy grew 9 percent, well below its heady double-digit rates of the past several years. Total global growth was 3.3 percent last year versus 5 percent in 2007.
Although the U.S. economy grew overall last year, its fourth-quarter performance decreased at an annual rate of 6.3 percent, the worst showing in a quarter-century and a clear reflection of the intensifying financial crisis. Consumers also cut spending at a 4.3-percent pace, as unemployment rose to a decade-plus high with no end in sight.
According to Bloomberg (New York), the U.S. GDP report also revealed that corporate profits dropped 16.5 percent from the third quarter to the fourth quarter, the biggest decline since 1953. For all of last year, profits were down 10.1 percent, the biggest annual decline since 1970. Last year also marked the slowest overall U.S. economic growth since the 2001 recession. Some economists believe that last year could represent the worst of the current recession, however. "We're at a turning point," Michael Darda, chief economist at MKM Partners (Greenwich, Conn.), said in a recent interview with Bloomberg Radio. "There are some glimmers of hope. By the fourth quarter, maybe even the third quarter [of 2009], we'll be pleasantly surprised by the economic data."
Wall Street, meanwhile, saw trillions of dollars of wealth held in equities vanish in 2008, as panicked investors sold into the market, preferring to hold cash. The Federal Reserve placed the lost household wealth at $11.1 trillion, about 18 percent lower than the previous year. The Dow Jones Industrial Average, which hit a record high of 14,164 in October 2007, finished last year down 34 percent at 8,776. It was the Dow's worst year since 1931.
On the commodities front, Barclays Capital (London) noted as 2008 wound down that a combination of "fear and shock" drove the global commodity markets, intensifying in the second half of the year. The London Metal Exchange's nonferrous price index, for example, was in near freefall in the fourth quarter, dropping 39 percent. From January to December the index fell a full 50 percent, including an eye-opening decline of 61 percent from its high for the year, recorded in March.
Another important price index by the Commodity Research Bureau (Chicago), which tracks domestic prices for copper scrap, lead scrap, steel scrap, tin, and zinc, mirrored the LME index with its own 50-percent drop. Finally, ReMA's steel scrap price reference indicator and its recovered paper price indicator recorded declines of 44 percent and 79 percent, respectively, in 2008.
With this sobering background in mind, here's a closer look at last year's turbulent market odyssey of seven major commodities.
Aluminum: Domestic apparent consumption of aluminum fell nearly 13 percent last year, marking the second consecutive year of lower annual consumption for the light metal, according to ReMA estimates and preliminary figures from the U.S. Geological Survey (Reston, Va.). CRU Group (London) had domestic refined aluminum consumption lower by 6.4 percent year-on-year, while the Aluminum Association (Arlington, Va.) reported aluminum demand in the United States and Canada decreased 8.1 percent last year. Other independent sources placed the 2008 domestic shipment decline around 8 percent to 10 percent compared with 2007. U.S. scrap consumption, meanwhile, declined at least 11 percent last year, reflecting lower demand from key consuming sectors such as automotive and construction, ReMA reports. Despite the decline in domestic demand and consumption, some analysts maintain that actual mill shipments and overall industry usage may have fared better than preliminary USGS reports suggest.
Nevertheless, by most measures 2008 was a struggle for the domestic and global aluminum industries, as demand faltered sharply in the second half and visible inventories trended toward record highs. Global aluminum producers responded by trimming production as much as 18 percent. Even so, U.S. primary production totaled 2.66 million mt, an increase of 3.9 percent over 2007.
Though the LME average 2008 price revealed a modest year-on-year decline, that average doesn't show the market's volatility. Exchange prices moved sharply higher in the first half of the year, reaching a record $3,220 a mt (LME cash) in July only to fall 55 percent by year's end, as demand collapsed and aggressive short selling and long liquidation exacerbated the downturn.
The aluminum scrap export market was a bright spot for most of last year, with total scrap exports rising 28 percent year-on-year. China was the force behind that rise, claiming 50 percent of the exported tonnage.
Copper: Many saw last year's copper market as divided into two distinct halves: a strong first half supported by a global market trending toward a statistical deficit followed by an extremely weak second half defined by a near collapse in demand and a refined metal surplus at year's end, despite production cutbacks.
The International Copper Study Group (Lisbon, Portugal) places last year's global surplus at 363,000 mt, marked by a first-half deficit of about 140,000 mt and a second-half surplus of around 500,000 mt. LME copper inventories ended 2008 at 340,550 mt, up 72 percent from 2007. Copper prices mirrored the changing global supply-and-demand balance: In early July, copper reached an all-time record $4.08 a pound, only to sink to a four-year low by late 2008.
On the demand side, ICSG reports that U.S. copper use declined 8.7 percent year-on-year to 2.14 million mt. Copper scrap consumption totaled 890,000 mt, 6.3 percent less than in 2007, while scrap exports managed a modest increase. Overall, however, less copper scrap was recovered last year as the domestic economy slipped deeper into recession. As supporting evidence, the U.S. manufacturing index tracked by the Institute for Supply Management (Tempe, Ariz.) slumped to a 28-year low by December 2008.
Iron and Steel: Domestic steel shipments totaled 97.85 million net tons in 2008, 8.1 percent less than in 2007, reports the American Iron and Steel Institute (Washington, D.C.). Steel imports also declined last year—down 4 percent—while exports soared 21 percent, to 13.5 million net tons, thanks mostly to the weaker dollar. Overall, though, last year was negative for the U.S. steel industry based on apparent steel consumption, which fell nearly 10 percent, to 105.5 million net tons. That was the worst performance in more than a decade, as demand fell and companies up and down the supply chain aggressively destocked their inventories. Mill utilization rates dropped in the final months of the year in response to declining monthly shipment rates, which slipped 50 percent—from 9.2 million net tons in July to 4.6 million net tons in December.
The global steel industry also weakened noticeably in the third and fourth quarters, as the financial crisis reduced construction activity and consumer demand for durable goods. World crude steel production declined 1.5 percent, to 1.31 billion mt, according to the World Steel Association (Brussels). If you exclude China—the world's largest steelmaker—global production fell 3.3 percent.
On the price front, Midwest hot-rolled coil prices (f.o.b.) rose steadily in the first half of the year, peaking at $1,068 a net ton in July. Prices dipped sharply lower in the following months, ending at $566 in December. No.1 HMS ferrous scrap followed the volatility in finished steel products, with the published HMS composite price peaking in July at $523.16 a gross ton and closing out the year at $185.17.
Nickel and Stainless Steel: Last year's weakness in the stainless steel sector continued to reflect primary nickel price corrections that began in the second half of 2007. Several factors led to and exacerbated the negative trend line, including product destocking, product substitution, and the global economic crisis, which took a severe toll on all stainless steel-containing capital and consumer goods.
Nickel production cuts were not enough to lower the statistical surplus, which swelled from 34,000 mt in 2007 to more than 70,000 mt last year, Barclays Capital reports. LME nickel inventories ended last year at 78,822 mt, up 64 percent from 2007. Nickel prices deteriorated as last year progressed, falling from a March high of $14.28 a pound to last December's $4.47, a decline of almost 70 percent.
In the stainless sector, which accounts for two-thirds of primary nickel consumption, world production fell 6.9 percent, to 25.9 million mt, last year, according to the International Stainless Steel Forum (Brussels). Analysts expect this downtrend, which adds to the 2-percent decrease in 2007, will continue in 2009.
North American stainless production in 2008 totaled 2.3 million mt, down 11.1 percent year-on-year, ISSF says. Domestic stainless shipments, meanwhile, fell 19 percent, to 1.38 million net tons, AISI reports.
On the scrap front, preliminary USGS data reveal a 35-percent decline in recovered nickel scrap. In contrast, stainless steel scrap exports rose 14 percent last year, according to trade data from the U.S. International Trade Commission (Washington, D.C.).
Lead and Zinc: The global refined lead market slipped into surplus last year, ending with a 19,000 mt oversupply, the first since 2002, according to the International Lead and Zinc Study Group (Lisbon). Much of this excess was due to the 7.5-percent increase in global production from 2007. Despite reduced demand in much of Europe, Japan, and Mexico, world use of refined lead rose 6.4 percent last year, thanks almost entirely to China, up 24.8 percent from 2007, and the United States, up 4 percent.
North American shipments of replacement automotive batteries in 2008 were just shy of 99 million, up 1.2 percent, according to Battery Council International (Chicago). Unfortunately, a decrease of nearly 14 percent in original equipment automotive batteries tempered this good news, reflecting the sharp contraction in the auto markets in the closing months of 2008.
In terms of recycling, the tonnage of lead recycled domestically increased 2.5 percent last year, improving scrap's market share to 76 percent, USGS reports. In addition, lead scrap exports set a record in 2008, jumping 36 percent to 175,000 mt, of which 114,000 mt went to Canada, which is consistently the largest importer of U.S. lead scrap.
Refined zinc production and use also increased in 2008, rising 2.9 percent and 1.6 percent, respectively, ILZSG reports. China spurred much of these increases, boosting its production 3.5 percent and its use 11.6 percent. The United States, on the other hand, declined in both areas—0.7 percent and 2.6 percent, respectively. That said, many mines and smelters, domestically and abroad, have been gradually paring back output to prevent an excessive surplus. Though the zinc surplus increased in 2008, the increase was slight and has been a cause for some relief when looking toward the future. Also notable, the stock-to-consumption ratio in 2008 was only 3.9 weeks, compared with 2.8 weeks in 2007.
Domestic zinc recycling totaled 420,000 mt last year, the same as in 2007, USGS says. That total, measured against the decline in apparent consumption to 1.17 million mt, increased scrap's market share to 36 percent. Zinc scrap exports, meanwhile, dropped 11 percent, to 90,992 mt, last year, with just over 82,000 mt heading to China.
Despite earlier forecasts of long-term prices exceeding $1 for both lead and zinc, neither metal ended the year over that mark. Lead trended upward in the beginning of 2008, then it faced a steep correction that persisted for the remainder of the year. From its February peak to its December trough, the LME three-month lead average plummeted 68 percent, ending at 44 cents a pound. Zinc, meanwhile, continued its gradual decline from its high in May 2007. In 2008, the LME three-month zinc average plunged 56 percent from its March peak through December, settling at 51 cents a pound.
Paper and Recovered Fiber: By virtually every measure, the domestic paper industry suffered through another painful year. Paper and paperboard output declined for the third straight year, and newsprint consumption continued its negative trend throughout 2008, decreasing for the 68th consecutive month—including 10 consecutive months of double-digit declines. For the boxmaking industry, 2008 shipments touched levels last seen in the mid-1990s.
Paper and paperboard producers responded by consolidating and permanently reducing capacity. As a result, paper and paperboard production fell 4.3 percent last year, to 87.7 million net tons, with paper production declining 5.1 percent and containerboard slipping 3.7 percent, according to the American Forest & Paper Association (Washington, D.C.). The total supply of new paper and paperboard for all consuming markets decreased 6.8 percent last year, AF&PA says. Industry capacity shrank to 96.3 million net tons, down 7.3 percent from 2007 and continuing an eight-year negative trend. The tonnage of paper recovered for recycling also slipped last year, though the recovery decline was not as severe as the drop in new supply. That explains how recovered fiber gained market share last year to 57.4 percent.
Prices for bulk grades of scrap paper held relatively steady around $122 a ton through the first eight months of last year before nose-diving in the final months, ending the year at $25.28 a ton, according to ReMA's scrap paper price indicator. The decline reflected low domestic and international demand for recovered fiber in an oversupplied market. U.S. scrap paper exports also decreased 1 percent last year, while the value of those exports fell more than 8 percent. •
Robert J. Garino is director of commodities and Tom Crane is member services coordinator for ISRI.
The long run of economic good fortune came to a dramatic end in 2008, with commodity markets suffering an unprecedented economic earthquake of evaporating demand and steep price corrections.