Metal prices rose sharply over the past year, with copper and steel up 50%, and iron ore appreciating 115% through June. This strength is especially remarkable considering that leading indicators in China, the world’s largest consumer of metals, have begun to slow amid credit tightening and greater emphasis on deleveraging.
In our view, three forces could potentially drive appreciation in metals prices over the medium term:
- China’s ongoing structural reforms have laid a foundation for the recovery and sustainability of metal prices. From 2015’s supply-side reforms in steel/cement to today’s financial reforms, the economy is gradually being steered away from boom-bust cycles. This has lent more stability to global commodity markets. Now, as part of China’s ongoing environmental reforms, we expect more restrictions in pollutive activities like steel production. Further, China is mulling export taxes on steel products, after rolling back export tax rebates earlier this year. Such measures will likely result in lower Chinese steel exports. While recently demand has softened, metals consumption is just normalizing down to high single-digit growth after months of larger increases, while inventories are also normalizing up to historical averages. Moreover, China has various stimulative options at its disposal, including ample room for local government bond issuance.
- Global ex-China demand has remained strong this year, evidenced by outperformance of U.S. and EU steel prices over Asian steel prices and surging U.S. physical copper premia levels. Positive macro data in the EU and U.S., in addition to significant additional infrastructure spending plans, suggest tailwinds for metals in the second half of 2021. In the medium term, transformations of traditional transportation and power are underway as more countries seek more sustainable economic development. Increasing electric vehicle penetration rates and growing use of renewable power should play a significant role in boosting potential demand growth over the next three to five years at the least.
- Despite the recovery in demand, metals supply remains anemic. This is partly driven by ESG risks. For example, a 2019 Brazilian dam disaster continues to cast a shadow over the safety and environmental impacts of iron ore mining, hampering production. Australia, another major iron ore exporter, has seen more frequent extreme weather events, leading to disruptions and additional costs. All told, this year’s projected 51 metric ton increase in iron ore supply will be inadequate to meet incremental demand of over 100 metric tons. Meanwhile, ongoing labor disputes in South America, and a possible increase in mining taxes, could adversely impact copper supply and result in deficits this year and 2022.
For credit investors, the buoyant metal outlook remains an attractive opportunity in the M&M sector, particularly in companies disciplined in capital allocation while building strong reserve buffers to weather the next downcycle.