Against the Grain

The base metals have been itching to rally for the past couple of days in spite of the mounting evidence of a global economic slowdown and combination of factors on the supply side has provided the match. First was an earthquake in Chile, which was followed by a rock slide at Freeport’s Grasberg mine and last night the report of an explosion at the same mine that caused no damage. This combined with reports of Chinese buying has seen prices recover well and this looks set to continue as various shorts are squeezed out again. All financial markets saw switchbacks as they followed the twists and turns of the latest US banking saga. The President of Argentina summed it up quite well, “Today the news in the papers, in all the papers, is the collapse of another bank far away in the United States — that bank that predicted the collapse of Argentina they should spend more time looking at their own accounts rather than looking at other countries”.

In Asia the focus was on Chinese Aug data retail sales rose 23.2% yoy (Jul 23.3%) with jewellery up 44.3%, garments +29.5%, meats +26.7%. Industrial production rose 12.8% yoy (14.7%) the slowest pace in 6 years on the back of slower exports, shortages in electricity (despite building a new power plant a week) and Olympic shutdowns. We have been told the latter affected less than 3% of China’s capacity and could be absorbed by other areas of more significance is the power shortages. China reported Aug metal production cu fell 0.5% to 320 kt, in the first 8 months of the year up 15%; al up 12.3% and 13.4% respectively, zn up 17.1% and 9.5% - were is the cutbacks in these two. Pb jumped 28% and 14%; ni 8.5% / 2% and sn fell 19.4% and -13.3%. The weekly Shanghai metal stocks saw cu fall 5558 tonnes to 13,554; al off 938 tonnes at 193,201 and zn up 364 tonnes at 71,175. The Japanese final Q2 GDP was down 0.7% and yoy -3.0%. The LME stocks registered a decline in cu stocks overall and rise in cancelled cu stock – the activity focusing on Korea. Over the week cu rose 2 kt; al up 13 kt; zn put in 100 tonnes; pb down 3 kt, ni up 2 kt and sn off 315 tonnes at 5% the biggest percentage move of them all. In Europe Jul Italian industrial production fell 1.1% (Jne +0.1%) yoy it declined 3.2% (-1.8%), Euroland industrial output fell -0.3% (-0.2%) with durable consumer goods falling 5.7%, yoy -1.7% (-0.8%). Weaker US$ and rising oil supported the metals as they pushed higher with cu test 7100.

There was a flurry of numbers out of the US Aug retail sales fell 0.3% against an expected positive number (Jne -0.1%) ex auto sales fell 0.7% again more than anticipated (+0.3%), Aug PPI -0.9% which should be no surprise after the fall in commodity prices (+1.2%) core PPI rose 0.2% (+0.7%). These two appeared to cancel each other out. Then at 15:00 the Spt preliminary Uni of Michigan consumer sentiment survey was extremely strong 73.1 (Aug 63.0), current reading 76.5 (71.0) and expectations 70.9 (57.9). Falling inflation and the presidential election signalling a change is improving the mood. Interestingly this is opposite consumer mood is against falling retail sales above. This saw the US$ lose ground as commodities picked up on growth prospects. Some of the activity will be related to book squaring ahead of the weekend with Hurricane Ike heading into Texas and plenty of booby traps still scattered around Wall Street.

Over the week (in the case of base metals last day and a half) cu rose 240, al up 26, zn up 150, pb recovered 140, ni gained 750, sn rose 950, gold fell US$ 53 / oz, oil down US$ 4.5 / bbl and the DJI recovered 250 points.

If evidence was needed that “supply shockers” live in hope it was evident y/day as cu rallied a smart US$ 100 (newswires referred to it as a leap) on news of a 5.8 scale earthquake in mid Chile (just above Antofagasta) coming after Freeport’s news of a minor problem at their Indonesian Grasberg mine the buyers bolted to 6970. Then the all clear from miners left them stranded. In Asia the LME / Shanghai cu arbitrage movement raised hopes that Chinese buyers could be tempted, this is the litmus test for demand. On the currency front the US$ broke below € 1.400. In NZ the central bank cut rates by 0.5% to 7.5% saying the economy is in recession and inflation will slow. In Brazil the central bank raised rates 0.75% to 13.75% to fight inflation. NZ is often seen as a market that leads the world trend while as a BRIC Brazil is seems to be bringing up the rear.

Mixed economic data in Asia, from Aug Australian unemployment rate fell to 4.1% (Jul 4.3%). Jul Japanese machine orders fell 3.9% (Jne -2.6%) yoy -4.7% (+9.7%). For a third week the Indian wholesale prices rise declined to 12.1% from previous 12.34%. See the attached article from the New York Times suggesting the problems in real estate could have reached China (www.nytimes.com). The LME stocks dominated by a 14 kt rise in al mostly into Rott 12 kt and rest Asia with the ni increase continuing Rott 426 tonnes. With a strong US$ and weaker oil price the base metals showed some resolve in not following. Any relief in the former saw buyers quickly into the metals. At these prices there is evidence of some selective re stocking in Asia.

As the US came to life base metals prices were almost unchanged on the day, the metals have all the hallmarks of being more worried about relief rally than further selling. The major element behind this worry is the amount of analyst comments about the threat of production cuts as prices move towards cash costs. In our experience the markets are not that rational world growth keeps slowing then metals price could quickly disregard such levels and miner prefer production to care and maintenance. Gold is certainly not acting in this way. The US weekly jobless claims were 445 k from previous 451 k. The Jul trade deficit increased to US$ 62.2 billion (Jne 56.8) while import prices fell 3.7% the biggest fall on record and reflecting a sharp oil price decline but volume increase. In Africa Jul South African manufacturing growth was 3.3% yoy (Jne +5.7%), it accounts for 16% of the economy.

In Geneva OPEC decided to cut daily production by 500 kbpd just under 2% to 28.8 million barrels per day as crude oil began probing US$ 100 / bbl. The market reaction was muted as most participants realise that demand is falling in the present global economic slowdown. There is no doubt the hoax of ’08 has been commodity prices as it becomes clear that an investor induced price push has not flowed into core inflation and easing demand has seen the run away prices pull back. This is perhaps best highlighted by a statistic we heard last week that in the past decade 96.6% of US workers have seen incomes fall between 2 / 6% as the economy has had average growth of 2.5%. This trend was reinforced by Aug Chinese CPI that rose 4.9% yoy (Jul +6.3%). This mood is reinforced by the performance of gold down 8% this year.

The weekly US ABC / Washington Post consumer sentiment index was -47 unchanged from the previous week. Other Chinese data the Aug PPI rose 10.1% (10%) with purchasing prices increasing 15.1% (+15.4%) while Aug urban fixed asset investment rose 27.4% yoy (first 7 months +27.3%). In Japan the Jul leading economic index was 91.6 (Jne 91.3) and coincident index 103.3 (101.6). Finally Russian Q2 GDP was 7.5% yoy (Q1 8.5%). The Turkish Q2 GDP rose 1.9% the slowest pace in 6 years (Q1 +6.7%). Zambia will hold presidential elections on Oct 30. It seems investors are a vindictive bunch it is reported on Bloomberg one under the veil of anonymity has reported metal fund Red Kite lost 30% in Aug, we doubt they would have said anything if they had been up that amount. It is no surprise that in this time of heightened uncertainty volatility hedge funds are beating stocks, bonds and commodity investments for the first time in 5 years, now traders are profiting from scaring themselves! The main highlight of LME stocks was an increase in cu 1725 into Europe and US and ni 210 received by Rott, since the start of Spt cu stocks have risen 17% and ni 5%. French Jul industrial output rose 1.2% (Jne -0.6%) as car output rose. We have most probably passed on enough bad news however the EU today cut its growth outlook for Euroland for the rest of the year and predicted a recession for Germany. It cut ’08 growth to 1.3% from previous 1.7%.

Cu gained ground on reports by Freeport of mine problems at Grasberg, which highlight’s the shock value supply disruptions still hold. The red hot data comes at 15:35 with the weekly US Department of Energy oil stock data saw stocks down. However this was not enough to stop the onslaught of fund selling.

The markets showed a classic reaction to the weekend announcement of the US governments “conservatorship” of Fannie Mae and Freddie Mac whatever the trending direction immediately and strongly move in the opposite direction, then try to workout what the action means. A “conservatorship” is an entity established by court order or regulatory authority, in the case of business enterprises, that some property, person or entity be subject to the legal control of another person or entity, known as a conservator. From what we can gather the US Treasury has taken over the firms but their future will be resolved after the new administration is bedded down in ’09. At their zenith the two entities were valued at US$ 140 billion today their value is around US$ 2 billion. The base metals rallied early y/day on the news and gave the gains back as investors realised it did not materially change the near term growth prospects.

Further evidence of a Chinese economic slowdown came today from the nation’s largest publicly traded real estate developer that reported a 35% yoy drop in Aug apartment sales as government lending curbs deterred buyers. Property demand in Chinese cities has as much as halved as lending has tightened with the general economic mood is not as optimistic as a year ago. The Chinese CSI 300 index is now down 60% this year. The Aug Japanese machine tool orders fell 14.2% (Jul -8.9%). In the metals India’s largest cu / zn producer Vedanta said it will invest US$ 10 bill to increase its al smelting capacity to 2.6 million tonnes pa by ’12 (year to Mch ’08 produced 396 kt). The new smelter in India’s Orissa state will be supported by an expansion of its Lanjigarh alumina plant to 5 mtpa from existing 1.4 million tonnes. BHPBilliton expects output at their Escondida cu mine in Chile to be 15% below capacity for the next two years as they mine through a low grade of ore. In ’07 the mines output increased 18%. In Korea stainless steel producer Posco is to extend a 20% (25 kt) reduction in production for a third month on weak demand. In the UK Jul manufacturing output fell 0.2% (Jne -0.4%) yoy -1.4% (-1.5%), and industrial production declined 0.4% (-0.1%) and yoy -1.8% (-1.7%). The LME stocks features were cu rising 1300; ni jumped 840 into Rott and al and pb fell. There seems to be a tightness of pb in Asia with Sing premium trading from below US$ 50 to over US$ 100 in the space of three days. For the second time this year the Baltic Dry Freight index has plummeted over 50% from a record high in a matter of days this time dropping from 11,600 to 5,500 points as worries about growth persist. In late pre market trading cu spiked to 6955 before slipping back.

Comments from the OPEC meeting indicating its output would remain unchanged and a lessening hurricane threat saw crude prices under pressure in early US trading. At 15:00 US Jul National Association of Realtors index of pending home sales fell 3.2% numbers like this enter a new phase from this moment after the government support for the mortgage business (Jne revised to +5.8% from +5.3%). US equities gave up y/days gains (which had only taken back to where they were this time last week) which weakened the US$ as traders turned attention to the FOMC meeting next week.

Equity markets around the world were pummelled last night some falling over 3% as investor gloom mounted about global economic growth prospects. In the US stocks that have benefited from the recent upturn in exports capitulated with Caterpillar down over 5%. Asian stocks saw their biggest weekly sell off in 13 years as the MSCI Asia Pacific dropped 6.8%. The world MSCI in early London was down 5.6% on the week the biggest fall since ’02. Significantly commodities were unable to get any traction from this something they have done frequently over the past year or so. This time a rampant US$ (testing € 1.42) is the dragging anchor as it rose to its highest level against the € since Nov and the US$ index at 78.9 a yearly high. The Russian central bank was forced to support the rouble as foreign investors reduced their exposure in light of recent political events. South Korea is another country who’s central bank is thought to have stepped into the market as the won has fallen 20% against the US$ this year.

The Shanghai weekly stocks saw cu rise 1487 tonnes to 19,112; al increased 1144 tonnes to 194,139 and zn declined 474 tonnes to 70,811. The base metals were under pressure in early London trading and this intensified as LME stocks saw cu jump over 18 k tonnes with 16,525 turning up in Busan. Over the week cu stocks rose 27.5 kt; al up 4 kt; zn down 1 kt; pb fell 4 kt; ni increased 1962 tonnes and sn up 50 tonnes. OPEC meets Spt 9 in Vienna with expectations there will be no change to the cartels production levels, yesterday the OPEC basket price US$ 103.64 / bbl. The DRC today announced current state owned mining companies will become commercial companies, of the 61 mining companies in licence renegotiations process 14 have satisfied government scrutiny while the others are still in discussions. The Jul OECD composite leading indicators fell 0.7 points to96.2 (Jne 96.9) indicating continued weakness in the G7, the BRIC countries showed expansion easing with India in a downturn.

Cu struggled to hold 7000 during the rings as the US$ failed to break through € 1.420. The Aug US non farm payrolls fell 84 k more than expected (Jul -60k revised from -51 k) manufacturing employment fell 61 k the largest monthly drop since ’03, construction -8 k, service producing -27 k as government jobs rose 17 k. The unemployment rate rose to 6.1% (5.7%) the work week was unchanged at 33.7 hours and hourly wage rate rose 0.4% to US$ 18.04. The US$ weakened back over € 1.43, gold strengthened 818 a clear winner in the “flight to security” stakes, oil up 107.8 and metals recovered after cu hit 6928 low. With no more data the markets have the rest of the afternoon to absorb this number. Some good news the ECRI institute said US underlying inflationary pressures are falling quite rapidly. Further US equity weakness saw post employment data gains given back as the funds look to protect core investments.

Getting out slightly early in a week the US$ dominated cu tumbled 643, al down 86, zn off 76, pb declined 180, ni fell 1750, sn dropped 1500, gold off US$ 23 / oz, oil down US$ 11 / bbl, the DJI dropped 560 points and US 10 year bond yields declined 0.25%.

The US Fed Beige Book released ahead of the Spt 16 FOMC meeting reported from twelve Federal Reserve Districts saw the pace of economic activity mostly slowing with business conditions described as “weak,” “soft,” or “subdued.” Consumer spending was concentrated on necessary items and retrenchment in discretionary spending. Tourism was mixed, transportation being adversely affected by fuel costs. Manufacturing activity was down with some improvement in the mid West. The agricultural sector noted some relief from dry conditions while energy and mining activity increased. Residential real estate was poor, commercial activity slowing and loan demand declining. A general pullback in hiring’s has moderated wage pressure. Commodity price pressure while high had dissipated as industry indicated it was passing costs on. Auto sales were weak and this was reinforced by August vehicle sales falling 15.6% yoy not even Toyota -9.4% was untouched.

It is usually Wed but today we get the headline data of the week, the US Department of Energy weekly crude and gasoline inventories this hot spot data has gained notoriety well above it status but has the ability to move markets and will do so today. Metal prices were firmer overnight as the US$ eased off its highs and oil rose. In early London trading buyers pushed prices further in what looked like short covering activity. The LME stocks were mixed cu and al continued to rise while zn and pb declined but the amounts were not enough to interrupt the macro influences. Metals pushed higher as oil pushed above US$ 110 / bbl as Hurricane Ike became the buzz, back to the weather charts. In Europe Jul German manufacturing orders fell 1.7% against an expected rise (Jne -2.6% from original -2.9%) yoy -0.7% (Jne -6%). French unemployment in Q2 was 7.6% unchanged from Q1. In the UK Aug new car registrations declined 18.6% yoy to 63,225 units. In metals the Kazakh government has introduced a draft law to introduce a minerals extraction tax from ’09 and rising in ’10, on cu it is proposed beginning at 8.7% of market value and zn 8%. This further highlights the rapidly rising cost push affecting miners throughout the world.

BoE and ECB left rates unchanged at 5% and 4.25% respectively. A gauge of how sentiment in commodities has changed was the lack of reaction to a comment by President Sarkozy during a meeting with the Syrian President that Iran’s nuclear programme may provoke an attack by Israel. A few weeks ago oil would have bolted on this type of talk. In the US Aug ADP National employment report predicts the private sector contracted by 33 k jobs (Jul +9 k). The Challenger Grey & Christmas layoffs fell 89 k (Jul -103 k). Weekly jobless claims were 444 k from previous 429 k. The Aug non farm payrolls are released tomorrow. The revised Q2 non farm productivity jumped to +4.3% (+2.2%) and unit labour costs significantly fell 0.5% (+1.3%). These clashed with the ECB President Trichet press conference where he gave a gloomy assessment of economic outlook, growth slowing and rising costs. The US$ strengthened against the € 1.445, gold, oil and base metals firmed. At 15:00 the Aug non manufacturing ISM was 50.6 which was against expectations new orders improved, the prices index fell as did employment a similar pattern to the manufacturing PMI (Jul 49.5). Then the big one DoE weekly oil inventory data fell 1.9 million barrels more than expected though Aug US oil consumption declined 3.5% yoy. This was offset by a rise in natural gas stocks. The US$ rallied as better US data trumped the Euroland outlook; US equities fell on the US employment outlook, oil fell taking other commodities with it.

A pall of gloom settled over the commodity sector today as a stronger US$, slowing economic growth and the failure of a major commodity related hedge fund took its toll. The Osprasie Fund said it was closing its flagship US$ 2.8 billion fund after it fell 38% since the start of the year (since forming in ’99 the fund has returned 15% / annum up to last year). Do not be surprised to see a rally today as traders view recent declines overdone as a result of this fund activity. At the outset of this commodity cycle trading was in hindsight relatively easy, years of under investment meant that when a sharp upturn in growth occurred suppliers were unable to meet demand. Now that buy and hold no longer works and those without an in-depth understanding of inter-play between other asset classes will have this weaknesses of philosophy quickly found out in these volatile conditions. We believe a realist standpoint is that the present economic slowdown has created a breathing spot in the longer term commodity cycle.

The metals have to contend with Spt option declaration this morning. In the US the weekly ABC / Washington Post consumer sentiment index improved to -47 from previous -50. Brazil reported Jul industrial production up 1% yoy +8.5% (Jne +6.4%) in a strong economy car sales rose 32%, retail sales above 10%, inflation is 6.4% and official rates at 13%. Australian Jne Q GDP rose 0.3% (Mch Q +0.7%) yoy growth +2.7%. The top Japanese cu smelter Pan Pacific Corp expects cu to be in  300 kt surplus in ’09 with demand rising 3.5% to 19.2 million tonnes (Chinese demand growing 8%) while output rise 4.9% to 19.5 million tonnes even after account for a disruption rate. They estimate ’08 global consumption will grow 1.8% (18.5 million tonnes) with Chinese demand having slowed to 3 / 4% (we have heard reports from China saying demand growth could even be flat) while production will be up 2.4% (18.55 million tonnes) easing previous deficits.

In Europe the Aug service PMI data was better than expected but still leaves the area in contraction, Italy 48.5 (45.6), France 48.0 (47.5), Germany 51.4 (53.1), Euroland 48.5 (48.3), UK 49.2 (47.4) and Russia 55.4 (58.3), holiday season probably helped. August Italian business confidence was 83.5 steady, UK consumer confidence 52.0 unchanged, Euroland Q2 GDP revised down to +1.4% from 1.5% (Q1 +2.1%) and Jul Euroland retail sales fell 0.4%, yoy -0.9%. The LME stocks had little impact. Metals marked time ahead of option declaration at 11:30 as the US$ tested 1.440, gold stayed below 800 and oil just above 108.

After a steady morning a weaker US$, higher oil and lower equities saw buyers take the metals higher. At 15:00 the US Jul factory orders increased 1.3% better than anticipated (Jne revised to 2.1% from +1.7%). Attention turning to equities after a hefty gain y/day was wiped out by the close today weakness has continued.

All eyes are on oil as Gustav dissipates into a tropical storm the crude price has fallen over 8%. Early trading in London saw it fall over US$ 7 / bbl to under US$ 106 / bbl (Fri close 117.3 have been over 120 that day). This has seen the “worry” pendulum swing back to the economic slowdown arena and hit the base metals. With investors moving to the sidelines economic growth is the main driver of commodity prices if that slows we remain in a long term price uptrend however in a short term consolidation phase of a duration which is yet to be determined though longer and more severe than anticipated three months ago.

In Australia the RBA cut rates by 0.25% to 7%, the first rate cut since ’01. The LME stocks dominated by cu up 6075 tonnes with material into Netherland warehouses 2800, Busan 1175 and US 2100 while zn moved out 1425 from Dubai and Sing. Little around on the data front, Jul Euroland PPI rose 1.1% (Jne +1%) with yoy rate at 9%. The strengthening US$ (below € 1.45 stronger than the beginning of the year) and falling oil price weighted on the metals.

Rather like Gustav the worst of the sell off seems to have occurred before the LME official rings, as US$ gave up ground and commodities picked up. After the US markets got going oil price was extremely volatile moving in US$ 0.50 cent increments every few minutes, the US$ either side of € 1.4500 and gold below US$ 800 / oz. The Aug US manufacturing PMI came in at 49.9 (Jul 50.0) this included a fall in the employment subset 49.7 (51.9), inventories rose 49.3 (45.0) while new orders increased 48.3 (45.8) and prices index 77.0 (88.5). The JP Morgan Aug global PMI was 48.6 with all the component parts slightly lower (Jul 49.0). July construction spending fell 0.6% in line with expectations (Jne +0.3% revised from -0.4%). Oil recovered from it sell off after Gustav helped by news that three more tropical storms are forming in the Atlantic (Hanna, Josephine and Ike) which should keep traders cautious and weather bound. Initial reports from NO say metals stocks there are undamaged.

Was it hurricane or McCain watch this weekend as Gustav swooped in on New Orleans and Sarah Palin barged her way onto the US political stage. As the hurricane bears down on New Orleans the tom / next on cu and zn jumped to extended contango’s above the arbitrage levels as bankers were determined not be caught holding potentially flooded material as with Katrina in 2005. >From The Times Spt 1 edition is a good article on China out by Rosemary Righter “China’s challenges demand its leaders be bold” (www.timesonline.co.uk).

From a global perspective the Aug Manufacturing PMI data painted a gloom picture in the developed world (US away) Italy 47.1 (45.3), France 45.8 (47.1), Germany 49.7 (50.9), Euroland 47.6 (47.4) and UK 45.9 (44.1) in the developing BRIC area, official China data 48.4 (unchanged), China CLSA 49.2 (53.3), India 57.9 an exception (57.8), Russia 49.4 first contraction since ‘04 (50.4), South Africa 47.0 (42.8). The German Jul retail sales fell 1.5% leaving the unchanged on the year. The LME stocks highlighted by a large intake of ni up 1206 with Tyne and Weir landing 1224. The ICSG reported the refined cu market in a 155 kt deficit in the year to May (year to May ’07 deficit 238 kt), cu output seen at 7.553 million tonnes and consumption 7.708 million tonnes.

Metal prices were under pressure and this was increased as oil prices dropped below US$ 111 / bbl, as Hurricane Gustav failed to gather extra momentum as it hurtled towards land and downgraded to a category 2 (crude oil 200 dma is at US$ 111.31 last broken in May ’07). In Japan the PM Fukuda resigns after less than a year in the office. The afternoon session is without the US so expect an early rush from the trading floors.