Against the Grain

WARNING: the LME is closed Mon and its end of the month, you could see some big price moves as traders use the US to window dress our guess (9 out of 10) chance prices will be higher on that day, unless you have something like China doing a big monetary policy move or such like).

A recovery in US equities yesterday lit the fire under the metals as they posted strong gains in Asia as sellers stood back in light turnover. The focus is on Western equities as a 3% decline on Shanghai equities was overlooked. This west – east divide is perhaps best understood taking into account banking “liquidity”. In the west interest rates are near zero (and set to remain there) while central banks keep the market liquid. In the east China avoids tinkering with interest rates but there is growing worries that liquidity is / will be tightened. Should western central banks begin to tilt toward rate rises / liquidity tightening we suspects financial markets would shudder. The Japanese have elections this Sun and the Liberal Democratic Party that has been in power for 54 years is heading for a heavy defeat not helped by Jul unemployment rising to a post was high of 5.7% (Jne 5.4%), consumer spending fell 2% yoy (+0.2%) and CPI -2.2% yoy (-1.8%), ex food and energy -0.9% (-0.7%).

The weekly Shanghai metal stocks all rose cu by 4975 tonnes to 86,625 (since late Jul stocks are up 75%); al 21,287 tonnes to 219,650 (up 22%) and zn 2038 tonnes at 117,499 (+16%). The LME weekly changes saw cu rise 6 kt; al fell 19 kt; zn up 1 kt; pb increased 3 kt; ni up 4 kt and sn 153 tonnes, however in an environment of investor usage as the key driver of prices such moves mean very little. The pb market continues to hold centre stage with Western analysts bullish about the China smelter shutdowns while Asian traders have no worries believing most smelters will be soon (if not already) back on line.

In Europe UK Aug GfK consumer confidence was unchanged at -25. The UK Q2 GDP revised to -0.7% from -0.8% and yoy -5.5% (-5.6%) increased government spending offset falls in business and consumer outlays.  The Aug EU economic confidence index rose to 80.6 (Jul 76.0), business climate indicator -2.21 (-2.70), consumer confidence -22 (-23), industrial confidence -26 (-30) and service sector confidence -11 (-18).

The US Jul personal income was unchanged (Jne -1.3%), personal spending rose 0.2% (+0.4%) as savings slipped to 4.2% (4.5%). Then at 15:00 the final Aug Uni of Michigan consumer sentiment index was 65.7 (Jul 66.0), current reading 66.6 (70.5) and expectations 65.0 (69.2). The US Department of Energy has set aside US$ 300 million to boost the sales of energy efficient electrical household goods the complicating factor is it will be done at a state level and they have till Oct 15 to submit rebate plans. After that it was back to equity surfing, though traders were reluctant to follow the sell side to aggressively on a Fri afternoon at the month end.

If you want to see bank regulators in action look at Nigeria where over the past fortnight five bank (40% of the sector) boards of management were summarily dismissed and a few bank bosses arrested and locked up as the country’s central bank injected US$ 2.6 billion into them after the discovery of bad loans to the tune of US$ 7.45 billion that they had run up. All the country’s 24 banks are being audited.

Very quiet Asian session with slightly weaker equities leaving metal prices in limbo, with the uncertainty over China’s monetary policy boosting the yen. The Spt South Korean manufacturing confidence index rose to 93 (Aug 80 and Mch 44). In Europe Aug Italian consumer confidence rose to 111.8 (Jul 107.5). In Australia Q2 business investment rose 3.3% (Q2 -7.3%). The German Spt GfK consumer confidence survey rose to 3.7 (Aug 3.4) while an Aug Euroland retail purchasing PMI dipped to 47.1 (Jul 47.3). In the UK Q2 total business investment fell 10.4% (Q1 -7.6%) yoy -18.4% (-9.7%). See the attached assessment of the UK economy in The Times Aug 26 by Ruth Lea “Summer recovery will turn to a cold winter” (www.timesonline.co.uk).

Apart from a fall in al LME stocks saw rise the norm with ni the largest into Rott.

The US “cash for clunkers” program generated car sales of 700 k units with Toyota accounting for 19%. The weekly initial jobless claims rose to 570 k (revised up to 580 k). The Q2 GDP preliminary was unchanged at -1% against an expected -1.5%, personal consumption was revised to -1.0% (-1.2%). At 14:30 cu traded tick for tick with the DJI (interestingly had a meeting with an equity analyst who was complaining that equities are only focused on metal prices while we said it was the other way round – who is leading who up the garden path?). Equity surfing was the order of the afternoon with DJI rallying from down 80 points to down 20 in the last half hour of the kerb.

The direction of equities seem to be driving the metals, the DJI closed higher but below where it was at y/days LME close electing some early Asian selling and a cu low of 6240. Then Asian equities advanced and this put a bid tone into the markets.

The metals continue to be dominated by the strong advance in pb as it moved above 2100 in early London trading. The China story continues to grow as it is reported that analysts from state-owned research group Antaike say as much as 60% percent of the nation’s pb production capacity does not comply with official environmental standards. No real surprise and suspect the same is true for many other industries (how many stories have we heard about, food, chemicals etc. We have a contact who worked at a Chinese gold mine where arsenic leached into a stream flowing through the accommodation, production continued a pace) but can the government afford to act on all of then, what would be the consequences for the country’s growth profile. China al producer Chalco says the country’s smelters, traders and warehouses hold up to 600 kt of stock. The LME stocks were of no consequence. In recent times we have seen a sharp increase in physical metal being offered out from the Asian area India, Vietnam and Shanghai cu is being offered as low as US$ 35 / tonne FOB. Between pre market and the floor cu price led a downturn, as equities pulled back. In UK afternoon a Bloomberg article appeared quoting the China State Council web site saying the government will increase guidance of industries including steel, cement, coal, chemicals, plate glass and wind power equipment – seen as an attempt to curb overcapacity. The Baltic freight futures continued to correct touched a three month low.

In Asia Aug South Korean consumer confidence rose to 114, above 100 is optimism (Jul 109) with government spending and low interest rates the drivers. Japan saw Jul exports down 36.5% yoy (-35.7%) with China -26.5%, US 39.5% and Europe -45.8%, as a trading nation this seems to us nothing short of a disaster yet investors pushed the Nikkei higher. Finally, the H1N1 flu threat rode to rescue Singapore as Jul industrial production rose 12.4% yoy (-9.2%) the booster was pharmaceuticals up 139% (+20%) they are 20% of manufacturing, ex bio medicals fell 7.4%. Electronics declined 5.6% (-19.2%) they make up 26% manufacturing. While the Malaysian Q2 GDP declined 3.9% (Q1 -6.2%). Into Europe the Aug German Ifo business climate index 90.5 (Jul 87.3), current reading 86.1 (84.3) and expectations 95.0 (90.4) as with all recent confidence data the improvement is stacked into the “future”.

Overnight the weekly ABC / Washington Post consumer sentiment index improved to -45 (-46). The MBA weekly mortgage applications rose 7.5% (+5.6%) though easily anticipated by the fall in bond yields as usual the devil is in the detail the refinancing index +12.7% while the purchase index +1%. The Jul durable goods orders rose 4.9% (Jne -2.5%), however ex transportation up 0.8% (+1.1%) and inventories of durable goods fell 0.8%. Ahead of US oil stocks oil under pressure 71.25. Then at 15:00 Jul new home sales rose 9.3% to 433 k units (+9.1% to 395 k units). Finally the “hottest data on the street” weekly DoE oil stocks posted a small rise, after the big fall last week a rise was expected.

For months we have been stressing the importance of COGS in any economic recovery (by that we meant the world economy can be seen as a series of cogs and look for those which have the momentum to shunt the whole economic machine back to a regular speed) and recent evidence shows how important China has been in getting the system turning again. A top Japanese government economist said “there’s no mistake that China’s economic recovery is contributing to a rebound in Japan and other economies in the region”. Since the lows South Korean industrial production has jumped 28% and Taiwan 26%. In Europe a bank released a report entitled “Eurozone Q2 GDP: Made in China”. French exports to China and other East Asia economies rose 18.7% Q2 (Q1 -16.2%), overall Euroland exports grew 6.3% (-6.2%). It seems China has replaced the US as the world locomotive but as Prof Kenneth Rogoff of Harvard (ex IMF chief economist) is quoted in the NYT “The big question is what happens next if the consumer in the US and Europe does not come back, I’m not sure Asia has a Plan B” (or the world economy as a whole, it seems all the eggs have been moved from one basket to another). Hong Kong reported Jul exports fell 19.9% yoy (Jne -5.4%), the breakdown showed a 15% drop in exports to the mainland, US -29.4%, UK -30.7% and Germany -29.8% with imports down 17.8%.

Metals pulled back from Mon close as equities underperformed, in the US the DJI gave back gains to end unchanged, while Shanghai lost 2.6% have being down over 5% at one stage as worries persist about future Chinese monetary policy. Another Chinese bank CEO warned of bubbles in the equity and property markets (suspect commodities as well. In China officials in Henan and Hunan provinces are checking pb smelters after the closure of a smelter in Shaanxi last week. The feature of LME stocks a rise in cu (Busan 3100) and drop in al, perhaps an indicator of the physical markets is the low level of cancelled warrants to total stock with sn the largest at 4%. The Mongolian Parliament has passed amendments clearing the way for Rio Tinto and Ivanhoe to finalise the investment agreement for the Oyu Tolgoi cu project targeted for 2013 and having average mine life cu production of 450 ktpa. The pb / zn spread hits US$ 210 from US$ 20 at Mon opening.

Late y/day the Chicago Fed released the Jul Midwest manufacturing index that rose to 79.9 (Jne 77.7) the gain accounted for entirely by the auto sector, with “cash for clunkers” at and end can it hold up. Very similar to housing where the rise in existing home sales Fri was attributed to “first home” buyers who get a Federal tax credit and prices hit by foreclosures, (by our rough reckoning, the US Census Bureau puts average US earnings at US$ 27,590 / year - the combined government car and house incentives are an extra 45% of untaxed income). The Jne Case – Shiller composite 10 city home price index rose 1.4%, yoy fell 15.1% (-16.8%) and the composite index of 20 cities -15.4% yoy (-17.1%). The Conference Board Aug consumer confidence index jumped to 54.1 shrugging off two months of falls (Jul 46.6), the rise expectations 73.5 (63.4) while present situation was 24.9 (23.3). The Aug Richmond Fed manufacturing index was 14.0 lower than expected (14.0). The DJI quickly up over 100 points, oil tested 75.0 with € steady at 1.435. Then the US Office of Budget Management in its annual mid session review saw ’09 growth contracting 2.8% ( previous-1.2%) and ’10 growth at 2% (+3.2) and ’11 +3.8% (4%) with unemployment hitting 10% in ’09 and 9.8% in ’10.

A good existing home sales figure in the US on Fri saw Asian markets playing catch up but one still gets the feeling there is more reticence in Asia as investors wait to see what moves the PBoC will take if any to slow the breakneck speed of the economy. In this environment we expect better economic data to support the markets with the wild card being a “China shock” (keeping in mind the 60^th anniversary of the People’s Republic of China is October 1). In the West with oil prices at a new post crash high expect them to act as significant drain on consumer disposable income, however unlike last year food prices have remained subdued. A good summary of the situation is coming from Dr Doom himself, Nouriel Roubini “The risk of a double –dip recession is rising”, FT Aug 24 (www.ft.com).

The Chinese Customs said Jul cu imports fell 23% to 292 kt from the Jne record level of 378 kt, the fall was offset by a 60% rise in cu scrap to 448 kt as higher prices send traders in search of value. The delayed reaction of the metal traders to news is hard to fathom this morning a 7% jump in pb was attributed to the closure of smelters in China associated with a poison scare reported on Aug 14; following a poison outbreak China’s Dongling Lead and Zinc Smelter in northwest Shaanxi closed 100 kt capacity plant. On Fri the pb / zn spread settled at below US$ 25 differential today it is over US$ 160, despite both metals being affected by the China plant shutdown. Either pb traders are very slow or there is something more to this rally.

In Europe the good numbers keep flowing as Euroland Jne industrial news orders rose 3.1% (May +1.8%) however still down a massive 25.1% yoy (-30.3%). As Hungary reduced official rates by 0.5% to 8%, Israel became the first country in the post recession era to increase rates by 0.25% to 0.75%.

The Jul Chicago Fed national activity index improved to -0.74 (Jne -1.8). With that out of the way it is “go with the flow”, as equities, US$ and oil interplay which turned out to be” running on the spot”, then just after 16:00 as the DJI reached a new daily high (+75) cu touched a daily low (6300). Then metals prices burst high cu rallying over US$ 100 in 20 minutes to a new daily high (6424) with DJI not moving & pb price above 2000. A US asset research group estimates commodity mutual funds have increased their assets by US$ 7 billion this year more than a tripling of yoy investment at US$ 89.6 billion (this excludes energy assets that separately rose US$ 2.54 billion to US$ 22.87 billion). Ahead is investor window dressing into the end of Aug, prices in a couple of the metals today look almost irrational since 07:00 this morning cu is up 16 having had a US$ 135 daily range in the last hour; al off 31; zn down 25; pb up 116; ni down 300 after a 650 overnight rally, with gold down 2.5, oil up 30 cents and US$ / € unchanged.

There seems to be an East / West split in market sentiment, in Asia talk of China planning to tighten bank capital requirements with the China Banking Regulatory Commission reported to have drafted rule changes. This has dented equity markets in the emerging sector and seen metals this week lag behind gains in oil. The freight markets have been in retreat as worries mount about decreased Chinese imports of bulk commodities. The West continues to see better economic numbers and rising equities.

Since the Shanghai equities peaked in early Aug we have seen a marked increase in Shanghai weekly metals stocks which continued this week cu rose 5543 tonnes to 81,650; al up 16,995 tonnes to 198, 363 and zn dipped 250 tonnes at 115,461. Asian metal trading was subdued partly because Select was down for a while and Europe began slowly before getting a lift from a weaker US$, rising oil and encouraging economic data. The LME stocks rose across the board on the week with marked difference in tonnage - cu 250 tonnes on the week; al jumped 75 kt; zn 875 tonnes; pb 2.4 kt; ni 1.5 kt and sn 368 tonnes. A new term entered the metals lexicon today, the BHPBilliton CEO introduced “clean demand”, in a briefing he said “we wont see clean demand until early next year, stocking events will probably play the major role for probably the next six months”.

In Europe preliminary Aug PMI figures showed continued recovery, Euroland manufacturing was estimated to be at 47.9 (Jul 46.3), services 49.5 (45.7) and the composite reading 50.0 (47.0) on the cusp of contraction and expansion. The two leading economies saw German manufacturing at 49.0 (45.7) and services at 54.0 (48.1) while France manufacturing was 50.2 (48.1) and services 48.9 (45.5), is France overtaking Germany as the powerhouse of European manufacturing? The manufacturing PMI data is certainly running ahead of actual industrial production numbers. In the UK Jul car production fell 17.9% yoy as the focus turns to what the government will do going forward with is car incentive scheme. In Russia 1H foreign direct invest collapsed by 45% yoy. While the  accident at the Sayano – Shushenskaya hydro electricity dam in Siberia which provides 15% of the country’s hydro electricity and 2% of its total power highlights the investment that is needed in Soviet era infrastructure.

Data for the week ended at 15:00 with US Jul existing home sale jumped 7.2% to 5.24million units better than expected (Jne +3.6% at 4.89 million). The rise was perhaps backed by all the wrong reasons, foreclosure-driven decline in prices, government credits for first-time buyers and near-record-low borrowing costs. After a blip last week “never be short on a Fri afternoon” was again the mantra. The “cash for clunkers” car scheme is being ended Aug 24 with nearly 500,000 cars being exchange as consumers turn from trucks and SUV’s to smaller cars with greater fuel efficiency. A full blown commodities charge was tainted by a strengthening US$. See the take on the US economy by Simon Johnson ex economist at the IMF in the NYT Aug 20 (www.nytimes.com).

On the week the honours go black gold, cu rose 40, al up 27, zn increased 52, pb a rise of 42, ni down 375, sn off 425, gold up US$ 8 / oz, oil jumped US$ 6 / bbl, DJI at time of writing up 139 points and US bond yields rose 0.03 %.

Again a “bear trap” slammed shut y/day after a number of non metal events boosted the other sectors oil, €, gold and equities but metals followed without the same “oomph” of recent times but certainly reinforced the feeling the bulls are the dominant beast in the arena proving it is very hard work to push prices lower but they snap back sharply. This morning the markets seem to have a “what do we do now” look about them, perhaps oil’s direction being the key.

In Asia equities recovered following the DJI as Shanghai posted a 4.5% gain slowing the momentum of the recent declines. Taiwan Q2 GDP was -7.5% (Q1 -10.1%). The South Korean Public Procurement Service said it will pause its al stockpiling programme in the near term as the metal’s price is too high. It has been reported in trade press that Chinese zn TC rose this week by US$ 20 / tonne to around US$ 175 / tonne. In China another outbreak of pb poisoning has seen at an unlicensed manganese smelter in Hunan province. The LME stocks were of no consequence.  The Rio Tinto H1 results showed net earnings fell 65% reflecting the yoy change in commodity prices. Their chief economist gave this good summation of their markets “But given the role of speculation in driving markets and anaemic OECD demand, it seems prudent to exercise some caution about the scale of the recent rally in some prices. Risks during 2010 arise from a range of sources, including: · Any deceleration in demand once economy-wide inventory rebuilding slows; · The possibility that any recent run up in physical commodity stocks could be placed back on the market; · An inevitable reduction in the pace of growth in government economic stimulus; · The likelihood that consumer spending – especially in OECD economies - will remain constrained for an extended period on concerns about high unemployment and the need to rebuild wealth following recent asset price deflation; and · The likelihood that supply and capacity growth will be encouraged by recent price and credit market improvements. · Risks to the global financial system appear to have abated; but the possibility of further serious shocks with negative consequences for overall economic growth cannot be entirely discounted” (www.riotinto.com).

The customer is well in the UK as Jul retail sales rose 0.4% (Jne +1.3%) as expected lifting yoy sales by 3.3% yoy (3.1%). Contrast this with the US, see the article from the Wall street Journal Aug 19 edition “Reluctant Shoppers Hold Back Recovery” (www.wsj.com). In the worst result on record in Jul the UK public sector borrowed £ 8 billion as corporate tax receipts tumbled and welfare costs jumped.

In the US the weekly initial jobless claims rose 15 k to 576 k. The DJI gave back all its pre market gains as investors are now expecting a big drop in this data soon, it opened around unchanged however oil remains the driver. Then at 15:00 the Jul Conference Board leading economic indicators index rose 0.6% to 101.6, coincident index was flat at 99.7 and lagging declined 0.3% to 110.8. And the Aug Philadelphia Fed index into positive territory 4.2 against an expected unchanged and improvements among all sub sections (-2.0). Despite a positive DJI, higher oil and slightly weaker US$ the metals struggled losing ground on the day – an unusual pattern.

The Jul consumer and producer inflation data has shown a sharp rise in the reporting of negative inflation rates (deflation), from China, US, Germany, Japan and some UK definitions. Deflation is defined as a decrease in general price levels and associated with times of negative or stagnate economic growth. It can be harmful as people delay spending hoping for cheaper prices (though the rise of instant gratification especially in electronic goods offsets this), employees resist wage cuts causing further inflation (evidence employers have been cutting hours and other things to avoid lay offs), real interest rates rise as consumers work of excess credit and increases debt for them and governments. Some of this could be offset by rising productivity, improved technology and lower costs especially in these times. This is before currency considerations in the UK petrol prices are nearly as high presently with crude at US$ 70 / bbl as they where this time last year with the price at over US$ 140 / bbl.

The Asian markets were under pressure again as equities in Shanghai declined 4.3% which is 20% since the Aug 4 peak, other markets followed Nikkei -0.7% and India 1.5%. The metals struck out for higher ground in early Asia helped by the DJI, oil and € with cu up to 6140 but this soon turned lower as sellers dominated proceedings like y/days London pm session. The Jne Japanese all industry activity index rose 0.1% below expectations (May +0.7%) while final Jul machine tool orders were down 72.3% (72.2%). See WSJ article on Australia’s relations with China “The China Paradox” (http://online wsj.com).

The metals certainly under performed y/day as interestingly did the soft commodity sector as broad commodity indices turned lower. We had hopes that with no al stock build up before third Wed the inflow might have slowed but post date has reversed that. The LME stocks dominated by a 52 kt al inflow (31 kt into the Netherlands & Detroit 16 kt). From Aug 26 the LME initial margin on al will rise US$ 750 to US$ 3500 per contract  and ni up US$ 1800 to US$ 13,200 / contract. The Russian Sayano – Shushenskaya hydro plant could take up to 5 years to repair with the company saying back up coal power stations will provide the lost energy. RUSAL takes 70% of its off take with two smelters with a combined capacity of 832 ktpa near it. The company says ’09 production could be affected by 10% going forward, in H1’09 its output was down 10% yoy at 1.98 million tonnes. The ILZSG reported a zn surplus of 273 kt in H1’09 with the stock to consumption ratio at 7.5 weeks in pb the surplus was 37 kt for the same period. Demand was down 18% in Europe, 11.6% US and 47% in Japan offset by Chinese usage up 25%.

In Europe Jul German PPI declined 1.5% (Jne -0.1%) falling yoy 7.8% (-4.6%) the biggest decline in 60 years as energy costs retreated. The UK industry group CBI reported Aug industrial trends total orders improved to -54 (Jul -59).

In the US last night the weekly ABC / Washington Post consumer sentiment index crept up to -46 from previous -47. The only data today weekly MBA mortgage applications rose 5.6% from previous week decline of 3.5% and look set to improve further as long rates fall. The annual “Jackson Hole” Wyoming meeting of guru’s run by the Kansas Fed begins today so watch out for “market moving” comments. Very nervous markets as they headed into the afternoon with every financial instrument watching each other like Olympic pursuit cycle finalists. Metals touch lows as US equities opened cu at 5818 before a rally, with oil up, € stronger and DJI not as low as expected – was a bear trap set? – Yes more by luck than management. At 15:30 US weekly oil stocks fell most in a year as imports declined by 15% this saw oil jump US$ 2 to 71.3 / bbl in five minutes. Separately the € rose over 1.42 and gold advanced US$ 7 as the US and Swiss reach agreement on the UBS tax affair. The Deere & Co the world’s largest farm equipment maker reported Q3 profits down 27% and going forward equipment sales to fall 34% as strong farm sales were offset by lower construction and lawn equipment. It will be interesting to see what Asia makes of the reasons for the oil, € and gold bounce with a late surge in the DJI.

Looks like panic over as metals plough higher after the recent poor US & Chinese data in Asian time helped by a weaker US$ and stronger oil, then this morning investors took heart from the fact German investors agreed with their outlook as the German Aug ZEW economic sentiment survey jumped to 56.1 (Jul 39.5). In another sign of “where is the customer” Jul Japanese department store sales fell 11.7% yoy (Jne -8.6%) for the seventeenth consecutive month. The Jne leading index was 79.9 (79.8).

The focus in the metals was on al where buyers latched onto the news of an accident at Russia’s biggest hydro electricity plant that supplies RUSAL Siberian plants with the energy to power the smelters. As with all Russian events the real truth of the damage will take sometime to come out. As for investors they overlooked the news y/day but took hold of it when prices moved higher. It must also be remembered that RUSAL’s al partner Glencore took over 800 kt of stock off their hands in May locking it up in a financing deal. The LME stock registered an al rise of 20 kt as some third Wed material was delivered. A report on Bloomberg quotes a Canadian  bank as saying “Copper, nickel and other base metals stockpiled by speculative Chinese investors including pig farmers maybe sold when market sentiment turns. A price surge and easy credit this year encouraged pig farmers, stockbrokers and businessmen to buy copper and nickel for speculation”. In the am session metals lacked the real upward momentum of late, perhaps it’s the quiet time of the month for investors, new funds allocated and too early to window dress.

The UK inflation data was more benign that expected Jul CPI was flat at +1.8% yoy as computer game prices offset food and fuel declines. The Retail Price Index fell 1.4% yoy (Jne -1.6%).

Late y/day the Aug US NAHB home index rose to 18 (Jul 17). The US data came at the opening of the session and was poor Jul PPI decline 0.9% double what was expected (Jne +1.8%), core PPI -0.1% (+0.5%), energy -2.4% (+6.6%). Then Jul housing starts fell 1% to 581 k units (+6.5% at 587 k units) and building permits -1.8% at 560 k units (+10% at 570 k units). With no more data the metals headed to the beach to “surf” equities and the US$, choppy waves to start with, then the surf was up but they fell off the board around 16:00 before recovering. Interestingly all these antics as DJI, € and oil plodded higher.