Investors often view financial crises through the lens of previous events they have either lived through or studied. Naturally, the events we have been experiencing this year are often compared to the Global Financial Crisis of 2008 or the dot-com bubble at the turn of the millennium. In an environment of increased financialisation, where assets become divorced from conditions on the ground (Wall Street vs Main Street), the comparisons may reveal some interesting parallels. But when you look at the industrial metals, each with their own unique supply and demand characteristics that markets must acknowledge, you get a sense that this time we may be in a radically different situation from the crises of old.
In recent economic downturns, the formula was relatively simple. Decreased demand led to falling prices. Bloomberg’s Industrial Metals Index is a particularly useful chart to look at, as it demonstrates the magnitude of the decline we saw during the last crisis. In 2007-2008 commodity prices were soaring. The index peaked above 255 in April of 2007 and then set another lower-high at around 240 in February 2008. As the crisis spread to the rest of the world, demand collapsed and by February 2009, the index dropped to just above 90, the largest drop in its history.
When you look at 2020, the moves on the index are tiny compared to 2008, industrial metals having never properly recovered since the last crisis. The monthly chart describes a series of lower-highs with another lower peak in early 2011 and an even lower one between December 2017 and January 2018. The coronavirus crisis sell-off is a mere blip on this chart, testing but failing to break the lows of both 2008 and 2015. This is followed by the sudden rise we have seen since March in almost all assets.
The difference this time is that we’re not just seeing a drop in demand due to a financial crisis. What we’re currently witnessing are massive, sporadic disruptions to both supply and demand that feed back on each other and make it incredibly difficult to predict commodity prices going forward. Copper, which is often referred to as Dr. Copper due to its price being correlated with the overall health of the global economy, is a perfect example of this. It has rallied by more than 50% since the lows in March, causing many to speculate that the global economy may be on the mend.
The reality may be a little more complex. While copper prices have certainly staged a comeback, this is despite forecasts for global GDP plummeting, a scenario that would have been unheard of in the past when copper and GDP (particularly Chinese GDP) moved in lockstep. The spread of the pandemic at different rates in different parts of the world, each with different measures for combatting it, has led to a situation where all the dynamics investors once took for granted have been overturned.
For instance, China was the first country affected and the first to lockdown. This was a huge shock to demand as China is the world’s largest copper importer. But China has also been the first to re-emerge from lockdown. As China’s economy began to power back up, demand for copper increased. But by this stage the virus had taken hold in South America, quickly turning what was initially a demand shock into a supply shock.
Chile, which is the world’s largest copper producer, has been severely affected by the pandemic. To date, thousands of mineworkers have fallen ill with Covid-19. With mining having been designated an essential activity, the country’s copper mines have remained open while reducing their workforce and ceasing all non-essential activities. As the virus continues to spread - Chile is now ranked 6th in the world by total COVID-19 cases - workers are protesting the situation and have even planned strikes. This is causing many to view Chile as a huge risk to global copper supply. Peru, which is the world’s second-largest copper producer and currently ranked 5th in the world by total COVID-19 cases, has experienced a massive slump in output since its own mines were shut by authorities in response to the pandemic.
Nickel and Uranium
Nickel, which is used in the production of stainless steel and other alloys, as well as in the rapidly growing battery sector, has also been greatly affected by the coronavirus pandemic. By the end of April, it was estimated that the metal had lost over 30% of its supply due to over-reliance on production from the Philippines. The Philippines recently became the world’s largest producer of nickel after Indonesia instituted an export ban on the metal in order to support its domestic smelting industries. Then, in March, the Philippines banned vessels entering Surigao del Norte in order to prevent the virus’s spread to its shores, casting a great deal of uncertainty over the supply of nickel going forward.
Uranium supply and demand dynamics are another of the areas experiencing upheaval due to the coronavirus pandemic. The story has been one of mine and processing facility closures, skeleton staffs upon reopening, and greatly curtailed production. This has been the case for many of the world’s producers including the world’s largest uranium mine Cigar Lake, Kazakhstan’s state-run Kazatomprom, Rössing Uranium mine in Namibia, and many more. The widespread lockdowns have also resulted in reducing energy consumption as well as altering load profiles and lowering wholesale energy prices. The World Nuclear Association has estimated that there will be a 10-20% drop in energy production as the consequences of the various factors affecting the industry play out.
The State of Play
What’s become clear is that we are now in a rather unique environment of convoluted supply and demand dynamics following the upheavals resulting from COVID-19. Though not everyone agrees on the health of these specific industries, there is one thing that most analysts do agree on; going forward, commodity prices are going to be incredibly difficult to predict. If the above chart suggests anything, it’s that in some ways we never truly recovered from the previous crisis, and we may just be getting started as far as this one is concerned.
We’re looking at a scenario where there is a moving target that’s constantly shifting and changing. Not only do speculators need to have a grasp of the demand arising from various quarters as lockdowns are lifted and businesses re-open, but they must also be aware of where the virus is taking hold, what industries are likely to be affected, and also the fundamental changes in the global economy as a result of the pandemic. The world is currently in a state of waiting for the dust to settle so as to get a clearer view of what the damage is.
Trading in such an environment can prove incredibly difficult but there are a few things to keep in mind and research further. Some analysts are starting to believe that the recent surge in the prices of industrial metals (due to fears over their continued supply) may have overshot fundamentals meaning there could be shorting opportunities at these levels. This is definitely an area for commodity traders to keep an eye on.