When the trade war started, market participants hoped that an agreement would be reached by the time of the US mid-term elections in November 2018. But that date came and went without a deal.
Fastmarkets then said there was a race against time before either a trade deal revives global growth or the fallout from the difficult trade environment, which has scuppered business and household confidence, drags the main economic powerhouses into recession.
Europe is stuck with low growth: GDP was just 1.4% in the second quarter of 2019. China’s GDP was 6.2% in the same period, with the National Bureau of Statistics saying the Chinese economy will face further “downward pressure” in the second half.
Deteriorating confidence and weak industrial commodity prices, especially for most base metals, have prompted consumers to reduce their stock levels. The London Metal Exchange Index (LMEX) of base metals prices has fallen by 19% to 2,772 since peaking at 3,436 in January 2018.
While sideways movement suggests that bases could be in place, this is unlikely - and only if a new trade deal were to reignite consumer interest could further falls be avoided.
One reason why prices have based out is because the supply fundamentals are generally tight - all of the base metals, with the exception of lead, are forecast by Fastmarkets to be in supply deficits this year and next.
Although supply deficits and in most cases falling and low stocks do not tally with low prices, such is the depressed state of the market. Reported base metals stocks, calculated in weeks of consumption, averaged 2.3 weeks at the end of the third quarter compared with four weeks at the end of 2018.
We would expect significant rallies in the event of a trade deal. A rebound in confidence is likely to boost physical demand but, given that the supply chain is destocked, also start a restocking rally. So we still have a potentially bullish outlook if politicians decide that a trade deal is in their interest.
But there is room for disappointment - and we are not sure how much more disappointment the market can take. Manufacturing purchasing managers’ index (PMI) data has been deteriorating - recent readings show contraction for Europe, China and Japan and slowing growth in the US.
For example, the September manufacturing PMI reading for Germany was 41.7, which was worse than the low of 43 registered during the 2012 European sovereign debt crisis in which Greece and other nations came perilously close to dropping out of the European Union.
So while the underlying fundamentals for the metals are robust, the fact that many equity markets are near record highs highlights the potential for complacency. The markets are living on cheap money; companies around the world raised a record amount of money via bonds to take advantage of low borrowing costs - low because many government bonds now have a negative yield. But these companies may be storing up trouble if the underlying business is weak.
If a trade deal fails to materialize, no amount of cheap money will offset falling corporate earnings, which could prompt a correction across equity markets.
Another broad-based flight to safety would probably affect industrial metals as well, even if they are already on relatively low ground. In the previous major deleveraging sell-off during the financial crisis in 2008, the price falls were stunning. For example, the three-month LME copper price over a six-month period fell by 68% to $2,825 per tonne from $8,940 per tonne. And the LMEX fell by 62% to 1,648 in January 2009 from 4,297 in February 2008.
Why would China and the US not urgently seek a trade deal given that the global economy is suffering and more alarm bells are ringing as each week passes?
Money has been pouring into assets that are traditionally considered to provide safety. The price of gold has rallied by 34% to $1,557 per oz from last year’s low at $1,160. US 10-year treasury yields have fallen as low as 1.47% compared with 3.2% in October 2018, such is the demand for them. And in Germany, investors have been prepared to accept a negative yield of as much as 0.7% to own a 10year German bund; the yield was last positive in late-April 2019.
These are sure signs that many institutional investors are worried about what is unfolding.
In such a situation, one would hope that common sense would prevail. But maybe the stand-off between the US and China is bigger than the trade deal itself; perhaps that is why havens are in so much demand.
Because the US economy is not suffering as much as China’s economy, the US may feel that it can hold out for a deal that corrects the imbalances. But China may want to hold out for as long as possible, even if it causes further pain, in the hope that the US economy will start to suffer just as the US enters an election year.
Given US President Donald Trump’s maverick traits, it is in China’s interest that Trump not win another term in office. Winning a second (and final) term as president could embolden Trump in the knowledge that he could focus on how to “Make America Great Again” without needing to worry about being re-elected.
The danger for the metals business is that, if a trade deal is not agreed in the weeks ahead, the threat of a downward economic spiral could prompt another deleveraging sell-off