For all the global instability we have started seeing – such as in Ukraine, the South China Sea, Gaza and Libya, global mining giant, Rio Tinto (RIO) remains pretty upbeat about the outlook for commodities.
And that’s despite of the growing fears about what will happen in financial markets when the Fed ends its current round of quantitative easing (markets fell when the first and second bouts of easing ended, only to rebound when the new round was announced).
Key commodities for the company, such as iron ore remain weak, and prices are forecast to weaken over the rest of this year and into 2015 by groups such as Goldman Sachs.
Coal prices are weak and show no signs of recovery and copper prices are stuck in a narrow range, with the market fairly well supplied.
But in its interim profit report, Rio’s confidence was striking.
In the second half of 2014, China’s crude steel production is expected to remain at the current level of approximately 830 Mt/a, with steel demand expected to grow by between three and four per cent over the previous year.
Growth in infrastructure (up around nine per cent), machinery (up around five per cent) and transport (up around 14 per cent) are expected to outweigh the weakness in residential construction activity (down around three per cent).
There has also been a strong increase in Chinese finished steel exports in recent months, in particular to Japan, Korea, Taiwan and the ASEAN region with net finished steel exports approximately 40 per cent higher in 2014 first half compared with the same period of 2013.
Much of the new non-Rio Tinto iron ore supply has been of lower iron ore content with higher contaminants. This has led to a more marked price differential between the 58 per cent and 62 per cent indices and greater discounting of lower-quality material by some producers.
In turn, lower-grade producers from China and less-traditional supply countries have started to curtail production, with approximately 125 million tonnes of high-cost supply expected to exit the market in 2014.
New mine supply has also moved the copper market into surplus over the past year, although the effects on prices have been more muted, with additional supply absorbed by Chinese bonded warehouses.
Chinese corporate bond defaults in March raised concerns over a potential hardening of regulation on copper stock financing, resulting in price volatility. While more copper supply is expected to ramp up over the coming year, the long-term fundamentals remain supported by the complexity and high cost of new projects.
Aluminium premiums, excluding China, reached record levels in 2014, in line with increased demand and a lack of physical supply.
Regulatory changes that increase the speed with which stocks can exit LME warehouses may result in declining premiums, but supply curtailments and stronger demand should mitigate this impact with the market outside China now in deficit.
Meanwhile, the ore export ban has stopped flows of Indonesian bauxite into China.
The impact on prices has so far been limited as Chinese refineries had built significant inventory positions. These have begun to deplete, which could result in stronger demand for alternative bauxite supplies if Indonesian exports do not resume in the coming months.
And on the global economy, there was the same confidence from the big miner, especially about the outlook for China.
Overall, we remain confident of the long-term fundamentals of demand, whilst recognising the changing nature of China’s economic development.
Volatility in global financial markets is currently low, attributable to clear monetary policy direction from central banks, but geopolitical uncertainties, notably in Ukraine, the Middle East and the South China Sea, and economic risks could give rise to short-term fluctuations in our markets.
In China, we still expect annual growth to end up near the official forecast of 7.5 per cent due to targeted expansionary policies. Endeavouring to address imbalances from its investment-led growth model, Chinese authorities are engaged in a delicate balancing act to control credit expansion while limiting loss of confidence and negative effects spreading across the national economy.
The large stimulus packages of the past have been replaced with a range of tailored measures to prevent adjustments escalating into a negative spiral. Intervention has included directives to banks, a modest depreciation of the Chinese RMB to unwind speculative currency inflows and a symbolic tolerance towards small bond defaults.
This intervention has been well managed so far with improvements in export growth and, to a lesser degree, manufacturing contributing to China’s GDP growth.
These measures have contributed to a bearish short-term outlook in China’s property market.
Weak sales growth, high inventories and financing difficulties are contributing to weak fundamentals. Offsetting this, in part, the Government is incentivising infrastructure investment.
In the United States, the rebound in second quarter growth, after the negative impacts from weather disruptions earlier in the year, indicates that the backbone of the recovery seems intact.
Unemployment has fallen and inflationary pressures are starting to build, once again raising questions over the timing of the first rise in the Federal Reserve rate since the global financial crisis.
The Eurozone continues to flirt with deflation risks, sparking debate over quantitative easing from the European Central Bank.
Growth remains unbalanced with Germany leading a stronger core while countries with high debt levels continue to lag despite bond yields being back to pre-crisis levels.
While growth is returning to the Eurozone for the first time since 2011, it remains anaemic and with unresolved underlying fragilities.
