It doesn’t all seem to have gone as planned, this summer. Anybody else remember the euphoria about rampant nickel prices a few months ago, when Indonesia announced the ore export ban? Or the commonplace enthusiasm for aluminium heading onwards and upwards once it broke $2200? It’s always easy to be wise with hindsight and I wouldn’t be entirely truthful if I didn’t add that I too expected to see markets perform more strongly than they have. Copper, gold and silver - none of those are setting the market alight, either.
Getting the Market Wrong
Obviously, everybody gets the market wrong sometimes, so it’s perfectly reasonable to see even the best analysts missing the target, but there really did seem to be a consensus a few months ago that we were on the verge of seeing well-based, fundamentally supported price action in the industrial metals - precious I accept are a slightly different kettle of fish. So perhaps it’s interesting to look at some of the possible causes of the flat to disappointing picture that has emerged in recent sessions.
First, there is the paradox of the global economy, where bad is good and good is possibly bad as well. Bad economic news - by which I mean a continuing failure of economies to grow substantively out of the trough of 2007/08's depression - strangely doesn’t have to be a negative, as long as their governments continue to keep the tap of cheap new money turned on. In other words, if free money is floating around, then (as I and other writers on this site and elsewhere seemingly never tire of pointing out) hard assets, like industrial commodities, should rise in value as a hedge against governmentally-inspired currency devaluation. We’ve seen pretty good evidence of that in recent years, but in the last period, actually the effect doesn’t seem to be working. Of course, it’s possible that the US taper is deterring buyers, but I’m not really convinced by that, on its own. As the taper programme progresses, so the prospect of increasing interest rates gets closer; so actually, there’s a two-edged sword swishing at asset prices here. It’s always been clear - to those who have thought about it - that it’s easier to start a programme of QE than it is to finish it; creating the initial illusion of growth as you pump out newly-minted liquidity is one thing. Making it stick when that very liquidity necessitates higher interest rates to control things is the bit that we haven’t yet seen executed.
So that’s one part of the picture - the financial side, if you like. There is also the fundamental side, which, as always, is somewhat more nuanced in its effect on the various different commodities. Nickel has been a case study in buying the rumour and selling the fact; a great rally on the Indonesian ore ban, and then a substantial decline in the face of the unexpected continuing growth of LME stocks. While that was initially suggested by some to be no more than a movement of stock as a defensive measure against the Qingdao games, that’s no longer an adequate explanation, even though some still seem to be promoting it. Aluminium, the other midsummer favourite, still seems to be struggling under the pressures of the issues created by warehousing problems. LME stockpiles are currently coming down, but mainly just to move into private storage. The premium levels generated by queues seem to me to be inhibiting business; it’s the same old issue - we can look at the total price, but the way that price is made up cannot be ignored.
I’m not going to analyse all of the metals here individually - they all have their own dynamics - but I will repeat the generalisation I made above: the performance has been disappointing.
There are a couple of other issues I’d highlight, without of course suggesting that they are all there is. First, there’s the thorny question of Chinese growth. That’s been looked at by lots of people and the comment I’d make is that consistently, over recent years, commentators and analysts have over-estimated it. Why, I’m not sure. Maybe it’s just the mathematical point that’s ignored - that the larger the economy gets, the slower the growth rate is likely to be in percentage terms. But it would be naive to leave it at that, and I don’t believe the experts are naive, so I can only put it down to over-optimism and an under-estimate of the effect of a faltering property sector. Or maybe an excess belief in the ability of the central government to control the property lending business?
The other issue I’d point out is the activity of the hedge funds. Now, I have to be careful here, because I can only really speak anecdotally, since funds are extremely reluctant (understandably) to comment too much themselves on their own business. One of my favourite analysts has been suggesting recently that there has been an increase in fund activity. I just don’t see it; short-term, CTA-style day-trading, maybe - I can’t really comment on that. But long horizon, value investing by serious hedge funds? I don’t think that’s come back, and that I think is quite possibly the biggest single factor in explaining the disappointing performance of the metals through this summer, in contrast to expectations. Whether or not one ‘likes’ the idea of industrial commodities as an investment vehicle, the truth is that that investment has become an integral part of the market pattern; yes, it undoubtedly pushes markets around, but it’s absence is clearly marked. Why aren’t they involved at the moment? I can do no better than quote a good friend of mine, a well-respected hedge-fund manager of many years standing: “No horizon or thesis anymore…just risk management and punting. A land of low vol, margin compression and reversion to the mean…..urgghh!” Doesn’t sound like he’s going to be back in size anytime soon - I think those hopes of healthy market rallies are getting pushed ever further into the future.
All those eager buyers waiting in the wings to go long “because prices have got so attractive”? Might be a long wait….