Today, I'd like to welcome Stuart Burns, Managing Director of Aptium Global, a middle market direct materials sourcing firm, to Spend Matters. Stuart heads Aptium's European and Asian operations. I asked Stuart, a former metals arbitrage specialist, to offer up his opinion on whether tightening credit markets have the potential to lead to major structural changes in the metals markets. In full disclosure, I have an economic interest in Aptium Global through my wife, who is also a partner in the firm.
In this post, I'd like to explore the likely impact on the metals markets of recent chaos in the credit markets.
The press and news channels have been awash with the rising tide of woe regarding the crisis in the subprime market and the resulting credit crunch in the interbank lending markets both in the USA and Western Europe. Central banks have had to step in as subprime lenders have filed for bankruptcy and not but two weeks ago, a perfectly solvent British lender Northern Rock, provider of 1 in 5 new mortgages to the UK housing market, faced a run on withdrawals of over US$ 4bn (for a bank with only US$40bn in deposits). As a result, its share price dropped 32% when it became known they were being provided emergency funding by the Bank of England.
Why and how did this situation unfold? This crisis in the interbank market occurred because the banks have stopped lending to each other. As some institutions face rollover of their Asset Backed Securities -- both mortgage and other rolled up debt instruments like car finance and credit card debt -- banks have had to hoard liquid assets and borrow cash in order to meet their obligations both in terms of reserves and self funded rollovers as the market for these forms of debt has dried up.
A precursor to a slowing US economy, the housing market has been in decline in many areas in the US for the last 18 months. But as this has now become a countrywide issue, the question is perhaps not when will these latest developments push the US into recession -- but when. With high levels of personal debt, a falling housing market, rising inflation leaving the Feds little more room for dramatic rate reductions, the US needs to generate 100,000 jobs per month just to meet new job seekers coming onto the market. Given this, we're predicting that there is every indication that the US will be in recession in 2008, or soon thereafter.
Our question is what impact will this have on the metals markets and can we expect turmoil there as investors liquidate positions possibly to meet obligations elsewhere or is there a flight of confidence in the current strong demand for raw materials?
The first thing to remember is that the world has moved on over the last 10-15 years. During the second half of the twentieth century, as the power house of the world economy, all other economies looked to the US for direction. That situation is changing, however, as the growth of Asia in general and the BRIC countries in particular (Brazil, Russia, India and China) has created a second source of growth and massive demand that will continue to power the world economy. Asia has taken over from the US as the largest consumer of most base metals -- almost 50% of Copper is consumed in Asia, much of it in China, followed by 22% in Europe and only 14% in the USA. China is also the largest consumer of Aluminium, Lead, Nickel, Zinc and Tin. A significant proportion of China’s growth is now fueled by internal consumption, particularly base metals for construction and industrial development and so will continue regardless of a reduction in US demand.
The second key point is that high as current prices for base metals are in a historical context, they have come off dramatically in the last 6 months and no longer look like a speculative bubble ready to burst. Current price levels for Copper, Aluminium, Nickel and Zinc are at or around the level they were 12 months ago. Nickel and Zinc have declined nearly 50% from their peaks at the turn of the year and Aluminium has come off over 15%. Only Lead where world stocks are down to less than 25,000 tons or the equivalent of one day of world consumption is still understandably at near record highs.
Although we could foresee worst case scenarios where institutions unwind positions to raise cash in a growing credit crisis and consumption is reduced by a lack of investment and consumer demand, in reality, the metals markets are more likely to be supported by a continued strong demand from Asia. New production capacity takes a long time to come on stream and so we can expect to see the current supply demand balance continue for the foreseeable future largely regardless of the fallout from the current credit crisis in the West. What's the net here? In our view, there's unlikely to be a silver lining for metal consumers to this current financial crisis in the form of lower costs -- current prices are here to stay.
Stuart Burns is a Managing Director at Aptium Global. He can be reached by email @ sburns (at) aptiumglobal (dot) com.