China - the Game-changer

The opportunity for consumers of industrial metals to hedge their exposure or for investors do buy precious and base metals at lower prices did not last long. While some metals pared gains made earlier last Friday, they closed the week with a gain compared to the preceding period. There were two factors at play, which supported the metals markets. The game-changer was probably China.

After the article for this blog was posted the previous Sunday, the EU agreed on the rescue of Ireland by providing 85bn euro credit (incl. credits from the IMF). However, the EU also announced the creation of a European Stabilization Mechanism, which includes the provision that private investors should contribute to a restructuring of a eurozone country’s national debt. While the German proposal had been watered down considerably, the vague rules did not reduce the uncertainty among private investors. As a result, the markets did not welcome the decision of the EU and fears of a contagion spreading to Portugal and Spain remained high. This weighed on the euro and was not a positive factor for metal markets.

However, the sentiment improved somewhat on Tuesday after a speech of ECB president Trichet. The market then was driven by a rumor that the ECB would decide at its monthly council meeting to increase the volume of purchasing government bonds from peripheral eurozone countries. At the press conference following the ECB council meeting, Mr. Trichet did not announce a certain volume of bond buying, which disappointed the markets somewhat. However, the ECB extended the period of providing full allotments at the repo tenders until the end of the first quarter next year. In addition, Mr. Trichet emphasized that the bond purchasing program remains fully in place. As the ECB had not set a limit for this program, it could not increase a limit and the actual volume of bond purchases depends on market conditions. Thus, the euro recovered from losses made at the beginning of the ECB press conference, which was a positive factor for metals.

But the strongest push for base metals came from China. After another hike of the minimum reserve requirements by 0.5%, the market feared that the People’s Bank of China would soon follow with a further increase of interest rates. The markets already priced in a lower demand for base metals from Chinese consumers. Thus, the consensus expected only a modest increase of the official Chinese purchasing manager index by 0.1 points. However, the index rose far stronger from 54.7 to 55.2. Also the HSBC PMI increased by 0.5 points to 55.3, which points to an acceleration of economic activity and not to a slow-down. We regard this development as a confirmation of our assessment that the Chinese authorities just want to prevent the economy from overheating but would not choke off GDP growth. Thus, a GDP growth close to 10% in 2011 appears to be achievable in China. This would imply that demand for base metals is likely to expand further and to support the price development.

 In the US, the monthly non-farm payroll figures disappointed and send the US dollar lower, which pushed precious and base metals higher. While the consensus expected that 143K new jobs were created, the Bureau of Labor Statistics reported only a plus of 39K new jobs. This was in a sharp contrast to the ADP private payroll estimate. Economists provided two explanations. First, that the seasonal adjustment factors underestimate the number of new jobs. Second, the so-called birth/death model of the BLS estimated that new founded businesses on balance reduced jobs. However, this is again in sharp contrast with the ADP figures, which indicated that new companies added to payrolls. Thus, we would put more emphasis on leading indicators of economic activity like the PMIs, which came in better than expected in the US for both, the manufacturing and the service sector.

As it seems that the euro has found a bottom, despite not being out of the woods yet, and economic activity indicators improve further, the outlook for GDP growth in China but also the US remains positive. This should be supportive for base and precious metals.