The impact of the earthquake on metal markets

After a devastating earthquake and a tsunami hit Japan, the thoughts are first with the victims of these natural disasters. This will especially be the case for those readers who have friends and family or colleagues in Japan. The author of this blog was also several times on business trips in Tokyo and had many colleagues in the Tokyo branch of his former employer. The hopes are that they all are well.

Nevertheless, as financial and commodity markets only pause over the weekend, it is also legitimate to ask what the impact of the catastrophe will be, which hit Japan so strongly last Friday. Against the background that the situation in Fukushima nuclear power station is very dangerous and could result in another disaster, it is rather difficult to assess the damage caused by the earthquake.

According to press reports, the Bank of Japan is ready to provide as much liquidity as needed to the financial system, when markets open on Monday morning local time. This should prevent a run on banks. A situation comparable to the collapse of Lehman Brothers is most likely to be avoided, at least, as long as no panic sets in.

Japan’s GDP growth in the final quarter of 2010 was 2.2% yoy, with a trend towards slower growth. It could not be ruled out that GDP growth will come closer to zero or even that GDP will contract in the second quarter of this year. As the earthquake hit Japan towards the end of the current quarter, the impact of the current quarter GDP growth is probably smaller, in particular as industrial production and retail sales pointed upwards in Q1. However, it is currently not obvious, how strongly industrial plants in Northern Japan are affected by the earthquake and the catastrophe at the Fukushima nuclear power station.

Nevertheless, history shows that the impact of a natural disaster on economic activity is very often only temporarily. It is quite obvious that the earthquake and the following tsunami have caused damages on infrastructure and housing facilities. Reconstruction work will be positive for GDP growth going forward. Also cars have been destructed and need to be replaced. It is currently unclear, if the domestic automotive companies have the facilities to replace them quickly, but purchases of new cars are also likely to increase, which would be positive for the demand for PGMs (catalytic converters) and aluminum as well as copper.

Japan is a country with a big export surplus. Short-term production short-falls might not necessarily be negative for global GDP growth as long as they could be substituted by products from other countries. Furthermore, the reconstruction work in Japan might lead to increasing imports to Japan, which would also be positive for the global economy. However, given the opaque situation about potential losses of industrial production, there is the risk that some products might not be easily replaced by other suppliers and that this could have a negative impact on industrial production in other countries in the short run.

Japan is an importer of commodities. Production losses over the next couple of weeks will have an impact on the demand for commodities by the world’s third biggest economy. This might especially be the case on Japanese imports of crude oil. Already on Friday, crude oil prices edged lower. This would also reduce the inflation fear triggered by the recent rise of oil prices after unrest in North Africa broke out.

Fears, the Bank of Japan might sell US Treasury holdings and repatriate the proceeds, led to a stronger yen versus the US dollar last Friday. However, those fears appear not to be well founded. Even if the BoJ would sell US Treasuries, it is unlikely that the Japanese central bank would intervene in FX markets to strengthen the yen. More likely would be that Japan uses the proceeds to pay for imports. Thus, the US dollar might rebound against the yen. Declining Japanese demand for commodities and a stronger US dollar against the yen would be negative factors for metal prices short-term. But reconstruction works are likely to lead to higher demand for commodities in the medium-term. Thus, metal markets might correct further down on fears of a global economic slow-down. However, we would regard this as an opportunity for consumers to hedge against the risk of medium-term price increases.