What Yuan devaluation means for base metal prices?

by- Sugandha Sachdeva | AVP & Incharge- Metals, Energy & Currency Research at Religare Securities Limited 

Base metals prices broadly have witnessed a steep decline in the recent past with copper, aluminium and nickel having fallen below 6 year lows, while zinc tumbled near to its 4 year lows on the London Mercantile Exchange .The situation looks quite dismal, as the decline is now more than 3 months old already ,with few dead cat bounces over the course of selloff. This significant fall in the prices owes its origin to the slowdown in demand all over. However, a talk about base metals is not complete unless one includes the big daddy China, the giant which accounts for 40% of the base metals demand alone and how can the base metals perform better when it is not in the best of its health lately ?Further the heat is being emitted from the US, which is expected to normalize its interest rates this year; however a lot has been discussed and talked about it already, so let’s just skip it for today.

The show in the base metals has turned ugly from the demand perspective, while it is not paying much heed towards the supply side of the things at the moment. Not much recovery is noticeable even after the droughts, floods, strikes, exports ban and power outages from the mines, which unambiguously indicates that the market is more concerned about the subdued demand outlook. There has been a knee jerk reaction seen in the entire pack after the People’s Bank of China devalued Yuan amid China’s economic slowdown, justifying it as a onetime process to adjust against the over strengthening of its currency against the dollar and  making it more market driven for a better price mechanism. This move however sparked off fears of a currency war among emerging economies, that led to the wide spread panic sell off in risk assets, although gradually the fears curbed when the bank issued more clarifications.

The step came in as increasing worry started to grip about the state of the Chinese economy, following a string of economic data from the country that continued to disappoint. China’s exports declined 8.3% on YOY basis in the month of July, while imports declined consecutively for the ninth month. Elsewhere, the Chinese manufacturing purchasing manager’s index, the measure of factory activity across the country too fell to a two-year low in the same period. This fall in China’s manufacturing and construction sectors could hurt further demand in base metals. In the wake of such a mess, the step to devalue the currency looks like an encouraging one by the PBOC. Firstly the increase in the infrastructure spending and signs of improvement in the property sector are likely to boost the domestic demand for base metals in China and secondly this move should encourage Chinese producers to produce more of the metal and export at a competitive price, although it will also lead to higher import price leading to a pressure on the demand, which is already subdued.

 China, has been pushing hard to escalate the internal demand lately but since things does not look very pretty as far as the demand is concerned, so despite discouraging the local producers by letting them shut down the ventures it looks more apt to subsidize them and keep the ball rolling. With devaluing Yuan at the same time, it has stated its intent to revive growth by reiterating its export-focused policy. In the global concept, this move by the largest consumer can lower the demand gradually and add to the prevailing supply glut, if this devaluation manifests more of this kind in future.

The weakening of currencies against the dollar is giving fuel to an already might dollar and making it difficult for the US exporters to sustain. This is a big threat to the recovery in the US economy which still looks fragile, in case this leads to an era of currency devaluations. The Yuan episode also implies an enigma regarding the timing of interest rate hikes in the US, given the fact that a rate hike is expected to feed the dollar further. For now, the markets look to have digested the negative news ,and the prices might stabilize. However, in case of any currency devaluation  spree, prices may get a further beating. Furthermore, any efforts by the Chinese government to boost the demand can support the prices of the base metals, otherwise it will be the demand that will remain the center stage and the deciding factor for the future course of base metals’ prices.

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