The nickel price bubble is slowly deflating but bears would be advised to tread carefully with a sharp fall in LME inventory threatening a repeat of the time-spread turbulence that rocked the London market in late September.
London Metal Exchange (LME) nickel surged to a five-year high of $18,850 on Sept. 2, from $12,000 per tonne at the start of July, as Indonesia brought forward to a ban on exports of nickel ore to January.
But the exuberance has dissipated with short-term fund money pulling out to leave LME three-month metal around $13,100 per tonne currently.
While nickel may be on the electric vehicle (EV) investment grid because of its use in lithium-ion batteries, an old driver is reasserting itself – namely the state of the stainless steel market.
Demand for stainless steel, which accounts for most of the world’s nickel usage, has been “depressing” everywhere but China, analysts at JP Morgan said. (“Metals Quarterly”, Nov. 22, 2019)
The bank is forecasting that stainless steel production in the rest of the world will fall 1.7 million tonnes this year, a contraction of 7% and the sharpest year-on-year decline since 2009.
China appears to be a bright light with production growing 12.6% in the first nine months of 2019, but the only problem is, according to JP Morgan, that production is outpacing demand growth.
Stainless steel stocks are building at China’s exchanges and along the supply chain and prices are falling. Since launching in late September the Shanghai Futures Exchange stainless steel contract has dropped from 15,575 yuan per tonne to today’s close at 13,830.
Chinese production margins have been negative almost the entire year, according to Goldman Sachs, but producers are caught in a “prisoner’s dilemma” and aren’t cutting production to balance the market because each fears losing market share if others don’t join in. (“Metals: The ‘prisoner’s dilemma’ of China’s stainless steel industry”, Dec. 4, 2019).
Capacity utilisation therefore remains high, as does demand for nickel units, a big factor in its outperformance this year relative to its base metal peers.
JP Morgan thinks the Chinese stainless steel stand-off is unsustainable and expects mills to start curtailing production into 2020, while Goldman Sachs is not so sure, arguing that only small high-cost producers will be washed out of the market.
While the two banks agree that what happens next in China’s giant stainless sector is the key to nickel’s fortunes, Goldman expects LME nickel prices to rebound near term but JP Morgan’s view is that fair value over the next year would be $12,000-13,000.
INDONESIAN NUMBERS GAME
The answer to the Chinese question lies at least partly in Indonesia, where the accelerated export ban threatens supplies of a key raw material for China’s stainless mills.
The market is scrambling to work out the impact on supply, given offsetting factors such as higher ore output in the Philippines and higher nickel pig iron (NPI) output in Indonesia itself.
The clue is in China’s monthly trade figures where it is already evident that Chinese buyers, unsurprisingly, are rushing to stock up ahead of the January 2020 ban.
China’s nickel ore imports from Indonesia surged to 2.5 million tonnes in September and to 3.1 million in October from 1.6 million in August.
Imports from the Philippines have also been strong, averaging 3.9 million tonnes per month since August, while those from New Caledonia, another potential replacement supplier, jumped to 341,000 tonnes in November from 187,000 tonnes in October.
Ferronickel imports have more than doubled this year thanks to high-volume flows of Indonesian NPI — classified as ferronickel by China’s customs department — but the buying spree hasn’t extended to refined nickel, of which China was a net exporter in October for the first time since 2014.
Imports of 12,100 tonnes in October were the lowest since March, while exports of 20,400 tonnes were an all-time high, albeit with the caveat that everything that left did so under an “entrepot” customs code, suggesting it had been sitting in a bonded warehouse and was simply re-exported.
LME STOCKS AT CRITICAL LEVELS
The two main destinations for China’s outbound nickel shipments in October were Taiwan (12,300 tonnes) and Singapore (6,900 tonnes).
Both are LME good delivery locations and extreme time-spread tightness at the end of September would have acted as a powerful magnet for physical deliveries into the exchange’s warehouse system.
LME cash nickel was commanding a decade-high premium of $240 per tonne over three-month metal at the start of October, sucking almost 82,000 tonnes of metal into LME warehouses since the start of September, although even more has been leaving.
Headline exchange inventory has fallen to 68,922 tonnes from 152,604 tonnes. Moreover, 42% of that is awaiting physical load-out leaving a mere 39,588 tonnes of what the LME terms “live” tonnage.
Citi analysts note that is very low relative to futures positions. (“Nickel – why you might consider trying to catch the falling knife”, Nov 20, 2019).
“Each LME 3rd Wednesday expiry will be tense since on average the open positions left to roll…are 1.2x the current warrant supply,” the bank said, warning that spread volatility was a new structural reality for nickel.
Nickel is once again being pulled in two different directions with stainless steel demand pushing outright prices down, while EV demand continues to empty LME warehouses.
Time-spreads are where these conflicting forces will likely meet. The LME benchmark cash-to-three-months spread has returned to calm contango over the last couple of weeks but that looks unlikely to last.