Citigroup turns bearish across the board (November 17, 2008)

Vancouver– In a new commodity outlook Citigroup Global Markets predicts all base metal markets moving to surplus in 2009, meaning trough cycle prices will dominate through 2009.

The underlying message is that demand growth across all regions is slowing and will continue to do so, as evidenced by large reductions to industrial production forecasts. That means base metals and bulk commodity markets (iron ore and coal) will move into surplus soon, oversupplying markets and leaving metals prices to be governed by costs and margins.

In short: the situation doesn’t look good for metal prices for the next two years.

Risk aversion remains the biggest problem for the commodity demand outlook. Citigroup thinks that credit rationing and severe market disruptions suggest severe recession in many developed economies, leading to a global industrial production growth rate of only 0.3% in 2009, versus the 2006-07 growth rate of 4-5%.

Notwithstanding governmental efforts to halt the financial meltdown, Citigroup believes the damage already done will limit the ability of developed Western economies to support global demand.

As for China, industrial production is already set to fall to 10.2% in 2009 from 18.2% in 2007. And, as for Western economies, Citigroup does not see government efforts — infrastructure spending and fiscal stimuli — as sufficient to offset the slowdown in housing and manufacturing.

So what does it all mean for commodity prices? The report notes that speculators and investors are “exiting commodity markets at a very rapid pace,” in terms of both long and short positions. The motives for de-risking abound, but the act accelerates commodity prices towards trough cycle targets.

Let’s start with copper. The aforementioned sharp cuts to global growth assumptions mean the copper market will be in surplus in 2009. As such, the trough cycle price will dominate; Citigroup has accordingly reduced its price forecast to US$2 per lb. for 2009 and US$2.25 per lb. for 2010.

Citigroup has not changed its forecast zinc prices. The market is already in surplus and reductions to global growth have simply increased that surplus; the research group expects prices to bottom in 2009 at US70 per lb. However, current spot prices have put supply under immense pressure — half of the zinc cost curve is unprofitable. The pressure has already forced production curtailments totalling more than 400 kilotonnes in 2008 capacity outside of China.

“If spot prices stay at current levels for a meaningful length of time, there is a risk of substantial cutbacks and the market tightening very quickly,” the report sates. More closures could bring the market back into balance. And the market remains tight in the more distant future: Citigroup predicts the price of zinc will recover to US90 per lb. by 2012.

The situation for nickel is similar. The market will remain in meaningful oversupply until 2011, under pressure from both supply increases and demand downturn. Some 30% of the cost curve is unprofitable at current prices and production curtailments have begun. Citigroup sees nickel prices bottoming in 2009 at US$6 per lb., with a slight recovery to US$8 per lb. by 2011.

Since China accounts for 36% of world demand for aluminum, slowing industrial production in the country has already had a dramatic impact on the metal’s demand outlook. The group had predicted that China’s energy crunch would push the government to force aluminum smelters to close, driving prices sharply higher in 2009. However, the energy crunch is abating; low prices will likely catalyze any closures now, since Chinese production is at the top of the cost curve.

The aluminum market is in surplus and will remain there until 2011. Citigroup predicts the price of aluminum will sit around US$1 per lb. in 2009, recovering slightly to US$1.20 in 2010.

Iron ore will also be in surplus. Iron ore is the commodity most leveraged to China, making its price highly susceptible to China’s slowing industrial production growth and reduced crude steel production. If major producers do not moderate production, then marginal, high-cost suppliers (such as India and China) will feel pressure. Citigroup thinks prices could fall as low as US$50 per tonne FOB, though it expects other forces could moderate that drop.