From Macquarie:
Should metals markets fear or welcome Donald Trump’s shock victory in the US Presidential election? Heightened uncertainty is almost a cliché, but here it is a fact given the President-elect’s policies are lacking in detail and sometimes contradictory. On balance short-term we see increased upside risks, but caution that it will be at the expense of weaker and more fragmented markets longer-term.
The immediate macro impact on metals markets caused by the shock result is likely to be small but negative. Our US economist David Doyle expects US growth to weaken on lower business and consumer confidence, but only modestly. Trump will only take over in January, after all, and the aftermath of the Brexit vote was a reminder that populists are…well popular. We still expect the Fed to raise rates in December, but now see a higher chance of a delay into 2017. Globally, confidence might be worse affected, but offsetting this we expect developed world central banks, already cautious, to remain looser for longer, while China, the most important player where metals are concerned, is likely to do what it’s always done in these situations – keep the liquidity pump on. Short-term the global upswing, as such, is likely to continue and this is positive backdrop for all metals. Or put another way, the main factors which have been driving commodity demand estimates higher seem ever more likely to still be supportive over 2017. The global industrial recovery this year has happened in spite of the US (the only region where IP has disappointed) and as China seeks to step into any US void in Asia, a positive overspill from a strong Chinese domestic economy will help.
Looking further ahead, our US economist expects the US economy to resume its previous growth trend. But the range of outcomes has widened markedly, with the prospect of fiscal stimulus (such as tax cuts, which Trump claims will boost growth 3.5% on average) offering upside but other stated Trump policy changes on trade and immigration threatening the downside, especially if campaign promises are taken at face-value.
Much will depend on how Trump governs. We believe Mr Trump will be more incentivised to pursue a path that would be less disruptive to the economic outlook than his campaign rhetoric indicated. But we would caution at assuming he will change tack too much. Such a shift was predicted during the primaries and for the election campaign, and while some of his more controversial policies have been toned down – such as immigration – the general thrust has been consistent.
A greater barrier will be the institutionalised tension between what US presidents want to do and what they can do – “checks and balances” in domestic policy, something which will only partially be eased for Trump by his remarkable victory and Republicans having majorities in both chambers of Congress.
This could be positive for metals markets. But how much? The amounts suggested are large, but not huge. Trump earlier in the campaign put a figure of $1 trillion additional infrastructure spending over a decade, which compares to about $400bn/year at current levels (and Chinese FAI spending annually of $2 trillion). Of course there is the thorny question of how to fund it – Trump has suggested private-sector financing aided by tax credits and taxation of US overseas company profits, but some surely would need to come from more government debt, and that might be hard to push through Congress. The impact would also be quite slow – there would be many lags in identifying and implementing this. In general though there is a trend here that should boost industrial metals consumption, especially if the US shift prompts other developed countries to adopt similar policies. For us, copper seems to be an obvious beneficiary, given the upgrading of distribution grids to cope with the major shift in utility structures which is occurring globally, with more connections into grids.
To be clear, US or even developed world infrastructure spending isn’t what it once was in terms of global metals demand. The actual impact of increase is small when compared to the scale of Chinese consumption – we estimate at most a 2% addition to global demand growth. This is something we discussed in previous Commodities Comments in September and October. Moreover, getting projects moving in the developed world is not a quick process, and thus metals demand from such a push may be years away. However, the expectation of this spending will drive two very commodity supportive factors. Firstly, a stocking cycle ahead of demand coming through, and secondly an asset allocation cycle back towards commodities as inflation expectations rise further (as highlighted by yield moves today). As such, we could have a period next year when Chinese demand and ex-China apparent demand are strong, which has historically been very supportive of metals prices.
If it all sounds like good news, it isn’t. US Presidents have many powers that are less constrained by the checks and balances. These are mostly in foreign policy but also include trade policy, a major risk.
Indirectly, Trump ran a protectionist campaign and has promised to withdraw from the TransPacific Partnership trade deal in Asia, renegotiated Nafta, label China a currency manipulator and bring trade cases against it at the WTO. Although we doubt he would follow all of this overall impact of this is likely to slow world trade, and be negative for the world economy (even if it boosts US growth). This has clear downside risks for medium term metals demand expectations.
Directly, it could lead to further fragmentations of metals (and perhaps energy) market pricing. We foresee a situation where domestic commodity prices are in many cases artificially amplified relative to those seen internationally via trade barriers and elevated customs checks, creating a two tier pricing system. In base metals, this might be absorbed via premiums over LME, but for others regional arbitrages will develop. Both commodities themselves and commodity containing goods are at the forefront of such potential measures given the heavy focus on manufacturing (i.e. high productivity) jobs in all economies. We reiterate that the world has lost steel and aluminium capacity to China already, and capital goods is the coming battleground.
In addition, the push towards de-globalisation will only delay further the necessary capacity reset many commodity markets still need. This is most notable for steel and aluminium, as governments increasingly step-in to support uneconomic domestic assets, keeping these markets in a perpetual state of overcapacity.
We certainly worry that 2017 will mark a strong front-loading of future metals demand. Certainly, there is an argument that developed world infrastructure is in dire need of upgrading through fiscal stimulus (particularly in the US, which has been waiting ~40 years for infrastructure spend). However, there is a limit to the extent and duration of such spending. To be clear, we are not saying fiscal stimulus will stop anytime soon, and if we move to an environment where governments can borrow ‘for free’ then debt will never be called, however every incremental dollar is likely to be increasingly less metals intensive. For example, rebuilding a bridge is easy and highly metals intensive, but once it is done it is done. Spending money on R&D or space programs, perhaps the next stage, will still drive growth but without the same metals intensity.
And even with such spending, it doesn’t remove the main area of concern from longer term metals markets – China’s demand trajectory. Indeed, in a world of protectionism and increased inflation from fixed asset spending China – having already frontloaded its own current five year plan with FAI – may be forced to choose a lower GDP, less metals intensive growth option.
In our opinion, we already lack visibility on Chinese growth and policy beyond the political transition in 2017. Moreover, the Chinese property market which has proven so supportive to metals demand in 2016, is set to see construction activity trend negative in H2 2017. Given this situation, even with the strong profitability seen across metals and mining at the present time, we are strongly of the view that growth capex should not be picking up strongly. Rather, we view the current strength in pricing as a window of opportunity for resource producers to restructure existing operations appropriately for the medium term, focus on operating efficiencies and undertake selective M&A.
Finally, and even less clear-cut, is what Trump’s Presidency will mean for America’s geopolitical leadership. As a candidate he has expressed scepticism over some of the country’s military alliances, especially where he sees the allies not pulling their weight financially. Other stated foreign policies stand some way outside of the US post-war consensus. Although again it is difficult to know how Trump the President will differ from Trump the candidate, at the very least it suggests a prolonged period of uncertainty, which could have a negative knock-on impact on the global economy. For these reasons we are bullish gold into 2017.
I ask you, with iron ore at $75, coking coal at $307 and thermal coal at $105, how much better can it get? It’s already priced. And with a rampaging USD as well?
Material downside ahead in the short term with decent levels holding through next year is my bet.
