Commodities | Apr 08 2020
Richard (Rick) Mills
Ahead of the Herd
As a general rule, the most successful man in life is the man who has the best information.
The coming supply crunch
As I write and you read, the world economy is getting pummeled, one blow after another, by demand destruction, as economies grind to a screeching halt due to unprecedented restrictions on economic and social activity owing to the relentless spread of the covid-19 coronavirus.
Since the virus began spreading its spiky particles across the globe, starting in the central Chinese city of Wuhan, then migrating via airplane travel to other Asian countries, Europe and North America, mines have closed, factories shut down, office buildings abandoned, storefront shops, restaurants and bars all locked and boarded up.
As of this writing, the number of coronavirus cases worldwide had surpassed 1.3 million, the grim death tally running over 73,000.
In the United States, the national health emergency threatens to further overwhelm its already over-taxed medical system, as front-line health workers, forced to work without proper protective equipment, risk their lives and an increasing number fall victim to the respiratory disease. The US currently has over 350,000 covid-19 infections, by far the most in the world, almost triple the next-worst hit, Italy and Spain. Also of note: Germany now has about 20,000 more coronavirus cases than China, where strict lockdown measures by Beijing have managed to control the outbreak.
I can’t think of any event in living memory suffused with as much human and economic misery as the coronavirus crisis is shaping up to be.
We won’t know the full extent of the economic fallout until quarterly reports start piling up the losses, but the damage is already glaringly evident.
On Friday, the International Labor Organization warned of almost 25 million layoffs worldwide if the coronavirus continues to ravage economies, the cuts reflecting the deepest recession since the 1930s Depression.
In its monthly labor report, the ILO said US employment in March fell for the first time in a decade, with payrolls slumping by more than 700,000, seven times more than economists had forecast. (the numbers are actually much worse because they only cover the first half of the month).
Last week 6.6 million Americans applied for unemployment insurance benefits. Bloomberg notes that when combined with the week before, the 9.96 million jobless is around the same as the first 6.5 months of the 2007-09 recession.
The European Union, the UK and Japan have also been hit hard. Over the past two weeks, 10 times the normal number of Britons filed for welfare payments, and 27% of businesses are cutting staff. Spain’s unemployment rate surged to nearly 14%, among the highest in the developed world. Not since World War II has Austria seen so many jobless. Germany’s normally powerful manufacturing sector struggled in 2019, and the country’s virtual lockdown is making a bad situation worse. Almost 1 in 5 German companies say they are at risk of insolvency, and a recent report says a recession is inevitable in the first half of the year.
The spike in worldwide unemployment is closely tied to demand destruction. With non-essential companies ordered to close, demand for manufactured and raw materials has all but disappeared.
Take a look at what is happening to oil, which still lubricates the world’s economy, despite what renewable energy advocates want to believe.
Last Monday the Brent and WTI crude oil price benchmarks both crashed to 18-year lows of just over $20 a barrel. Prices have dropped 30% since the beginning of January.
The long-suffering oil markets are being bombarded not only by demand destruction at an unprecedented scale, but oversupply, as Saudi Arabia and Russia, engaged in a price war, flood pipelines with excess product. As CNN Business puts it,
The renewed selling in the oil patch underscores the unprecedented collapse in demand caused by the social distancing restrictions imposed by governments around the world. Highways are empty. Entire airlines are shutting down. Macy's just furloughed a majority of its 125,000 workers. Factories large and small have halted production.
According to IHS Markit, most of the global demand decline is from China, also Europe, Japan, South Korea, the Middle East and North America.
Things have gotten so bad, global oil consumption will likely implode by 12 million barrels a day this quarter, against total daily demand of around 100 million barrels, the steepest decline ever recorded, according to Bank of America. Among the only upsides are US motorists, who are likely to see sub-$2 per gallon gasoline, as over 50% of gas demand is expected to dry up, more than during the financial crisis, amid orders to work from home. Natural gas demand is also in free-fall.
We see plummeting demand too, in the latest US manufacturing figures. Marketwatch reports new orders for manufactured goods slumped in March, reflected by a 7.6-point fall in the ISM new-orders index, the lowest since the Great Recession. The Institute for Supply Management reported its manufacturing index dropped a full percentage in March, to 49.1%. Any number below 50 signals an economic contraction.
Internationally, IHS Markit says global manufacturing PMI is at its lowest since May 2009, as the order book downturn accelerates. Excluding China, whose production has risen marginally as the country slowly returns to normal, after closing down factories and entirely locking down 50 million Chinese for a month, global output fell the most in 11 years:
The worldwide drop in production, orders and trade flows was predominantly linked to factory closures, in turn connected to measures to contain the COVID-19 pandemic, as well as slumping demand and input shortages. Supply chain delays rose to the highest recorded since global production growth boomed in 2004.
So far, those paying close attention to covid-19’s effects on the global economy have focused on demand, reflected as mentioned by falling crude oil prices, copper which slumped 16% over the past month, and major slow-downs in goods orders and PMIs.
Supply chain pressures
But for a complete picture of how bad it could get, longer-term, we need to also be following supply, ie., of all the items that go into manufacturing processes, top to bottom. That includes raw materials, chemicals, parts and parts components, finished products.
As we wrote at the beginning of this crisis, supply chains are being severely impacted. Now that covid-19 has spread to over 100 countries, thanks to globalism’s removal of trade barriers, just about every company’s supply chain that does business beyond its borders is vulnerable.
We see “supply destruction” most despairingly in the shortage of life-saving ventilators, and virus-impeding medical supply masks, gloves and gowns. Most of this stuff, and the majority of the world’s pharmaceuticals, are made in China. Here in BC, pharmacies are only allowing patients to order prescriptions monthly instead of tri-monthly, to guard against hoarding.
President Trump last week invoked the Defense Production Act in ordering 3M to only produce masks for the domestic market, no exports. Canada is also having trouble getting enough masks particularly in Quebec and Ontario, the worst-hit provinces. How is the 3M export ban going to affect them?
One of the biggest fears is a disruption of grocery deliveries that could lead to a shortage of food. We’re not there yet, but we are already seeing empty shelves at supermarkets, the result of hoarding and grocery chains unable to keep certain items (like toilet paper, pasta) in stock.
It goes right down to the bottom of the food chain. Farmers can’t get their produce to consumers because of lockdowns. Restrictions on people’s movement, including temporary foreign workers, mean millions of laborers can’t get to the farms for harvesting and planting. That could mean perfectly good food is left rotting in the fields.
Less truckers are available to keep good moving, as logistics firms slash workers and hours. Air freight capacity has reportedly plummeted, as planes are grounded. Imports of Indian vegetables to Canada, like onions, okra and eggplant, have dropped 80% in the past two weeks, Reuters said.
There is also a shortage of refrigerated storage containers, “reefers” in the industry vernacular, because of a drop in voyages from China. The smooth flow of international shipping requires a steady supply of both full and empty containers. The largest container shipping line in the world, Maersk, reportedly is forecasting the covid crisis will weigh on earnings this year.
When China was in lockdown, among the industries worst impacted by covid-19 restrictions, were automobiles, electronics and fashion.
Most of the world’s consumer electronics are made in China, including flat-screen televisions, mobile phones and computers. Apple’s supply chain is deeply enmeshed with the country, including iPhones assembled at Foxconn’s plants in Shenzen and Zhengzhou. Apple closed all its retail stores and offices in China for roughly 6 weeks. CEO Tim Cook warned investors that second-quarter earnings will likely be almost $30 billion less than first-quarter revenues of $91.8 billion, due to the virus’ impacts on iPhone manufacturing and sales in China.
Toy companies delayed shipments and new product launches, due to factory closures in China where some 85% of the world’s toys are made.
The “just in time” nature of automobile fabrication and assembly means that any glitch in the system reverberates down the supply chain, often to dramatic effect. Hyundai for example was forced to suspend operations at its Ulsan factory complex, the largest auto-manufacturing facility in the world, due to a lack of parts. Nissan and Fiat Chrysler also had to close plants, temporarily.
Metal supply troubles loom
Back to mining, we foresee major problems happening on the supply side, if demand for key industrial metals like copper, nickel and zinc, and critical metals such as lithium and rare earths, continue to take hits, alongside supply chain interruptions that delay or cancel shipments of raw materials.
Indeed we can already see pressure mounting on China’s metals supply chains. Being the first to come out of the pandemic, the issues we see developing there regarding metals supply, might be a template for what is to come for countries still in the throes of the coronavirus.
Over the past several years, China has been building new smelters in order to ramp up domestic production of refined metals, at the cost of needing to import more raw materials to feed those smelters. That worked fine when there were no restrictions on exports from key supplier countries like Chile and Peru (copper), Indonesia and the Philippines (nickel) and South Africa (palladium, chromium).
Now, however, with increased restrictions on industry due to the covid-19 crisis, China is finding it’s not so easy to keep the supply of metals flowing.
Last year China imported 83% of its chromium from South Africa, but since the government ordered all mines and furnaces closed down on March 26, local producers Samancor, Tharisa and Glencore-Merafe Chrome have declared force majeure on deliveries.
Over in Indonesia, the declaration of a national emergency has put added pressure on an already stressed China-nickel supply chain. The south east Asian country has been an important supplier to China’s nickel pig iron (NPI) producers, but in January, it slapped a ban on exports of nickel ore to boost its domestic smelting industry. Indonesia’s nickel miners are now calling on the government to relax the ban to help offset the fall in exports of processed nickel caused by the coronavirus.
According to the Indonesian Smelter Company Association, exports and local absorption of processed nickel have fallen between 20 and 25% since the coronavirus outbreak began late last year in China.
Tin is a good example of how China’s lockdown of its domestic smelters at the height of the coronavirus crisis, in January and February, resulted in higher imports of refined metals, versus raw ores.
Reuters columnist Andy Home points out that China’s imports of tin concentrates fell by 20% last year, and were down another 29% in January-February, as border controls and restrictions on movement squeezed flows of raw material.
With several Chinese smelters also locked down over the peak of the coronavirus outbreak in China, the country’s shortfall has translated into accelerated imports of refined tin metal.
China imported 1,660 tonnes of tin in January-February, compared with 3,000 tonnes and 2,500 tonnes for the whole of 2019 and 2018 respectively.
It flipped to being a net refined tin importer for the first time since 2017.
It may be a template for how raw materials’ disruption translates into higher imports of refined metal, upending a long-running trend of increased Chinese self-sufficiency at the metal stage [refining] of the production value chain.
That would be good for refineries outside of China, but only assuming they can get their hands on the raw ores needed for processing.
There are increasing reports of miners either idling output, or cutting back production, as they manage the effects of the coronavirus. End users and investors ignore these mounting threats to mine supply at their peril, as supply restrictions will inevitably translate into higher prices.
Following is a current run-down of virus-related mine closures and interruptions:
In Canada, Vale SA placed its Voisey’s Bay nickel mine in Labrador on care and maintenance, and halted an underground expansion, due to concerns about coronavirus spread. Gold miner Agnico-Eagle sent its 450 workers in Nunavut home with pay, although Meliadine and Meadowbank continue to operate. Canada’s oldest diamond mine, Ekati in the Northwest Territories, and Cameco’s giant Cigar Lake uranium mine in Saskatchewan, have both been temporarily shuttered until the threat from the coronavirus dissipates.
The virus has hit US coal producers, already reeling from lower demand for the polluting fossil fuel, particularly hard. Australia’s Coronado Resources recently announced an idling of its US thermal and metallurgical coal mines in Virginia and West Virginia. Pennsylvania-based Consol Energy has temporarily curtailed production at its Bailey coal mine, while Alliance Resource Partners will freeze coal output at all its Illinois basin mines.
South Africa’s Harmony Gold said it expects limited gold production during the country’s 21-day lockdown to slow the spread of covid-19. Another big bullion producer, Gold Fields, is anticipating a loss of 16,000 ounces from its South Deep mine, which generated profits last year after a decade of losses. The company says the shutdown will negatively impact its full-year earnings and annual production guidance of 1.4 million ounces.
South32 and Petra Diamonds both withdrew their full-year guidance at South African operations, including South32’s thermal coal, aluminum, manganese and a smelter.
Impala Platinum said it is planning on transitioning to care and maintenance at its mining, smelting and refining operations in the country – the top producer of platinum and second-largest miner of palladium.
Several large gold and silver mines are being shuttered in Mexico. They include Newmont’s Peñasquito mine in the state of Zacatecas, Mexico’s largest gold mine, second-biggest silver mine and a top producer of zinc and lead; Pan American Silver’s La Colorada and Dolores mines; and Toronto-based Sierra Metals’ Bolivar and Cusi underground mines.
For Anglo American, a 15-day quarantine in Peru meant a demobilization of 10,000 workers at its Qullaveco copper project, while for Gold Fields, its Cerro Corona operation has been paused.
Finally, copper miners in Chile are reportedly considering cutting production amid strict measures to contain the coronavirus. At time of writing, the world’s largest copper producer had logged about 4,800 coronavirus infections.
The country’s Cochilco copper commission has revised its 2020 copper price prediction down 45 cents to $2.50 a pound, amid a significant downturn in copper demand from Chile’s number one buyer, China. Its January estimate was $2.85/lb.
Shutting down a mine, even temporarily, is a major endeavor incomparable to something like idling a factory or closing a chain of retail stores. Putting an operation on ‘care and maintenance’ involves a number of practical measures to ensure the safe storage of ore stockpiles and tailings dams, disposal of scrap and waste materials, slope and bench stability, groundwater management, and keeping the site secure, just to name a few.
Equally, once steps have been taken to close a mine and inform all employees, contractors and overseers, getting it started again isn’t like flipping a switch. It takes a minimum of a few weeks and for larger mines, months, before production can return to full capacity.
The point is, idling so many mines in several countries will certainly have an impact on mine supply and metals prices. We may not see the impacts of supply destruction yet, with markets and governments still coming to grips with the hollowing out of demand, including mass layoffs, as the coronavirus continues to ravage populations in North America, Europe and Asia.
As I write this, Boris Johnson’s coronavirus condition has worsened; the gregarious UK Prime Minister has reportedly been moved to an intensive care unit at a hospital in London. If he dies, the seriousness of covid-19 will reach a new level of panic.
As AOTH, our mandate is to analyze current market conditions to make smart, sometimes bold predictions of how mined commodities will perform in future. With the exception of gold, demand destruction has gripped most metals markets and put downward pressure on prices. This was to be expected. The question for investors to consider, is how long before drastically lower metal supplies, owing to virus-related mine closures, and supply chain pressures, catch up to the huge drop in demand for them?
When that happens, we should see prices begin to correct.
We can check global stockpiles for signs of supply depletion. Right now all the base metals with the exception of nickel, are showing no signs of running out of stockpiles, in fact warehouse levels are increasing due to oversupply. I’ll be watching the levels closely though over the next few months for indications of tightening supplies.
It’s entirely possible that, should the covid-19 crisis continue beyond a few months, warehouses will eventually run out of stockpiles, and we could be looking at widespread shortages, ergo, much higher prices.
A final point: Economists sometimes forget, in analyzing manufacturing data used to try and predict economic growth, that no manufacturing comes without mining. The prices of manufacturing inputs are directly related to the scarcity or abundance of metals used to create parts and components. For example, the demand for palladium has skyrocketed over the past few years due to the need for gasoline catalytic converters required to meet stricter air emissions standards. Silver rises and falls based on the need for its many industrial uses. The price of an electric vehicles depend on the size and quality of the electric motor, whose value depends on the availability, and prices, of battery metals lithium, cobalt, nickel, manganese and graphite.
A decline in the value of “real” goods, either grown/ raised/ farmed/ fished or extracted from the earth and sea, is one of the first victims of an economic crisis. These front-line commodities though will also be among the first to bounce back when demand is restored, although we expect beaten-down supply to lag explosive demand for some time. Investors on the right side of this trade clearly stand to benefit.
Richard (Rick) Mills
Richard is the owner of Aheadoftheherd.com and invests in the junior resource/bio-tech sectors. His articles have been published on over 400 websites, including:
WallStreetJournal, USAToday, NationalPost, Lewrockwell, MontrealGazette, VancouverSun, CBSnews, HuffingtonPost, Londonthenews, Wealthwire, CalgaryHerald, Forbes, Dallasnews, SGTReport, Vantagewire, Indiatimes, ninemsn, ibtimes and the Association of Mining Analysts.
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