Base Metals: Acceleration in Chinese financial-sector regulatory tightening generated deleveraging effects – Standard Chartered

The analysis team at Standard Chartered suggests that while China’s macro data has remained relatively robust so far this year, an acceleration in financial-sector regulatory tightening has generated some clear deleveraging effects over the past month, particularly in terms of higher short-term lending rates. 

Key Quotes

“We think that ultimately the People’s Bank of China (PBoC) will proactively inject liquidity to prevent a funding crisis in the interbank market. However, increasing regulatory constraints will limit some funding channels, which will likely impact activity in the real economy, e.g., for property developers. Given China’s economic data has remained robust (through Q1 at least), only evidence of a deterioration in that trend will likely promote easing in terms of the financial-sector reform agenda. If this assumption holds true, then the outcome is likely to be a phase of price stagnation in the coming months unless individual supply dynamics can offer sufficient counterbalancing constraints.” 

“To this end, one of the key points of fundamental discussion is likely to be expectations of China’s aluminium supply profile this year and into 2018. Given the policy shift onshore towards tackling pollution and associated capacity cuts, we have adjusted China supply lower for both H2-2017 (950kt) and 2018 (2.4 million tonnes, Mt). This reflects the impact of anticipated cuts via both the winter heating season capacity reductions and closure of a portion of ‘illegal’ currently operating capacity. The policy-driven nature of the cuts does, however, generate fatter tail risks than normal to this forecast. Moreover, we think that there is likely to be some investor fatigue in terms of conviction towards the story since cuts will likely be concentrated in Q4 this year, almost five months away. Given the significant investor length in LME aluminium positioning, we think price upside will be constrained in Q2 but that investors should position for upside into Q4.” 

“China’s supply outlook is also set to dominate copper discussions. The surge in China’s secondary refined production so far this year has been a key factor in weakening its refined copper import volumes year-to-date. However, given that scrap discounts have narrowed steadily so far this year and there is evidence that the authorities may limit scrap supply onshore via environmental regulation, we think this headwind is dissipating. Without the sharp rise in scrap and onshore refined supply, the refined market would have been significantly tighter than has been seen year-to-date. We believe that the refined market will tighten in H2 this year and that China’s net refined import volumes will rebound into mid-year. Given constrained ex-China refined supply, if net refined import volumes rise above 250-270kt per month, the ex-China refined market will fall into deficit. This should support LME copper prices, as well as have a tightening effect on spreads.”