China housing worries outweigh auctions for Cu, Zn

Efforts by China to reverse rallies in base metal prices have so far had a limited impact, but a wider clampdown on housing and power markets potentially portends deeper drops.

China's National Food and Strategic Reserves Administration (NFRSA) held three auctions of aluminum, zinc and copper totaling 420,000 metric tons from 5 July to 1 September. China has attempted to curb rallies in multiple commodities with a focus on aiding small and medium-sized companies.

Three-month London Metal Exchange (LME) prices for aluminum rose by 65pc to $2,917/t on 24 September from a year earlier, while the equivalent copper price was up by 41pc to $9,270/t and zinc climbed by 29pc to $3,106/t.

NFRSA has planned a fourth auction for 9 October that will mirror volumes from its latest auction.

Although still small in the scope of annual consumption, the next auction will bring the total aluminum, copper and zinc auctioned to 280,000t, 110,000t and 180,000t, respectively. Direct impacts on LME pricing have so far been limited, with the steepest drop in pricing occurring in the 1 September auction when copper prices fell by 1.6pc. But in almost every case, the exchange quickly made back any losses. Base metal markets actually rose on the day of the first two auctions.

Real estate bubble

China's cuts elsewhere in the economy may in fact outstrip declines intended from the base metal auctions.

Concerns have grown over the past week among US base metal market participants that the fallout from real estate developer Evergrande's debt crisis could curb demand in one of the country's largest sectors. Investors have worried that Evergrande's financial woes could have a domino effect or reflect wider issues for the real estate market

Since Evergrande announced on 14 September of a growing risk of default, LME copper prices have dropped by 4pc, while the impact on aluminum and zinc remains muted. China has been attempting to reduce debt held by large real estate developers since at least a year ago. The People's Bank of China and the Ministry of Housing and Urban-Rural Development announced new rules in August 2020 dubbed the "three red lines," which included a 70pc maximum liability-to-asset ratio, a debt-to-equity ratio of less than 100pc and cash holdings at least equal to short-term borrowing, according to Chinese state-run media.

Some have estimated these attempts to reduce the debt-laden real estate market are simply unfolding faster than expected, but also given the size and speed of the Evergrande crisis, other major developers might be next.

Even with an active role from the government in countering the wider impacts to the economy, less construction activity would dent copper, zinc and aluminum demand.

China accounted for 52pc, or 12.7mn t, of copper demand in 2019, according to the International Copper Study Group, with building and construction representing 28pc of global demand. Meanwhile, China consumed half, or more than 6mn t, of the world's refined zinc in 2020, according to the International Lead and Zinc Study Group.

Cuts to Chinese scrap consumption would also cut off a significant outlet for US exporters, further weighing on local premiums on top of any exchange declines.

Power markets

Real estate market concerns have been complicated by surging electricity prices and blackouts.

A tight supply of coal to feed power plants across China has forced widespread issues at metal production plants and their consumers.

In the near-term, the cuts to metal production have lifted costs while squeezing availability. Electricity-intensive metals like silicon have endured the biggest production cuts, with prices surging, but base metal plants have also lowered output.

The longer-term implications that the higher costs and slowdown could have are less clear. Although export demand will likely remain once power grids normalize, a weakening to the entire economy probably would result in domestic demand cuts.

By Zach Schumacher