Why volatility in metal prices doesn’t predict much

He juggles and shudders his hour on stage

And then you can’t hear it: it’s a story

Said a fool, full of sound and fury,

Not indicating anything.

This famous passage from Shakespeare’s Macbeth about life (Act 5, Scene V) appears to characterize recent movements in commodity markets. Commodity markets in general and metals markets in particular have been in free fall, despite strong fears of inflation everywhere.

The first globally synchronous growth year after the Global Financial Crisis (GFC) was in 2017. Central banks around the world began tightening monetary policy almost 10 years after the dramatic reduction in rates to counter the GFC. The US federal funds rate rose from an effective low of zero in December 2008 to a high of 2.5% in 2018. With the onset of the pandemic, that rate was again reduced to zero in April 2020. Despite the occasional zigs and zags, metals have declined. Real prices (adjusted for inflation) have been on the downside for several decades. This is as it should be. As demand for metals increases, supply increases over time to (exceed) demand and exert downward pressure on prices. As a matter of course, the all-time real price of copper goes back to 1865 CE.

Over the past two decades, commodity prices have risen marginally every time interest rates have come down sharply, especially if accompanied by quantitative easing. As the Fed doubled the size of its balance sheet to $9 trillion, the price of copper more than doubled from a trough in March 2020 to $5 per pound, reaching its latest peak in February 2022. Similarly, zinc doubled to $4,500 a tonne and steel doubled. Yuan 6,000 per ton in that period. Since then, silver, copper and steel are down more than 20% and iron ore and hot rolled coil steel are down more than 40%. The only metal to buck the recent declining trend has been lithium, which is up nearly 1,000% since its trough in 2020, mostly due to exceptional demand for electric vehicle batteries.

Therefore, contrary to what is commonly believed, metal prices have declined widely at a time when inflation has become a major concern. In fact, the recent peak in metal prices generally coincides with the onset of significant inflationary fears. The fall in metal prices since then can be explained by five factors: 1) As central banks around the world have woken up to battle inflation and begin to tighten policy, the metals are buoyed by fears of a ‘recession’. reflecting; 2) As liquidity is being withdrawn, activity in metal futures has fallen sharply, especially because futures speculation tends to be leveraged; 3) The ‘zero COVID’ policy in China has dramatically reduced the demand for industrial metals; 4) Commodity prices have declined as the dollar has risen, but metal prices in other currencies have not declined as much; and 5) These price drops follow an earlier sharp rise in prices, and in many cases, prices still remain above 2019 levels.

The recently released US economic data for the second quarter of 2022 indicates a technical slowdown there. As a result, markets have dialed back expectations of aggressive monetary tightening by the US Fed, and metal prices have halted their decline. Recent action suggests that metals markets are not the ‘leading indicator’ of the economic activity or inflation that market participants might expect. Rather, like other markets, metals are responding to the action of central banks and are being eliminated as contemporary indicators. The next important step will come only if the Fed unexpectedly changes course and/or the Chinese economy starts growing significantly again.

China’s latest official growth figures point to a seasonally adjusted 2.6% decline in second-quarter GDP. China may face a technical slowdown in the third quarter. Apart from the initial pandemic quarter in 2020, this is the lowest growth rate in 30 years and makes it nearly impossible to achieve China’s annual growth target of 5.5%. With more than two dozen cities still under some form of lockdown, its immediate growth prospects seem limited, which in turn will keep a lid on industrial metal prices.

The Fed’s dot-plot shows that US central bank governors believe dollar short rates will peak at around 3.3% in January 2023 and then drop to an average of around 2.5%. This is a little lower and a little earlier than last month. This lack of aggressive tightening is likely to lay the groundwork for the metal prices. Amid the Fed’s actions and China’s slowdown, metals will likely trade in a range bound for some time.

Fluctuations in global metal prices have meaningful consequences for companies in India. Especially since the prices of many metals are still fixed in US dollars, the effect of the price hike is even greater if the rupee depreciates against the dollar. The rupee per metric tonne in India has remained in a narrow range for more than a year, tracking a fall in commodity prices and a rally in the dollar. In rupee terms, aluminium, zinc and tin declined marginally. Thus, inflationary pressures seem to be behind us from the rise in commodity metal prices in rupee terms.

All that fury, doesn’t really represent anything.

PS: “The story the data tells us is often what we want to hear,” said Nate Silver.

Narayana Ramachandran is the chairman of Include Labs. Read Narayan’s mint column at www.livemint.com/avisiblehand

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