INTERVIEW: Jefferies' LaFemina says 'new normal' in metals markets will take time

London — Significant volatility in metals markets will continue until we get to a "new normal" following the COVID-19 markets crisis and this will take time worldwide, despite encouraging progress in China, Christopher LaFemina, managing director for global metals and mining equity research at investment bank Jefferies LLC, said in an interview with S&P Global Platts.

Some markets in China are now seeing "something more like a V-shape recovery rather than the dreaded L or U shape recovery," LaFemina told Platts reporters in an interview this week, noting that China's April industrial production was actually up on the year, and its fixed asset investment growth and property markets are beginning to reaccelerate.

"China's economy is very driven by government actions," the analyst said. "But it's encouraging to see at least that China may be getting to a new normal a little bit quicker than we had anticipated. Hopefully, the rest of the world can follow to some extent."

Still, he added that a V-shaped recovery outside China is unlikely.

"US and European demand has been very, very weak," he said.

Mine shutdowns uphold prices

Despite a collapse in metals demand in China in January and February, followed by demand weakness globally which provoked price volatility, the impact of the COVID-19 crisis has been less serious than otherwise might have been expected on metals prices due to mine shutdowns that have reduced supply, LaFemina said.

Iron ore is a case in point, where prices have remained firm on supply restraints, and because major steelmaker China -- where the extent of the downturn now looks to be less than in markets such as Europe and the US -- accounts for around 75% of the seaborne market, he said.

However, it is unlikely that prices for iron ore will rise much above their current levels of around $96/mt, while prices for copper, nickel, zinc and aluminum can all be expected to rise, in line with recoveries in the US and European economies, he said.

"If we do get a recovery in those economies [the US and Europe], it will not be offset by a corresponding increase in supply, and prices for pretty much everything should recover. For many commodities, we've been at fairly deep cyclical trough. So it's not a surprise that the path of least resistance should be higher. But I do think that the supply constraints will be meaningful over the next 12 or 18 months. So again, it's copper, nickel, zinc, aluminum, even coal prices going higher from here," he said.

Copper – growth areas

Copper is a favorite for analysts and investors alike.

In addition to its applications in traditional wiring and construction, LaFemina pointed to copper's growing markets in electric vehicle charging infrastructure, renewable energy -- where it is used heavily -- and a potential end-market in antimicrobial applications, which could allow it to be less exposed to cyclical demand factors, and increasingly linked to GDP growth.

"Copper is a surface contact killer, right? So if you look at things like influenza A and a lot of bacteria, they die when they touch copper," LaFemina said. "So in hospital rooms and shared services, will we start to switch from aluminum and stainless steel [to copper]? That's a possibility."

Prices for copper, widely viewed as a barometer of global economic health, are now firmly back over $5,000/mt and are unlikely to return to recent lows of around $4,300/mt, according to LaFemina.

"I would expect there to be significant volatility going forward, but I think copper probably has bottomed," he said. "Also keep in mind that mining companies have cut capex guidance for 2020 by 20% on average: some of those cut...are related to copper projects that are being slowed. And that means that the supply growth outlook for copper is actually a little bit more bullish for the price. You're not going to have as much supply growth coming online as demand recovers heading into 2021 and 2022. So I think the trajectory, the path of least resistance to copper is likely to be to the upside."

Regarding reports that the Chinese government may now be purchasing metals stocks from local merchants, LaFemina expressed the opinion that it "would be very wise to build strategic stocks of commodities when prices are low."

In a scenario where demand could potentially lag supply for many years, building inventories of strategic metals now appears to be a pretty prudent move, he said.

M&A, aluminum consolidation

Mining companies will increasingly seek merger and acquisition opportunities to grow as economies recover from COVID-19 and a "growth mentality" reemerges: "starting probably small, but ultimately becoming, as we've seen in prior cycles, large-scale transformational type deals," LaFemina said. "It's pretty clear that the major miners at least want more exposure to copper and they want more exposure to kind of new age commodities, battery materials, for example. So things like lithium, maybe even potash, but again, copper and nickel. I think these are the commodities where the investment will go in the future, not only for organic growth projects over time, but also in terms of M&A."

In line with the trend to reduce coal usage, the lack of capital available to the coal industry will limit investment in new capacity to an extreme, he said.

In aluminum, meanwhile, new smelter capacity added in China over the last 20 years has led to global overcapacity that has led to the need for consolidation and capacity cuts, La Femina said.

"A few million tons of capacity at least...has to come off line before the market can genuinely get tight...some of that needs to get shut down and price will be the incentive for that to happen. Smelters need to be, I would argue, permanently dismantled. But I think we are in the early stages of that process, and we will see that play out over the next couple of years."

Structural 'green' trend

Investments in technology and innovation to reduce the sector's environmental footprint may now be slowed down a bit due to austerity and it's unlikely that the COVID-19 crisis will accelerate companies "going greener", LaFemina said.

However, "the move to dry processing, for example, using less water, using less chemicals is now a structural trend in the industry...that trend is a permanent trend," he said.

In the move towards products such as green steel and green aluminium the need to adhere to environmental, social and governance principles has made the metals industry "highly motivated...by being greener, [companies] become more investible," LaFemina said.