February labelled an 'economic write-off' for China

NEW analysis by Wood Mackenzie concludes February will likely be “an economic write-off” for China due to the COVID-19 outbreak and Lunar New Year.
February labelled an 'economic write-off' for China February labelled an 'economic write-off' for China February labelled an 'economic write-off' for China February labelled an 'economic write-off' for China February labelled an 'economic write-off' for China

Fears of a global pandemic remain

Henry Lazenby

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The rate of new coronavirus infections in China seems to have stabilised, just as the death toll climbed above 2000 and 75,193 confirmed cases are being monitored across the globe. However, the ripple effects the pandemic have wreaked on global supply chains are only now being felt, and questions linger on how long the impact on commodities such as zinc, lead, copper and gold will last.

The extended Lunar New Year holiday has ended but a return to work by millions of people has been slowed to a trickle. A combination of transport restrictions, quarantine periods, staffing shortages and a government-mandated staged return to work means the normal post-holiday bounce back in economic activity won't happen.

Not unlike the unfolding scenario with copper supply and demand, WoodMac is flagging acid storage at capacity as a major headache for Chinese zinc smelters, with 11 significant operations having either shut down or curtailed production. Depending on many factors, these smelters plan to restart later this month, or to defer production as far out to May.

"The extent of the cutbacks at some of the smelters and others will be the result of smelters bringing forward planned maintenance, and so this month's shortfall in output will be recoverable later in the year. However, the longer the disruption to transport and the Chinese economy lasts, the greater the likelihood of significant cuts in refined production," WoodMac analysts said.

Zinc smelter production cuts will not only affect the zinc market in China but will have a knock-on effect in the rest of the world, as they cut China's appetite for imported concentrates. This will put the rest of world's concentrate market further into surplus and put additional upward pressure on zinc treatment charges.

For lead, reduced primary production will reduce the need for imported concentrate, pushing treatment charges upwards. However, should the situation return to normal, WoodMac expects the slow refilling of the scrap battery supply chain within China may incentivise its primary smelters to try and take advantage of a slow ramp-up in secondary lead production by buying imported concentrate, potentially pushing treatment charges lower.

Although the number of cases beyond China's borders is limited, the influence on global ‘just in time' supply chains is spreading to manufacturers outside China. A shortage of Chinese-produced components has the potential to undermine the recovery in the global manufacturing sector that, was only just getting under way in the wake of the de-escalation of the US-China trade war.

The impact of the virus is already being felt keenly by the global automotive sector, with Hyundai being forced to close factories in South Korea, as have other manufacturers elsewhere in Asia. Fiat Chrysler announced that one of its European plants might have to close due to a shortage of critical parts.

With shipping times of 6-8 weeks from China to Europe, the impact of the coronavirus may not begin to filter through until March-April on European and US users of Chinese-made components.

Although Chinese authorities are moving to provide support to the economy through interest rate cuts, proposed tax breaks and other measures, these will have minimal impact on an economy that has "effectively been put on hold" by the efforts to contain the spread of the virus.

Long-lasting effects

The longer the lockdown is maintained, the greater the probability of lasting economic damage to households and businesses. WoodMac warned the longer the situation took to resolve, the more deferred demand could be destroyed.

"In such a situation the critical unknown will be whether China's zinc and lead producers will be willing to return production to pre-crisis levels despite potentially weaker demand or whether the likely cashflow squeeze on consumers will be transmitted through the zinc and lead value chain, constraining the recovery in output," said WoodMac.

Meanwhile, the World Gold Council weighed in on COVID-19's potential impact on gold.

Extrapolating from the 2002 SARS epidemic in southern China, director of investment research Juan Carlos Artigas said it was all but certain that China's consumer demand would ease by 10-15% for the March quarter.

Whether demand rebounds or continues to soften will depend on the duration of the epidemic and its impact on global economic growth. The impact on gold's price performance is less clear.

"If the situation is resolved relatively quickly and the global impact is contained, the outcome may be limited to softer Chinese gold demand and a transient impact on price," said Artigas.

"If the epidemic spreads further and continues to affect investor sentiment, global flight-to-quality flows, amidst concerns of a global deceleration, may have a more sustained (positive) impact on the gold price."

The gold price rose Tuesday close to a seven-year high of US$1608.20.

Moody's Investors Service said Tuesday it had increased the top end of its price sensitivity range for gold by 4%.

"We have expanded our price sensitivity range for gold, based on supportive factors including lower-for-longer interest rates and geopolitical uncertainties," analysts said.

The sensitivity range was increased at the higher end by $100/oz, to $1400, while the lower end of the range remains $1100/oz. This changes the midpoint to $1250, from $1200.

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