Interview: Rory Johnston of Scotiabank looks to 2020

Rory Johnston is a commodity economist covering energy and metal markets in Scotiabank’s economics department. His research includes the Scotiabank Commodity Price Index (a monthly assessment of developments affecting the prices of major Canadian export commodities), contributions to Scotiabank’s Global Outlook (the department’s flagship quarterly forecast), as well as notes on various topics of interest to the Canadian commodity sector. He recently spoke to The Northern Miner’s Trish Saywell about his outlook for 2020.

The Northern Miner: Let’s start with the macro issues affecting metal prices.

Rory Johnston: Obviously on the macro level we’re facing in some cases unprecedented headline risks. There’s lots of uncertainty from trade wars to security issues around the Middle East, to impeachment and everything in between.

It’s fair to say that while we have rebounded a little bit over the last few months because of some positive trade developments, we’re still in what I would generally call a bearish macro environment. A couple of years ago I would have talked about global synchronized growth. The entire global economy was accelerating from 2017 into 2018, and a lot of that was because of the stimulus that came on both in China and from the widening fiscal deficit in the United States. So the world’s two biggest economies were engaging in bouts of fairly sizeable stimulus and that really boosted and buoyed the global economy on the upside.

But what happens with stimulus is that they didn’t necessarily create demand — they borrow demand from the future. And we’re in a phase of paying that back. We’re just coming off those highs of 2017 and 2018, so 2019 was always going to be a little bit of a slow year, and probably 2020 as well, even before you add on the trade war and uncertainty related to the new NAFTA or whatever moniker you go with. Things really started to fall off from early to mid-2018, when the U.S. trade war with China really picked up steam. Between early 2016 to mid-2018 you had most risk assets, whether it be oil, or copper or the rest of the base metals, all enjoying this bull-run. Copper prices ran from US$2 per lb. all the way up to US$3.30 per lb. or more, well ahead of what we thought it should be based on prevailing fundamentals. Then everything fell out of bed. The trade war ramped up and macro sentiment soured and investors channelled that bearish sentiment into metal prices, primarily through copper, but it brought the whole metals complex down.

What I want to stress, though, is that while the global economy is a bit slow right now, it isn’t slow by historical standards, and the global consumer remains relatively strong, particularly in North America. Consumers are in a healthy place. You have tight labour markets, wages are rising, so the consumer is doing pretty well. The challenges have been on the business and investment side and that’s where the trade war takes its biggest whack. Even though businesses are used to risky environments, this moment on the trade side is so uncertain, and in some ways so unpredictable, that businesses have throttled back investment to wait for the dust to settle.

As an example, a company might have started pulling back its supply chain exposure to China because of the trade war, and started repositioning some of its supply chain to Mexico because the U.S. had just done a trade deal with Mexico and thought it should be safe. But then the U.S. president comes out and announces he is ramping up tariffs on all Mexican exports. Now that didn’t end up taking place. But it’s things like that, which seemingly happen at the drop of a hat, that really spook investors who are looking to spend billions of dollars investing in assets that have long life spans. They don’t know if something is going to be a money winner or a money loser because of this heightened uncertainty.

Going into 2020, we’re going to have that uncertainty remain more or less level where it is now. A little bit down from its highs earlier this year, but uncertainty will remain straight through 2020 and into the presidential elections. Regardless of who wins, whether the Republicans or Democrats take the White House, you will then start to have some of that uncertainty gradually decline, whether it’s because it’s a different president in the Oval Office, or whether it’s because by that stage, businesses will have become more used to dealing with the uncertainty. They will have bolstered their supply chains against that type of disruption. We do think that while fairly bleak today, there are still strong fundamentals in the global economy and they will start bearing fruit in 2020–2021, when we get some of that certainty back and businesses start ramping up investment. The global economy will really start to accelerate in 2021.

TNM: What is your outlook on the U.S./Canadian dollar exchange rate?

RJ: We see the Canadian dollar weakening a bit, or remaining weak right now, but strengthening over 2020, again as some of those risky assets begin to recover and as tolerance for risk comes back. We do think that will begin to tighten. Right now the exchange rate is about US$1.32 to the Canadian dollar and we expect that will fall to about US$1.25 to the Canadian dollar by the exit of 2020, and remain flat thereafter.

TNM: Copper?

RJ: If we look at copper, we had a mild deficit in 2018 and a mild surplus in 2019. There will be a mild deficit in 2020. And if growth starts to accelerate, that deficit will remain relatively persistent. But if growth tends to slow, 2021 could see a surplus again. But right now copper is under US$2.80 per pound. It’s up from US$2.60 per lb. just a month or two ago, before the trade news started to be positive. Prices could rise to around US$3 per lb. by 2021 and then remain level in the low threes for the next couple of years. There are a couple of things that are going to pull on that demand. There are new Chinese air-conditioning standards that could shift demand around and will likely mean that demand from the air conditioning sector in China, which is a major consumer of copper, will be a little bit weaker in the first half of 2020 as they destock the older units, but after that things will stabilize. Exchange-listed copper inventories are still relatively low, they are down by 60% from where they were in early 2018 and 37% lower than in the late third quarter of 2019, so those things remain positive factors underpinning or putting floors below how far copper can fall. That said, copper remains well below where it was when investors were really betting on tighter markets and more global growth in 2018, so right now the risk sentiment for copper is to the upside. At this stage it looks more likely that we’re going to add more length to the contracts, which should mean relatively good things for copper prices going forward.

The entire metal sector has been underweight since, call it June 2018, when the trade war really started ramping up. The one metal that has managed to boost its fortunes, at least temporarily, is nickel. Nickel was gaining strength on two major fronts: First, there was this constant fervor around electric vehicles (EVs) and how much nickel EVs were going to require, and second, the Indonesian government, which had planned in the coming years once again to restrict exports of unrefined nickel ore, particularly into China, actually accelerated that and now the export ban is going to take effect at the beginning of 2020, so there was a little bit of a crunch there as nickel balances tightened. But going forward, some of the gains nickel made between July and September 2019 — prices gained 50% — are going to start to come back down to earth. While fundamentals are relatively supportive, and inventories are falling, we do believe that some of this recent price strength has been overdone. Part of what’s bringing nickel prices back down to earth is a bit of the fizzling of, at least in the near-term, prospects of the EV sector, after China paired back some of its subsidies to electric vehicles. After it did that, sales in China fell fairly quickly, so these types of things are going to take the wind out of metals that are seen as exposed to EVs, whether it’s nickel, cobalt or lithium. All of these commodities have suffered over the last 12 monthsas the news came out about weaker subsidies in China, because at this stage, EVs are still a very policy-exposed sector and policies change quickly, which does bring more sudden movements in prices.

TNM: What is your nickel price forecast in 2020?

RJ: In 2020 we see about US$7.50 per lb. That rises to US$8 per lb. in the early 2020s and remains flat after that.

TNM: Your copper price forecast?

RJ: In 2020 we expect copper to average US$2.75 per lb., or just higher than what it is now, and US$3 per lb. in 2021 and US$3.25 per lb. in 2022.

TNM: Iron ore?

RJ: Obviously the big story there has been weaker supply from Brazil. A lot of it has moved with the current state of the steel margins in China, which had been weak and have improved recently. Prices have jumped back up to US$90ish per tonne, and those are going to ease back down as the sector settles down. We expect the US$72-per-tonne-level in 2020, falling to about US$65 per tonne in 2021 and US$60 per tonne in 2022. Things will loosen from their currently tight positions going forward as the steel sector slows after we get through some of the potential stimulus in China and more of that Brazilian supply comes back into the market.

With coking coal, which is the flip side of the steel equation, prices for a long period of time were above US$200 per tonne on the back of a variety of supply disruptions, predominantly in Australia. But prices have fallen 30% since crashing under that US$200-per-tonne-level this past summer, and prices right now are around US$130 or US$140 per tonne. Those prices are going to rise again. There is some weakness right now, Chinese quotas aren’t letting enough coal into the Chinese domestic space, and some of that is getting backed up in the seaborne market and weakened prices there. But that’s going to turn a corner after that quota resets in 2020, and prices are going to gradually climb back up to the US$150-per-tonne level, which is where we see the longer-term outlook for metallurgical coal on a seaborne marginal cost basis.

The other thing that is really interesting is what is happening in the zinc market. We had many years of deficits, which finally cascaded into decade-high prices in early 2018 before the metals complex started weakening on the trade war. Those really high prices did exactly what they were supposed to do — they brought a lot of mine supply to the market. You would expect that would quickly translate to metal supply, which would start to weaken prices. But while prices are down with the entire metals complex since the U.S.–China trade war, backwardation in zinc contracts, or the premium you pay for deliveries today versus three months from now, are signalling that spot markets remain relatively tight. Inventories are at perilously low levels on the global exchanges. The issue here mainly is that concentrate supply growth hasn’t yet translated to metal supply growth because there are bottlenecks and insufficient throughput in the global smelting sector. This is particularly true in China, where you have environmental regulations forcing some capacity idling at Chinese smelters, which is further contributing to the tight market. It’s a few months out until we get some balance, and after that, it will move into surplus as we finally translate new mine supply into concentrate and bring an end to this bull cycle. Prices are then going to fall back down a little bit. The zinc price will average US$1.08 per lb. in 2020 and fall to US$1.05 per lb. in 2021, US$1 per lb.in 2022, and 95¢ per lb.in 2023. Annual average prices for zinc moved from under US$1 per lb. in 2016 to over US$1.30 per lb. in 2017 and 2018, and reached their decade high of around $1.60 per lb. in 2018. But prices are going to fall back down to earth. This is just one of those cycles in the metal space where we expect a period of high prices will be followed by some weakness.

TNM: Do you cover any of the EV metals like lithium and cobalt?

RJ: I don’t follow them in depth, but generally what’s going on there is that both lithium and cobalt have experienced a relatively weak 2019. They are among some of the worst performing commodities in the space due to the mismatch between hope for EV demand and the reality of, at times, sometimes sluggish EV pickup. This relates to what I was saying about some of the rollback of subsidies for EVs in China. You had a lot of companies building capacity in the lithium and cobalt markets  aiming to satisfy that fledgling and rising demand for batteries in the EV sector. But now because of that slightly slower uptick in demand, we’re probably going to remain mildly oversupplied for both materials for the next couple of years. After that, the effect of cumulative EV growth will eventually mean that we start to have very tight markets again. At this stage, we’re going through a period of slightly oversupplied markets, but more than that, I think, is the uncertainty, and the uncertainty relates to how long these subsidies are going to last. How much additional policy support will there be for renewables, intensive manufacturing and production? Will it be supported by global governments? And because of the politics around climate change policies, the outlook is still very uncertain, and because of that we’re going to have periods of wild ups and downs in both markets, and that will be tied a lot to the latest news about the outlook for the EV industry. 

TNM: Let’s move to precious metals.

RJ: On the gold side, we expect prices will head to their near-term high in the coming year, coinciding with the 2020 election in the U.S. and elevated uncertainty around that. Even though we do not see overall uncertainty rising from current levels today, we do expect there will be an additional risk premium on precious metals like gold. Our latest outlook for gold is that it will rise from an average annual price of US$1,400 per oz. in 2019 to a cycle high of US$1,550 per oz. in 2020. Then there will be a slow decline as global uncertainty begins to wane into 2021. We see US$1,475 per oz. in 2021 and US$1,425 per oz. in 2022, and then gradually declining towards a longer-term stable price of around US$1,300 per oz. in the mid-2020s.

We see silver hitting a cycle high of US$18.75 per oz. in 2020 and then declining along a similar trajectory as gold, back down to US$17.75 per oz. in 2021 and by mid-2020, when gold is around $1,300 per oz., we expect silver will be in the US$16 to US$16.50 per oz. range. That will be on a combination of things: global sentiment recovering from its current bearishness and central banks eventually raising interest rates again as the global economy steadies itself. At the same time as central banks start to see things get a little safer, you’re going to have less of a political risk premium on things like gold, which are typically more sensitive to those kind of risks.

TNM: What’s your outlook for the European economies?

JR: Broadly speaking, Europe is hurting from the global slowdown. The traditional driver in Europe, Germany, is weak and is likely right on the edge of some sort of a technical recession because of its heavy trade exposure. Meanwhile, countries where exports are typically less a growth driver, like France, are outperforming the German economy because they are less exposed to exports and more focused on their domestic economies.

TNM: The Canadian economy?

JR: We see the Canadian economy having a bit of a boost coming out of the federal election. There’s going to be some stimulus spending coming into the economy to boost profits a little bit there, but after that, there will be a little bit of a payback period. If stimulus increases growth in the front end, we typically get a bit of a payback at the back end, and then after that the economy will stabilize around 1.8% growth year-on-year in early 2020 onwards.

We do think the U.S. economy, juxtaposed to the Canadian economy, had a much bigger stimulus boost coming off the 2016 election, so there’s going to be a longer payback period there, and a longer period of sub-par U.S. growth. But  that will eventually be followed by a return to trend, which in the U.S. is slightly higher than in Canada — call it about 2% versus 1.8% at their steady states.