Don't Catch the Metals Knife

Taking production off the market is likely to have only a fleeting impact.

China's metals producers have called time on the commodity bust. 

Progressive Metal

One-day price change in major metals contracts, Nov. 26

Source: Bloomberg

Note: LME contracts are for 3-month forwards; Comex copper is for the current month

The China Nonferrous Metals Industry Association has asked the government's National Development and Reform Commission to buy nickel, aluminum and other metals to prop up prices, people with knowledge of the matter told Bloomberg News. They're also pushing regulators to investigate short-selling of metals contracts, according to other people. Chinese nickel and copper producers will meet Friday and Saturday to discuss their response to the price slump, people familiar with companies in those industries said.

 Nickel and aluminum contracts traded in London, and copper traded in Chicago, all gained more than 2 percent Thursday on the news.

This won't end well.

The pain currently tearing through metals markets isn't being driven by the malign activity of speculators or insufficient government stockpiles. Quite the opposite. So don't make the mistake of thinking that a short-term price surge indicates a turning point in the commodity bust.

Take the example of Glencore. The Swiss miner-trader caused the price of zinc to jump 10 percent Oct. 9, when it announced that it would take production equivalent to about 4 percent of global supply off the market. Three-month forwards on the London Metal Exchange posted the biggest one-day gain for the contract in records dating back to 1989.

That seems impressive, until it's put in context:

Look Out Below

Glencore's cuts didn't change the long-run trajectory of zinc prices

Source: Bloomberg

If anything, the the government purchases and harassment of short-sellers being urged by China's metals producers will do even less to address the issue than Glencore's supply cuts, and the announcement of similar shutdowns by Chinese zinc producers last week.

The problem in commodities markets is a fundamental one: Supply surged in recent years to meet demand that is now receding. Solving that requires real changes in the activities of producers and consumers. Slumping prices are doing their traditional job of finding a point at which the market will clear and bring supply and demand back in balance. None of this will be fixed by tweaking things in the markets.

As Gadfly columnist Liam Denning wrote on Wednesday in relation to oil, building up a stockpile of a commodity doesn't make supply disappear -- unless you follow the unenviable example of the Thai government, which bought perishable rice and then let it rot. Indeed, metal stacked in warehouses is so easily delivered to the market that a build-up of inventory typically causes prices to fall, not rise:

Buying Won't Help

Copper prices rise when stocks fall, not the other way around

Source: London Metal Exchange

Short-sellers aren't the problem, either. The U.S. has banned trade in onion futures since the 1950s, after a couple of onion traders in Chicago cooked up a bizarre scheme to corner the market. The ban has, if anything, increased onions' price volatility, according to the Canadian economist David Jacks.

The metals producers' plea won't fall on entirely deaf ears. China is both the world's biggest consumer and biggest producer of most mined commodities. That means that unlike Opec, which is firmly on the side of oil producers, or the International Energy Agency, which favors consumers, the government may have divided loyalties. 

Even so, the issue of whether commodity prices should be supported or allowed to wilt is ultimately a zero-sum game about which parts of China's economy should be nurtured. In the long run, the country will be better off if commodity prices fall and the government spends its cash on more socially useful activities than increasing materials prices for domestic companies.

China's miners are in a battle they can't win.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

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