CICC: New paradigm of commodity supply and demand Differentiation still the main trend

CICC released a research report stating that the recent decline in bulk commodities sharply contrasts with the market in the first half of the year. In the second half of the year, as macroeconomic expectations weaken, the bulk commodities market is also facing significant selling pressure. At the current point in time, with the Federal Reserve cutting interest rates by 50 basis points and domestic demand at a low ebb, it is expected that the pricing of bulk commodities will gradually return to their respective fundamentals. The future theme of the bulk commodities market remains the transition of downstream new and old demand momentum and the potential contradiction between upstream capacity investment and price disconnect. The incremental demand from green and emerging economies is still in the stage of quantitative change, not yet reaching a qualitative turning point. In conclusion, the team believes that the start of the super cycle may still be premature, and under the new paradigm of supply and demand, bulk commodity market pricing may continue to focus on the differentiation of supply and demand conditions. The recent decline in bulk commodities sharply contrasts with the market in the first half of the year. In the first half of the year, CICC observed a more pronounced supply constraint due to insufficient upstream capital expenditure, with structural shortages gradually emerging, such as concentrated excess capacity in oil and brewing conflicts in metal mining and smelting. With expectations of demand growth improving, the market began to form consistent expectations of scarcity pricing for commodities like copper and oil. The "super cycle" of bulk commodities is surging again. However, as we enter the second half of the year, macroeconomic conditions are becoming more volatile, and the spiral risks of adjustment from these expectations are becoming evident. Weakness in US employment and economic data, along with concerns about a hard landing, have intensified. China's fiscal transformation from physical work remains slow, and the demand for energy and industrial metals may be lackluster. As macroeconomic expectations weaken, the bulk commodities market is also facing significant selling pressure, with prices of crude oil, iron ore, and rebar falling below $70/barrel, $90/ton, and 3000 RMB/ton respectively, all hitting new lows since 2024. At the current point in time, with the Federal Reserve implementing a cut of 50 basis points, the likelihood of a soft landing for the US economy has increased, and concerns about economic recession have eased. With domestic demand at a low ebb, the marginal improvement in energy and industrial metal demand, along with accelerated destocking, is taking place. In a situation of improved macroeconomic sentiment both domestically and internationally, CICC expects bulk commodity pricing to gradually return to their respective fundamentals. In the foreseeable future, CICC believes that the theme of the bulk commodities market continues to be the transition of downstream new and old demand momentum and the potential contradiction between upstream capacity investment and price disconnect. Although fundamentally CICC believes that the global bulk commodity market may have completed the transition from mostly surplus to mostly scarcity by 2024, the incremental demand from green and emerging economies is still in the stage of quantitative change and has not yet reached a qualitative turning point. Traditional existing demand still faces potential drag from a global economic slowdown. The transition from scarcity on the balance sheet to reality still relies on the realization of demand growth expectations, and if the relay of new and old momentum falters, excess speculation under premature scarcity pricing may also face adjustment risks. In conclusion, CICC believes that the start of the super cycle may still be premature, and under the new paradigm of supply and demand, bulk commodity market pricing may continue to focus on the differentiation of supply and demand conditions. Demand-side, the relay of new and old momentum is transitioning from quantitative change to qualitative change Emerging economies may replace China as the new driver of incremental demand: The growth trajectory of global demand for commodities in various countries mostly follows an S-curve. Consumption (or per capita consumption) first slowly climbs, then grows rapidly, and finally stabilizes and enters a long-term trend. Looking at the position on the S-curve, China's consumption of various commodities is already at or about to reach its peak, while emerging economies such as India, with relatively low per capita consumption of various goods, are still in the early stages of the S-curve. Over the past 20 years, China's urbanization and industrialization have been the main drivers of global commodity consumption growth, but CICC believes that this momentum is gradually slowing down. China's population has reached its peak, and with the growth rate of urbanization slowing down and nearing its end, the center of demand in China has passed the turning point and is on a downward trend. The incremental space for traditional infrastructure is also limited, and industrial metal consumption will be significantly under pressure, especially for commodities dependent on real estate and construction. At the same time, as the economy continues to grow, new forces like India and Southeast Asia, which are in the ascending phase of demand, whether they can contribute to incremental demand globally as the demand returns to endogenous drivers, is of great interest to the market. The acceleration of urbanization and industrialization in emerging economies could bring significant growth potential to global commodity demand. The proportion of demand for green transformation continues to increase, gradually decoupling some commodities from the traditional economic cycle: global economic slowdown, the peak of real estate and infrastructure demand in China, and the dual carbon goals will also pose significant pressure on fossil fuel consumption. However, while traditional demand is under pressure, green transformation also brings new opportunities for some commodities. Taking non-ferrous metals as an example, in the traditional demand framework, non-ferrous metal demand is mainly driven by cycles in China's real estate and infrastructure. However, comparing downstream data for copper and aluminum in 2018 and 2023, CICC found that the proportion of new energy demand has been rapidly increasing over the past five years. In CICC's historical balance sheet, the proportion of new energy demand for copper (including photovoltaics, wind power, and new energy vehicles) has increased from 4% in 2018 to 14% in 2023, while for aluminum, the proportion of new energy demand (including photovoltaics, ultra-high voltage, and new energy vehicles) has risen from 3% in 2018 to 16% in 2023. Although the growth rate of new energy has slowed marginally, from a base perspective, it is already significant enough to offset the negative impact of the downward trend in domestic real estate cycles on copper demand in recent years. On the supply side, there is a clear differentiation between new and old energy sources, regions, and up and downstream, which may bring risks New energy is not established while old energy is already declining, energy supply may lack elasticity: Under the pressure of green transformation, CICC sees that multinational oil and coal companies have maintained high production discipline, with the proportion of the relatively abundant cash flows from the past few years converting into capital expenditure not being high. Capital expenditure intentions are generally weak and face many external constraints. This means that the supply side of fossil fuels may lack sufficient elasticity to respond to demand fluctuations. Although investment in new energy continues to increase, the lack of stability in new energy power supply due to natural conditions may mean that commodities with high energy density such as electrolytic aluminum and chemicals could face temporary supply risks. In order to meet carbon emission requirements, traditional fossil fuel companies are under pressure to transition to new energy sources, but this transition may take time and face challenges. (Note: Some of the text may have been truncated due to character limits.)The relevant industry policies implemented will also constrain the supply of goods.Emerging resource countries provide increments, but uncertainties are on the rise simultaneously: From a regional perspective, the exploitation of commodities is increasingly concentrated in emerging resource countries in Asia, Africa, and Latin America, such as copper in Chile and Peru, iron ore and coal in India, coal, nickel, and copper in Indonesia, coal in Mongolia, bauxite and iron ore in Guinea, tin in Myanmar, etc. These countries have seen rapid growth in mining development investment in recent years, either for domestic urbanization and industrial needs or for commodity export demand. CICC expects these countries and regions to become major sources of incremental supply for commodities in the future. These regions are rich in resources, but infrastructure such as ports and roads is inadequate, political risks are high, and there is uncertainty in the progress of development. Most importantly, in the trend of anti-globalization, resource-rich countries may hoard resources and witness a rise in resource protectionism. Various trade policies related to resource security may become important sources of supply risk in commodity markets that cannot be ignored. The concentration of capital expenditure and the mismatch in production expansion cycles intensify contradictions in the mining and metallurgy industries: In recent years, CICC has observed a general trend of profit distribution shifting towards the upstream in major commodity chains. This is manifested in the significant decline in copper industry TC/RC, iron ore and coking coal prices encroaching on steel mill profits, or in the suppression of pig breeding profits by feed prices in the Shenzhen Agricultural Power Group industry. Compared to the smelting end, upstream capital expenditure is relatively low, and the average grade of mines is gradually declining, causing bottleneck constraints in supply. This may fundamentally stem from the contradiction between the uneconomical nature of traditional resource development scale and the economies of scale in the manufacturing industry. The downstream manufacturing sector has greater elasticity in expanding production compared to upstream raw materials, lacking an advantage in profit distribution, and facing relatively excess production capacity compared to end demand, making it difficult for cost pressures to trickle down. The profits of the intermediate sector are pressured in both directions. A new paradigm in supply and demand conditions, differentiation remains the current theme In the commodity market, signs of inadequate supply conditions have emerged, but the start of the second half of the cycle still depends on the trend-breaking of demand. Under the new paradigm of supply and demand conditions, differentiation remains the current theme. Demand is the primary basis for CICC to differentiate price performance. The same inadequacy in upstream investment serves as a drive towards higher copper prices, but only as a bottom support for iron ore and coal prices, reflecting the differences in demand direction. CICC predicts that the divergence in prices of black and non-ferrous metals may continue to be a long-term trend. For commodities such as copper with relatively optimistic demand prospects, speculative sentiment-driven sporadic price increases are not beneficial for supply release, only amplifying the price elasticity of demand and triggering negative feedback on the demand side. Sustained high prices may encourage continuous investment in the supply side to meet the gap. Of course, the so-called supply-demand gap is only a theoretical deduction of future supply and demand. In the long run, both supply and demand will match each other through price mechanisms. Prices will rise until enough marginal supply is stimulated, or marginal demanders are squeezed out. Taking copper as an example, under the assumption of relatively rigid demand, to stimulate a sufficient amount of copper supply increment, the theoretically incentivized price of copper should be above $10,600 per ton. For commodities such as iron ore and coal with relatively pessimistic demand prospects, prices may seek downward support based on costs, and the long-term equilibrium price should anchor at the marginal position of the cost curve. Taking iron ore as an example, from the cost curve, CICC predicts that the theoretical central axis of the future price is around $80 per ton. However, expectations are reflexive, as a lack of market impetus to expand investment will lead to a spontaneous contraction of the cost curve, lacking the elasticity to respond to demand fluctuations. The performance of copper prices in the coming years may mirror the trend of iron ore prices in recent years. Since 2021, the central axis of iron ore prices has gradually shifted downward, while the upper and lower bounds of price fluctuations have also been narrowing. As China's steel demand reaches its peak turning point, market awareness needs to be established. The clearer the market's understanding of the supply-demand prospects, the narrower the price fluctuations. In comparison, CICC predicts that the future performance of copper prices may involve a process of oscillating upward central axis but gradually narrowing price fluctuations. On the one hand, price increases are the likely path to supply-demand matching, while on the other hand, the elasticity of the copper supply-demand curve will become clearer, making it harder for extreme high or low prices to occur.