Yield Curves Frighten Investors

Metal prices suffered last week as flattening yield curves in the US suggest an economic slowdown is approaching for the American economy, and that has caused terror amongst international investors.

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After a respite during the first week of December, last week saw a return to difficult trading conditions for metals, with sharp price falls in particular for zinc and aluminium. Zinc fell 3.9% over the seven days to the end of Friday, closing in London on US$2,533/t, with aluminium down 2.7% at US$1,921/t. Nickel was 1.2% lower over the week at US$10,845/t, with copper down for a second consecutive week at US$6,114/t, albeit only 0.7% lower last week.  

It was not all bad news for metals. After the heavy falls at the end of November, iron ore was up for the second consecutive week, closing on Friday at US$67.0/t (62% Fe), up 4.4% on the previous Friday. Gold was unchanged over the week at US$1,243/oz but could have been expected to react more to the heightened uncertainty on international markets.

The weaker base metals prices were an entirely understandable reaction to worrying market signals last week. Foremost amongst these was a flattening of yield curves in the US. Many people that measure these things believe yield curves can foretell a recession, and the news is not good.

The yield curve refers to the interest rates paid by fixed-income instruments (corporate bonds, Treasury securities etc) with differing dates to maturity. Usually, the longer a bond's maturity length, the more interest you can expect, ie an upward sloping interest curve with time. A flat curve occurs when yields are roughly the same for different maturities. This is where we are now in the US, and this has panicked investors because a flat yield curve often leads to an inverted one, where shorter-dated bonds actually pay more than longer-dated ones. An inverted yield curve has preceded every US recession since the second world war.

Investors reacted by last week pulling more money out of funds invested in US equities than at any time since the stock market sell-off in February, according to data from EPFR Global. Analysts blamed intensifying trade concerns, gyrating forecasts for interest rates and moderating expectations for earnings growth in 2019. The S&P 500 is 9% lower so far this quarter and on course for its worst quarterly performance in seven years.

Concern over trade between China and the US was not helped by Beijing's arrest of a second Canadian citizen. These arrests follow the arrest in Vancouver (on a US extradition warrant) of a senior executive at Chinese telecom group Huawei. China's foreign ministry said the two men had been detained as part of an investigation into activity "harmful to national security".

As if that wasn't bad enough for sentiment, the US last week refused to agree an increase in finance for the International Monetary Fund (IMF). The organisation's managing director, Christine Lagarde, said an increase in quota payments was necessary to put the IMF on a more stable financial footing. The US Treasury disagreed, saying that the IMF has ample firepower, and must rely on alternative funding mechanisms in a crisis. The decision reflects President Trump's aversion to multilateral institutions.

The mood of investors was not helped by confirmation last week that the European Central Bank will next year end its quantitative easing programme. The decade-long experiment to stave off economic recession by spending and easy access to capital had seen interest rates head towards zero (and below in several celebrated instances).

Quantitative tightening is now widely expected in Europe, and investor sentiment in the eurozone last week fell to its lowest level in four years. Research firm Sentix said its current index had entered negative territory, and the company's managing director, Manfred Hübner, noted that the firm's 'expectation gauge' suggested there is "practically no glimmer of hope". He blamed escalating tension over international trade, the budget crisis in Italy, unrest in France and Brexit. "It is coming from all corners at the moment", he said.

On top of these difficult general market conditions comes confirmation that miners are falling still further out of favour amongst investors. Analysts at Citigroup Inc. estimate that assets under management invested in commodities have fallen 10-15% from last year to a low of US$411 billion in November. Much of the problem is a deep mistrust amongst fund managers that the mining companies can restrain themselves from embarking upon another stint of expensive, and ultimately costly, acquisitions.

Meanwhile, there was good and bad news for coal last week. According to a report from InfluenceMap, a UK non-profit organisation, the world's biggest investors have been ramping up their holdings in coal over the past few years. The world's leading fund managers are reported to have raised their holdings in thermal coal by 20% since 2016, despite the concern over global warming and coal's detrimental role (which was an important theme at the recently completed UN climate-control meeting in Katowic).

Almost coinciding with the InfluenceMap report came a decision by the European Bank for Reconstruction and Development to adopt a "no coal, no caveats" financing policy as it seeks to combat climate change. The move brought into sharp focus the difference in attitudes between financing organisations over coal.

Chris Hinde

Chief Commentator, Mining Beacon

Previously editorial director of Mining Journal, and more recently head of S&P Global Market Intelligence's metals and mining team, Chris is now Mining Beacon's editor-in-chief and lead commentator. He posts two blogs every week, one on Monday reviewing market conditions over the prior week, and a second on Thursday looking at issues on the global mining scene. There is also a quarterly blog on business opportunities in the sector.