What does H2 2023 look like for critical materials?

Opinion Pieces




What does H2 2023 look like for critical materials?

The major economies have mostly trended opposite in 2023 to market expectations at the start of the year.

China’s economic recovery has lagged with the country’s Q2 GDP rising 6.3% year-on-year, but only 0.8% quarter-on-quarter, raising concerns about the Chinese post-COVID recovery. Although Project Blue still believes that the 5% GDP target set by the Chinese government will be achieved, any upside will be limited and largely depend on any stimulus measures, monetary or fiscal, taken in the second part of the year.

The manufacturing PMI remained below 50 during the April-July period while the non-manufacturing PMI (although staying above the 50 level), posted a gradual decline since March. Retail sales rose by only 3.1% year-on-year in June, a sharp deceleration from the respective 18.4% and 12.7% increases in April and May. Additionally, the average new home prices in China's 70 major cities were flat year-on-year in June 2023 after edging up 0.1% in the previous month. A weak global outlook did not help as exports also dropped 14.5% year-on-year in July.

At the beginning of the year, the USA and Europe had faced concerns of a recession in 2023, however, both have steered clear for now. The US economy remains on a strong path and consumer spending remains the main driver with strong employment gains. Inflation is slowing. The headline June PCE declined to 3% but with a core PCE of 4.1%, the Fed is still likely to increase interest rates by another 25bp before the end of 2023, from a current 5.5%. The Euro-area economy rose by 0.3% quarter-on-quarter in Q2 after stagnating in Q1. Despite the weak German economy, Europe may avoid recession in 2023 with the latest ECB growth forecast at 0.9%.

With European and USA economies stabilising but with little upside for the remainder of the year, the focus is on China and whether the country can engineer counter-cyclical trends for H2 2023. The Political Bureau (Politbureau) of the Communist Party of China (CPC) Central Committee held their meeting in July, which focused on the current economic situation and outlined plans for the second half of the year.

Can China stop a sliding economy in H2?

The July Politbureau meeting urged a ‘proactive’ fiscal stance, a ‘prudent’ monetary policy and called for ‘policy adjustments’ regarding the property sector to encourage “counter-cyclical” economic trends. However, it failed to announce specific measures to revive the slowing economy.

China has relied essentially on a loose monetary policy to revive its economy, which has proved, so far, ineffective. The July data indicates that China fell into deflation, suggesting that the economy is in a liquidity trap. Project Blue believes that fiscal measures would be the most appropriate to stimulate domestic consumption both in the short and longer term. Any large infrastructure spending appears unlikely given the country’s high debt to GDP and the inherent boom and bust associated risks.    

The National Development and Reform Commission (NDRC) announced measures on restoring and incentivising consumption at the end of July through a series of policies on property and finance. The measures consist of 20 policies/initiatives across six areas, targeting broad-scale consumption, including in the automobile and property sector. Overall, market sentiment is that these will see gradual improvements, but policy will need to be timely and act across supply chains from downstream to upstream. Project Blue believes this window of opportunity is narrowing, and if it is not realized in 2023, any visible results from stimulus measures will slip into Q2 2024, post China Spring Festival.

Property plans and the implications for steel

China’s top leaders signaled more support for the troubled real estate sector alongside pledges to boost consumption and resolve local government debt. NDRC policies put in place at the end of July included reducing existing housing loans, first set of interest rates and down payments to boost renovation and investment.

However, domestic sentiment on China’s ability to support a counter-cyclical push over H2 is wavering. A credit crisis is evolving with Ever Grand and more recently Country Garden defaulting on more than RMB3Tn (US$413.3Bn) so far. These developments will likely see domestic investment lag behind incentive programmes.

As a result, we could see concerns rise about the Chinese economic recovery in H2 with the late arrival of concrete stimulus measures. Project Blue believes that any rebound on the property market will be very gradual and probably more of a 2024 story as confidence remains low on the buyers' side (savings have increased in China by 18% in H1 2023) and cash low on the property developers' side.

Switching to the steel industry, which has followed cyclical construction seasons, we can see that Chinese steel production is currently only slightly ahead of its 2022 level for the first half of the year but missing the typical elevated post-China-New-Year construction season quarter. 

A typical trend would see steel production decline over H2 and into winter, but counter-cyclical policies could result in steel production tracking towards the stimulus pattern of elevated H2 output as seen in 2020, post the original COVID-19 pandemic lockdowns. However, if steel output continues at the 90Mt per month level, Chinese production would reach record levels in 2023, which goes against the country’s 14th Five-Year Plan to limit steel output and focus on value added products.

With market sentiment still cautious on the success of the recent policy announcements, Project Blue expects demand to support typical “cyclical” steel production trends in H2 2023. If policies prove to gain traction, we can likely expect a positive Q2 after the Chinese 2024 Spring Festival. Longer term, a relatively young blast furnace industry in China will likely see steel production remain high. Project Blue forecasts a plateau in Chinese steel production before switching to a gradual decline.

Electrifying into rural communities

As China EV subsidies rolled-off at the end of 2022, and with the lunar new year falling in late January, Q1 2023 data pointed towards a significant slow-down in EV sales growth in China. While some of this slow-down was anticipated, the resulting price cuts by auto-manufacturers were deeper and more widespread than forecast. China’s Q2 sales point towards these discounts beginning to restimulate the high levels of EV sales growth associated with a market that accounted for nearly 63% of 2022 global EV sales by volume.

In an attempt to boost the automotive sector further following the Politbureau, the NDRC policies aim to improve purchase restrictions and re-circulation in the second-hand vehicle market. For battery EVs, the proposal is to exempt vehicle purchase taxes (currently at 7.5-10% of the sales price) until 2025 and a reduced 50% over 2026 and 2027.

As with supporting uplift of the property market, the policy is looking to expand EV infrastructure and power supply in rural areas and implement peak and valley electricity prices. This could see xEV sales continue to outperform 2022 sales levels, although with a market share skewed towards smaller and cheaper xEVs in rural areas.

Critical material basket prices remain low

Project Blue’s Critical Materials Basket Price Index tracks prices across 30 critical materials, including battery and EV metals, technology metals, steel and alloys, and industrial minerals.

Over the last 12 months, the Critical Materials Basket Price Index fell sharply from a post-COVID recovery March 2022 high through to an October 2022 low, largely in response to weakening global macroeconomic conditions. Prices corrected through to February 2023 in response to high energy costs before declining again towards a new low in June 2023 as energy costs normalised and China’s anticipated economic recovery lagged expectations. July saw a modest increase, weighted to the semiconductor material China export-restriction narrative of gallium and market tightness for molybdenum.

Some of the most significant year-on-year falls have been observed in cobalt, gallium, light rare earths and lithium prices, which have fallen to levels that are roughly half of those found a year ago. The leaders of the pack on the upside are molybdenum, tellurium, germanium, PGMs and chromium.

Alloy and battery prices are facing headwinds, with prices suppressed by a weaker-than-expected economic performance in China. Battery raw material markets are being held down by surplus supply, which has led to subdued prices into July. Steel alloys have faced weak demand and smelters shutting down with an unprofitable cost base, however, prices have carried a stronger upside pressure from cost fundamentals.

With a concerned and cautious market expectation for the economic performance in China over H2, Project Blue’s outlook is for the critical materials basket prices to remain largely flat in the short term. However, several prices are poised to ramp up, necessitated by high costs, and any materialisation of incentives in China could kickstart a recovery. For now, expectations are weighted towards end-Q1 2024 rather than earlier.