growth promising, but hurdles persistbeyondmarket.nirmalbang.com/issue94/download/magazine.pdf ·...

GROWTHPROMISING,BUT HURDLESPERSIST

For Pr ivate Circulat ion Volume 1 Issue 94 14th Mar ’14

COMMODITY SPECIAL

It’s simplified...Beyond Market 14th Mar ’142

DB Corner – Page 3

Growth Promising, But Hurdles PersistDespite improving global economic outlook, we are not very bullish on commodities as we expect the Chinese economy to contract in 2014– Page 6

Still OptimisticWhile investment demand for gold is likely to remain firm in the first half of the year, we expect silver prices to post moderate gains too – Page 14

Demand StrainsIrrational higher prices may depress demand for natural gas in the coming months – 2

Waning InfluenceHigher supply may overtake demand for crude oil in the near future with shale evolution replacing it as the preferred commodity among global economies – Page 26

“Following A Crisis Year, There Are Early Positive Signs That Can Usher In A Lot Of Opportunities For Growth Ahead.”Mr Samir Shah, Managing Director and Chief Executive Officer at the National Commodity & Derivatives Exchange Ltd (NCDEX) talks about the commodity market in India and its growth prospects in the future– Page 33

Downside Limited In NickelSurplus shrinkage and high raw material costs support nickel prices from a near-term perspective – Page 36

A Deluge Of SortsSupply glut on the back of rising mine and smelter production looms large in the near future for copper – Page 40

A BreatherMine closures and production cuts in the near future could lend support to aluminium prices – Page 44

On A ReboundMine supply constraints to keep prices of zinc upbeat in the medium term – Page 48

A Firming TrendExpected supply tightness in lead in 2014 is likely to keep markets well-supported – Page 52

Volume 1 Issue: 94, 14th Mar ’14

Editor-in-Chief & Publisher: Rakesh BhandariEditor: Tushita NigamSenior Sub-Editor: Kiran V Uchil

Art Director: Sachin KambleJunior Designer: Sagar Padwal

Marketing & Operations:Divya Bhurat, Shreelatha Gollavathini

We, at Beyond Market welcome your views, comments and feedback. Do help us to grow better as per your liking. This is our attempt to reach you better while crossing horizons...

Web: www.nirmalbang.com [email protected] No: 022 - 3926 8047

HEAD OFFICE Nirmal Bang Financial Services Pvt LtdSonawala Building, 25 Bank Street, Fort, Mumbai - 400001 Tel. 022-3926 7500/7501

CORPORATE OFFICE B-2, 301/302, Marathon Innova,Off Ganpatrao Kadam Marg,Lower Parel (W), Mumbai - 400 013Tel: 022 - 3926 8000/8001

Research Team: Sunil Jain, Kunal Shah, Devidas Rajadhikary,Harshal Mehta, Somya Dixit, Sakina Mandsaurwala,Mohammed Azeem, Ishwar Kelwadkar

Balkrishna Industries Ltd (LTP: `416.20), Dewan Housing Finance Corporation Ltd (LTP: `221.65) and CCL Products (India) Ltd (LTP: `45.40).

In the coming fortnight, market participants should keep an eye on announcements by the Reserve Bank of India at its monetary policy meet as well as the direction the rupee may take subsequentlY.

It’s simplified...Beyond Market 14th Mar ’14 3

Disclaimer It is safe to assume that my clients and I may have an investment interest in the stocks/sectors discussed. Investors are required to take an independent decision before investing. Investment in equity is subject to market risk. Our research should not be considered as an advertisement or advice, professional or otherwise. The investor is requested to take into consideration all the risk factors including their financial condition, suitability to risk return profile and the like and take professional advice before investing.

n the previous fortnight, the standoff between Russia and Ukraine over Crimea, and the opposition of other G7 nations

to it, dominated the news globally. Further, diplomatic efforts to cool off the escalating crisis continued without any headway as many fear that the geopolitical tension could weigh on the commodity markets.

Domestically, the Indian rupee extended its gains against the US dollar and increased expectations of further strengthening of the Indian currency on account of lower current account deficit (CAD) as well as FII inflows, both on the equity and debt front. This had a positive impact on sectors like banking and other riskier assets, but had a negative impact on companies driven by export earnings like pharmaceuticals and IT.

I Markets were seen making new highs, mainly driven by the likelihood of a stable government and pre-election rallies, which created the right mood for the upcoming Lok Sabha polls in the country starting 7th of next month.

The markets look good in the coming fortnight. The Nifty has support at the 6,500 and 6,450 levels with an expected target of around 6,750.

Stocks that look good from investment and trading perspectives are Lupin Ltd (LTP: `960.40), Aurobindo Pharma Ltd (LTP: `507.80), Larsen & Toubro Ltd (LTP: `1,237.40), Bharat Petroleum Corporation Ltd (LTP: `418.75), Apollo Tyres Ltd (LTP: `126.95) SRF Ltd (LTP: `306.30), Jet Airways (India) Ltd (LTP: `237.75),

The markets look goodin the coming fortnight.

Sensex: 21,934.83Nifty: 6,537.25

(As on 10th Mar ’14)


Tushita NigamEditor

The commodity research team at Nirmal Bang is not quite bullish on the commodities market for the year 2014 despite improving global economic outlook owing to the expected contraction in the Chinese economy. In this backdrop, the latest issue of Beyond Market focuses on the current state of the commodities market, different complexes and their likely movements through the year.

Apart from this, the issue covers articles on expectations of firm investment demand for gold in the first half of the year and moderate gains in silver among the precious metal complex, supply being more than demand for crude oil due to the evolution of shale gas, which could replace the former as the preferred commodity among economies world over and the possibility of demand being depressed for natural gas due to irrationally high prices.

As far as the base metals complex is concerned, we have covered nickel, copper, aluminium, zinc and lead in this issue. While surplus shrinkage and high raw material costs will support nickel prices, the supply glut is likely to loom large in the near future for copper. Similarly, mine closures and production cuts are likely to support aluminium prices and supply constraints will keep zinc as well as lead prices up.

We have also featured an interview of Mr Samir Shah, Managing Director and Chief Executive Officer at the National Commodity & Derivatives Exchange Ltd (NCDEX) where he talks about the commodity market in India and its growth prospects in the future.

Last but not the least we would like to thank the Commodity Research Team at Nirmal Bang for helping us put together this special issue on commodities and making it a collector’s copY.

ABumpyRide


THE CHINESE SLOWDOWN

Kunal ShahHead - Commodities Research,Nirmal Bang

During the year 2013, we witnessed a sharp correction in commodity prices, especially bullions. Base metals and agriculture commodities too corrected sharply. Finally with the tapering of the US bond purchase program, commodity prices were trading in line with their fundamentals.

There is a big structural change taking place in the global economy, with various developed economies showing signs of stronger recovery and developing economies, except India are finding difficulties with tapering of the bond purchase program in the US.

In India, measures to curb gold imports have resulted in revival of the Indian economy, as our current account deficit (CAD), which was 6.5% of our GDP in Q3 FY13, dropped to 0.8% in the corresponding period of FY14 and the absence of robust Indian gold demand impacted international gold prices in 2013. It is high time for people of India to understand that investing in gold will not lead to economic growth and if India’s investment demand for gold cools off it will have a huge positive impact on the economy.

In 2014, the biggest concern for commodities market participants continues to be the slowdown in China. A decade back bull run in commodities started with robust growth outlook of China and now with the Chinese economy likely to slow down going forward in 2014, there are headwinds for many commodities as demand concerns will persist. Produc-tion of many commodities have hit record high but now demand concerns from China will weigh on the prices of several commodities.

There is structural change going on in the context of the energy sector with the emergence of shale gas and shale oil. United States’ crude oil production has surged from 4 mbpd in 2008 to above 8 mbpd in 2013 and natural gas production has surged to 28.9 bcf in the year 2013, which was just 4 bcf in 2007. The most important thing is it’s not the end, this is likely to continue for years to come and this revolution is spreading across the globe.

With these developments we are of the view that the era of high crude oil prices is likely to come to an end sooner than later, which is going to have a major change in the economic and political landscape of the global economy. I foresee lower energy prices in the year to come, which will be a boon for the emerging markets and will provide a much bigger growth trajectory for the global economY.

I foresee lower energyprices in the year to come,which will be a boon forthe emerging markets.

Despite improving global

economic outlook, we are not

very bullish on commodities

as the Chinese economy is

expected to contract in 2014

GROWTHPROMISING,BUT HURDLESPERSIST



he theme for 2014 is ‘changing economic and political landscape’, going forward. The global economy is undergoing a major change owing to which we believe the dynamics of many asset

classes, especially commodities, will change.

How many of us remember 11th Jul ’08 when NYMEX near-month contract of crude oil made a high of around $147/barrel? What were the implications it had on the global economy?

Although we do not want to discuss why crude oil prices moved up from $65 in Jul ’07 to $147 in Jul ’08, the fact is that rising energy prices or the sharp spike in energy prices remains one of the biggest threats to the global economy.

The road to sustained recovery is possible with stable and perhaps lower energy prices. There is structural change going on in the context of the energy sector with the emergence of shale gas and shale oil.

United States’ crude oil production has surged from 4 mbpd in 2008 to above 8 mbpd in 2013 and natural gas production has surged to 28.9 bcf in the year 2013, which was just 4 bcf in 2007. The most important thing is it’s not the end; this is likely to continue for years to come and this revolution is spreading across the globe.

With these developments we are of the view that the era of high crude oil prices is likely to come to an end sooner than later, which will have a major change in the economic and political landscape of the global economy.

Since the technological revolution between 1990 and 2001, there was no major revolution till the energy revolution in the US. Like technology and information services revolution led to the growth in the global economy, we believe now energy revolution in the form of shale oil and shale gas is likely to provide much bigger growth trajectory to the global economy.

After the US many countries are keen and moving towards the path of energy independence, including China.

The US is clearly the winner and is in the best position to benefit from energy revolution. The US trade deficit is shrinking rapidly because of the drop in oil imports from OPEC and Canada.

Between 2010 and the end of 2012, the industry added 1,69,000 jobs nationwide, growing at a rate of about ten times of the overall US employment. The US has started exporting natural gas and from being the net importer of

T LNG, it has become the exporter of LNG. Energy cost in the US is much cheaper than other countries as the number of gas-based power plants is increasing, which will lead to lower manufacturing costs for producers.

In the US in 2006, 0.81 million thousand megawatt hour of electricity was produced by natural gas-based power plants and now 1.3 million thousand megawatt hour of electricity is produced by gas-based power plants (more than 20% of total power).

Emerging markets have been major contributors to the global GDP, but now the US share in the global GDP is likely to increase, going forward. There is a shift in the economic landscape. In the last five years everyone used to talk about China. However, now the whole focus has shifted back to the US.

Oil producing countries enjoyed higher oil prices in the last five years due to geopolitical tensions across the world, easy monetary policies, and robust Chinese demand growth. However, now the only upside risk to oil prices is geopolitical tensions.

We foresee a gradual drop in oil prices in the years to come, which will lead to a shift in the political landscape across the globe, where Middle East, Russia and other oil producers will be in a spot and the US will be in a much better shape.

Chinese growth engine contributed the most to the global growth in the last five years. Lending of money to state-owned corporations by government-owned banks remains the prime reason for the property bubble and economic growth. Credit bubbles are popping up in the economy as well.

Chinese growth is likely to remain subdued due to the ongoing credit crisis and the wave of defaults in the financial sector remains a large threat for China. The biggest risk to upside growth trajectory for the global economy is China. We don’t expect any meaningful revival of Chinese growth.

The theme for 2014 is global economy, which has recovered from a crisis and is heading for a new trajectory of growth and one of the biggest reasons for the same is energy boom.

Commodities super cycle is not dead; the demand from the developed world is likely to inch up whereas Chinese demand will remain subdued. On the other hand, supply side of most commodities is likely to remain strong. We


believe during 2014, broadly commodity prices will not be able to outperform in spite of uptick in global GDP. The US dollar is back and likely to strengthen, going forward in 2014, which will also put pressure on the prices of dollar-denominated commodities.

MACRO OUTLOOK

The global economy had yet another difficult year in 2013 with a GDP growth of about 2.4%. The advanced economies’ below-trend growth continued, with the output rising at an average annual rate of about 1.3%, while emerging economies experienced a modest growth of 4.8% growth. After a year of sub-par global growth, the economic performance could pick up modestly in both advanced economies and emerging markets in 2014.

Moreover, tail risks will be less salient in 2014. For example, the threats of another euro zone debt crisis, another government shutdown or debt-ceiling fight in the United States, a hard landing in China is likely to be far more subdued.

The global growth is likely to accelerate to 3.2% in 2014 followed by a growth of 3.4% in 2015 as per the World Bank Global Economic Prospects (GEP) Report. Most of this acceleration is expected to come from advanced economies as they benefit from a half-decade of painful private sector deleveraging, a smaller fiscal drag, and maintenance of accommodative monetary policies.

The GEP report states that advance economies could grow at an annual pace closer to 2.2 in 2014. Amongst high-income economies, the recovery is most advanced in the US, with the GDP expanding for 10 quarters now. According to World Bank GEP, the US economy is projected to grow by 2.8% this year from 1.8% in 2013, firming to 2.9% and 3% in 2015 and 2016, respectively. Growth in the Euro zone, after two years of contraction is projected to be 1.1% in 2014, and 1.4% and 1.5% in 2015 and 2016, respectively.

Despite this most advanced economies will barely reach potential growth, or will remain below it. Households, banks and some non-financial firms in most advanced economies remain saddled with high debt ratios, implying continued deleveraging.

High budget deficits and public-debt burdens will force several governments to continue painful fiscal adjustment albeit at a lower pace. And an abundance of policy and regulatory uncertainties are likely to keep private

investment spending under check.

Growth in developing countries will pick up from 4.8% in 2013 to 5.3% this year, 5.5% in 2015. Most of it hinges on expectations of improved exports from emerging markets, backed by brisk recovery in advanced economies.

In sum, the global economy will grow faster in the year 2014, while tail risks will be lower. But with the possible exception of the US, growth will remain anemic in most advanced economies.

Further, emerging market fragility to a slowdown or reversal in capital-flow on the US Fed’s exit from quantitative easing including China’s uncertain efforts at economic rebalancing could somewhat become a drag on global growth.

The outlook for 2014 is also contained by long-term constraints as the structural reforms that these economies need to boost their potential growth are being implemented too slowly.

UNITED STATES

The outlook for the US economy remains bright for 2014 on expectations of higher spending from households and corporates after years of deleveraging. Turning to projections, growth in the United States is expected to be 2.8% in 2014, up from 1.9% in 2013.

Following upward surprises to inventories in the second half of 2013, the pickup in 2014 will be carried by final domestic demand, supported in part by a reduction in the fiscal drag as a result of the recent budget agreement. The optimism on US economic growth received a boost as the latest GDP report showed that consumers fuelled solid economic growth in the final quarter of 2013.

Consumer spending, which accounts for almost 70% of the US economy surged in Q4 2013 at an annual rate of 3.3%, the best pace since 2010 and a big jump from the 2% growth rate of the previous quarter.

The report also showed that the government spending fell at a 4.9% rate in Q4 2013, shrinking Q4 2013 growth by about 0.3 percentage point. That was a result of the plunge in federal spending, in part, of the government’s 16-day partial shutdown during October ‘13.

For 2013 as a whole, the economy grew a tepid 1.9%, weaker than the 2.8% increase in 2012 as the growth was held back by higher taxes and federal spending cuts that


with modest improvements in labour and housing markets, the US economy could witness the best growth in 2014 since the recession.

kicked in early 2013.

However, the fiscal drag will diminish sharply in 2014 with the passage of the budget deal in the US Congress, which halts tens of billions in additional spending cuts that were due to kick in in the year 2014.

The US economic outlook has also strengthened from a shrinking trade deficit. This trend may not continue this year because stronger economic growth and consumer spending will push up imports.

However, the US should benefit from a domestic oil boom and thereby declining US oil imports should more than offset stronger domestic consumption, narrowing the trade gap slightly again.

The US is expected to surpass Russia and Saudi Arabia as the world’s top oil producer by 2015 and become self-sufficient in oil production in the next two decades, according to recent estimates by the International Energy Agency (IEA).

More broadly, the trade deficit has fallen slightly since early 2012 and is sharply lower than record imbalances reached before the 2008-09 recession. Moreover, with the rising cost of production in China owing to high wages coupled with a rising yuan, the manufacturers are expected to continue to bring production back to the US, which would help fuel a manufacturing revival furthermore.

In addition to this, US manufacturers are expected to gain from rising global trade that could continue to narrow the gap in coming years, adding incrementally to the US GDP.

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Shrinking US Trade Deficit

Modest Job Creation In The US

Source: Reuters, NB Research


Furthermore, steady recovery in the labour market would give more households money to spend and help increase consumer spending. With diminished fiscal drag, coupled

EURO ZONE OUTLOOK

In spite of an improved outlook for advanced economies, the Euro zone is still likely to stand lower in this pack. While the Euro zone’s tail risks are lower, its fundamental problems remain unresolved.

Low potential growth, high unemployment, still-high and rising levels of public debt and extremely tight credit rationing owing to banks’ ongoing deleveraging continue to pose downside risks to the fragile recovery.

The Euro area economy will likely recover with a consensus expectation of about 1% growth in 2014 over 0.4% contraction estimated for 2013. Germany is expected to expand at the fastest pace, with 1.7% expansion, followed by France with 0.8% growth in 2014. Spain is expected to expand 0.7%, which is slightly higher than the 0.5% growth expected for Italy this year.

However, the latest run of data suggests that the Euro area economy remains fragile and that recovery is fraught with uncertainties. Though progress towards a banking union is on track, no steps have been taken towards establishing a fiscal union, even as austerity fatigue and political risks in the Euro zone’s periphery grow.

In fact, the European Central Bank (ECB) also debunked the myth of a sustainable economic recovery in the Euro zone when it reduced its main refinancing rate to 0.25% from 0.50% earlier in its monetary policy meeting.

Steep declines in headline and core inflation to below 1%


underscore the deflationary risks in the Euro zone. It seems a very real risk, given record excess capacity, a constrained fiscal policy amid high debt levels, and bank capital shortfalls have weakened the financial transmission.

The perils of deflationary concerns coupled with a subdued credit environment are trickling down to the broader economy as the corporate sector cuts spending, resulting in elevated levels of unemployment at over 12%.

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Euro Zone Inflation And Unemployment Rate

Source: Bloomberg, NB Research

Japan GDP

Japan Unemployment Rate

Source: Bloomberg

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ECB Loans

Source: ECB, NB Research

The biggest headwind for Euro area outlook stems from the process of deleveraging by Euro zone banks due to stricter capital norms, which continue to undermine credit growth at household and corporate levels.

Though sentiment indicators have turned positive in the Euro zone, backed by better financial conditions, credit growth remains in the negative territory as a result of banks’ balance sheet contraction.

It is evident that better financial conditions are not transmitting to the real economy as such. With the European banks’ stress tests in sight after the formation of the banking union, there is a slim chance of any significant revival in credit off take as banks would look to clean up their balance sheets further.

Although some of Euro area’s peripheral countries showed broadly-positive developments as Ireland and Spain exited from the financial sector bailout plan, a broad-based recovery still looks elusive in the Euro zone.

JAPAN

The biggest highlight of 2013 after the US recovery was Japan. Economic policies advocated by Japanese Prime Minister Shinzo Abe in the form aggressive monetary easing and expanding infrastructure spending have led to a rebound in the Japanese economy.

These aggressive policies have led to revival in Japanese GDP, leading to a drop in the unemployment rate and a sharp devaluation in yen. Japanese exports for the year 2013 have revived because of weak yen and ‘Abenomics’ has fired all cylinders.

Going forward in 2014, on the one hand the liquidity from the US is likely to moderate and real rates are likely to move up due to tapering of its bond purchase programme and on the other hand Japan will maintain its easy monetary policies so the Japanese yen will weaken further vis-a-vis dollar, going forward.


A weaker yen will boost exports and lead to higher corporate profits and bonuses, which will stimulate the economy. So, export growth will remain strong in 2014.

The major risk in 2014 in Japan from April ’14 is consumption tax. Consumption tax is likely to move up from 5% to 8%, and is a major event to watch out for Japan in 2014. But this will put upward pressure on prices and eventually lead to higher inflation.

Deflationary pressures in Japan have been easing and consumption tax hike will contribute to inflation. Inflation in Japan has moved up for the first time above 1% after 4 years in 2013.

Interestingly in order to avoid any major downside risk due to consumption tax hike, the Japanese government has already announced a package of 5 trillion yen. But we believe after the consumption tax hike, it will be challenging for Japan to maintain its robust growth.

CHINA

The Chinese economy witnessed massive explosion of credit post the Lehman Brothers crisis, when a massive

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stimulus package was announced in 2009, which was the inception of the credit bubble in the economy.

It’s the investment for the future, which had led to growth. Massive investments and the explosion of credit led to a sharp rise in housing prices, where the number of restrictions has been imposed to stop the sharp appreciation in property prices.

The new Premier Li Keqian is taking the right steps by not breeding asset bubbles in economy and has pledged to streamline administration and promote transparency of government affairs to fight corruption.

China’s central government’s debt has been increasing at an alarming pace. During 2012 it was 14.8% of the GDP and by end of 2013 it has increased to 22.5% of the GDP. Credit-driven growth in China has taken a big hit after a huge debt pile up at central government and inter-bank lending rate since the second half of 2013 has been shooting up sharply.

China’s 10-year bond yield has surged 3.53 to 4.64 in the last six months. Since June PBOC has taken a number of measures to stabilize interbank lending rates, including massive liquidity infusion in January ’14 of yuan 375 billion, but rates still remain high.


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Source: Bloomberg, NB Research Source: Bloomberg, NB Research

CHINA GDP

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The root of the Chinese problem laid in the humongous stimulus packages that were doled out at the start of the year 2009, which led to a massive investment-led growth in the last five years. The explosion of credit since the start of 2009 has led to problems in China.

Over the last five years, non-banking institutions such as trust companies’ funding have soared dramatically. Debt of local government and state-owned enterprises rose manifolds, liquidity issues at big state-owned banks are now surfacing.

There is tremendous stress in the financial sector, the cost of funding has increased, the government is not in a position to cut interest rates in spite of subdued inflation, and credit growth is slowing in the economy. Investment-led growth in China is likely to drop significantly in the current year.

On 31st Dec ’13, China released the much-awaited government debt audit report, in which China’s local-government debt bulged to 17.9 trillion yuan ($2.95 trillion) and general government debt stood at 30.3 tn ($4.99 trillion), 56% of GDP.

Borrowing from shadow financing has increased sharply as compared to the previous report. We believe these developments will lead to tighter regulation and drop in credit growth in China.

The state council has released ‘Document No 107’, the first regulatory framework for shadow banking, which will lead to a drop in credit growth, which eventually hinders the growth of the economy.

Chinese corporates are highly leveraged and have huge excess capacities. Credit squeeze in the economy has started impacting corporate bond issuance, which in the last few months have dropped sharply.

Yuan appreciation, coupled with high wage inflation has also become a problem for many Chinese companies. Due to shale gas and oil revolution in the US, the difference between products Made in USA and Made in China is likely to come down further.

On the one hand where the United States has been deleveraging successfully, China in the year 2014 is likely to deleverage, which is going to be painful in the short term; credit growth is likely to slow down further and growth is likely to contract for the year 2014.

Chinese slowdown is one of the biggest reasons in spite of improving global economic outlook why we are not very bullish on commodities. We expect the Chinese economy to contract during the year 2014.

STILL OPTIMISTIC?While investment demand for gold is likely to remain firm in the first half of the year, we expect silver prices to post moderate gains too

While investment demand for gold is likely to remain firm in the first half of the year, we expect silver prices to post moderate gains too



The yellow metal’s decade-old golden run that gave investors phenomenal returns during the last five years finally ended in 2013. Investors were mainly driven to the yellow metal owing to fears of hyperinflation, debt crisis in the Euro zone and massive monetary debasement.

Gold prices peaked out following the announcement of quantitative easing in the United States in September ’12. After the US Federal Reserve started its third round of quantitative easing (QE) in the form of bond purchase programme, gold prices started correcting. And a massive selling of gold futures was seen in the year 2013. This, despite the fact that gold prices have shot up every time there has been an announcement of a stimulus package in the US.

Highlights Of The Fall In Gold Prices

Investing in gold does not lead to economic growth. Warren Buffett agrees when he says: “It’s a non-productive asset.” But it is only due to fear that investors invest in gold. Further, the sub-prime crisis in the US in 2007, which was followed by the great recession across the globe, justified investors’ rationale behind staying invested in gold. However, they moved out of gold and began investing in other riskier assets once the US economy started recovering from the crisis and growing slowly and steadily in 2013.

The Euro zone also started showing signs of stabilization, which further led to a drop in premium from gold. And last but not the least, imports by the world’s largest consumer of gold till 2013, India, dropped sharply after the country raised import duty, coupled with the introduction of the 80:20 scheme from the country’s apex bank, the Reserve Bank of India (RBI) in July, which requires importers of the commodity to supply at least 20% of their imports to exporters.

GOLD

Source: Thomson Reuters GFMS, NB Research

2839.110.8

1649.4-

4499.3

1994.6319.9

88.942.987.8

240.5780

2774.5456.8

-1232.4

35.64499.3

2864-

1590.8-

4454.8

1950.7284.5

84.438.6

113.4213

733.92684.6

544.139.7

1006.5179.9

4454.8

2982.2-

1371.4382.7

4736.3

2197.9282.4

8537.3

103.8283.4791.9

2989.8358.6

501337.9

-4736.3

2968.224

1159.578.7

4230.3

2292.7283.9

9440.8

82236.9737.7

3030.4275

-924.9

-4230.3

2011 2012 2013E 2014ESUPPLY

Mine ProductionNet Producer Hedging

Total Scrap Used In FabricationImplied Net Disinvestment

Total Supply DEMAND

Jewellery FabricationElectronics

Other Industrial And DecorativeDentistry

Medals And Imitation CoinsOfficial Coins

Fabrication Excluding JewelleryTotal Fabrication

Net Official Sector PurchasesNet Producer De-hedging

Net Physical Bar InvestmentImplied Net Investment

Total Demand

Demand And Supply

Fabrication Demand

After the drop in global jewellery fabrication demand in 2012, it has soared by more than 10%. The correction in prices in the first half of 2013 led to a frenzy in buying in India, China and several other countries. But during the second half of 2013, the demand from China remained robust, while the demand from India began fading due to sharp depreciation in the Indian rupee, coupled with high prices prevalent in the domestic markets vis a vis international prices.


In 2013, China overtook India to become the world’s largest consumer and producer of gold. Moving forward, in 2014, we expect moderate demand growth of 3%-4% in jewellery due to slowdown in the Chinese economy, which will have an adverse impact on demand for the yellow metal.


Source: Thomson Reuters GFMS, NB Research Source: Thomson Reuters GFMS, NB Research



Jewellery Fabrication Demand Total Fabrication Demand From India And China

Year-On-Year Inflows And Outflows In Gold ETF Total Gold ETF’s Holding As On December ’13

Physical Bar Demand Continues To Remains Strong Total Fabrication Vs Total Investment Demand

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Investment demand is one of the most important aspects when determining the outlook on gold. While on one hand, the demand for physical bars has been increasing from Asia and the Middle East, on the other hand a large number of investors continue to shed gold exchange-traded funds. The demand for physical bars has increased by more than 30% following the steep correction in gold prices and holdings in gold ETFs have dropped by more than 30%. In 2010, 2011 and 2012 gold ETF holdings have surged by 846 tonnes. In fact, in the year 2013 there was redemption of 882 tonnes.

Investment Demand


On the one hand while total fabrication demand for gold is on an up move, the total investment demand has been declining. The start of year 2014 has been rough and growth concerns in the emerging markets have taken centre stage.

We believe fears over slowdown in the emerging markets could lead to a modest uptick in investment demand and outflows from ETFs could moderate.

Post the financial meltdown of 2007-08, the main theme was portfolio diversification. And India, China, Russia, Turkey, South Korea, Ukraine, Indonesia and several other countries started buying gold. After the sharp fall in prices, even central banks’ buying pace slowed down in the year 2013.

The interesting thing about the buying trend by central banks is that accumulation has taken place in the last three years when gold prices were on the up move. Due to outflows from the emerging markets and slowdown in the emerging markets, we expect buying by central banks to remain subdued in 2014.

Absence Of Robust Indian Gold Demand Is A Big Concern For Gold Bulls

The Indian rupee also depreciated sharply. This lent support to the Indian gold prices and we saw a mere correction of 8% in Indian gold as compared to 28% on the international bourses in 2013.

In India, gold is still very expensive due to poor availability. Premiums in the domestic markets have also surged sharply owing to the imposition of 10% import duty. The $140/ounce premium makes gold very expensive in India. India’s gold demand has risen five times from 200 tonnes in 1990s to more than 1,000 tonnes in 2012. Prices too have risen ten-fold in the same period in India.

The demand for yellow metal in India will persist mainly due to the billion plus population and social customs that involve the purchase of gold for auspicious occasions irrespective of the price. The emergence of a new class of investors, also comprising rural investors, with an appetite for investment in gold for real returns, adds to the demand, and subsequently to imports.

India’s love for gold is costing the government huge sums of money, which is reflecting in the widening current account deficit. The consistent rise in gold imports over the last five years has led to the deterioration in the balance of payments position, resulting in external sector vulnerability in India.

Policymakers are worried about the widening current account deficit (CAD), which has been compounded by the negligent supply of gold in the country and over 35% growth in value terms since the last four years, creating major problems for the country.

In 2007-08, India imported $16.7 billion worth of gold and in 2012-13* India imported $53.8 billion worth of gold. Large gold imports have led to major concerns in macroeconomic management. The management of demand and supply of gold has important policy implications for fiscal policy and exchange rate management.


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-33.677.3

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Year Official Sector Purchase/ Sale

2007200820092010201120122013

Moderate Pace Of Gold Purchases By Central Banks

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Primarily this surge has been led by high investment demand (35%-40%) on account of high inflation and negative real interest rates at the consumer level. The deterioration in current account deficit due to large gold imports has implications for financing the same.

In this context, a major concern that has emerged is the impact of huge gold imports on external stability as a huge CAD financing gap can potentially reduce foreign exchange reserves and become a drag on external debt. Following these concerns, we have had multiple episodes of sharp rupee depreciation over the last few years.

In view of these concerns, both the government and the Reserve Bank have taken a slew of measures to curb gold demand in FY14. The Indian government raised the import duty on gold to 10%, which was 2% at the start of 2013.

Higher import duty resulted into higher gold prices, scarcity of gold and high premiums in India. Along with that the RBI introduced 80:20 schemes in July, which said that 20% of the imported gold had to be exported back.

The RBI’s measures had the desired impact on the current account deficit with gold imports falling significantly to US $1.2 billion in November ’13. The results are visible as gold imports have declined drastically to $3.9 billion in Q2 FY14 against the average of $16.5 billion in the previous three quarters. Going by the trend, initial estimates indicate FY14 imports are about 500 tonnes compared with imports of 835 tonnes in FY13.

This, coupled with some uptick in exports, will certainly lead to a substantial reduction in India’s CAD for FY14. It is now estimated that FY14 CAD could print below $50 billion from $88 billion in FY13. However, we should be mindful that the ongoing compression in gold imports can’t go on forever. It is high time that the government addresses the domestic structural and policy issues so that savings and other mainstream investment channels, lead to a sustained fall in gold imports.

Smuggling of gold has also become one of the major issues

Source: DGCI&S, RBI & NB Research*

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CAD ($ bn)-1.3-2.3-2.8-2.7-4.2-4.8

CAD As % of GDP 16.720.728.640.556.253.8

Gold Imports ($ bn)1.31.72.12.4

32.8

Gold Imports As % Of GDPItems/Year2007-082008-092009-102010-112011-122012-13*

Gold Imports And Current Account Deficit (CAD)

and gold is now being smuggled from all parts of the border and the government can’t afford this for a longer period. The moment the government eases some of the restrictions and cuts import duty, Indian demand will lend support to international gold prices.

But we don’t see any major relief. Indian demand will remain subdued for one more year and gold bulls will still have to wait one more year for robust Indian demand.

China’s Gold Demand

The silver lining in one of the darkest years in the last decade for gold was Chinese demand. China’s gold output in 2013 rose 6.2% from the previous year to a record high of 428.16 tonnes, making the country the world's biggest producer for the seventh straight year. At the same time Chinese demand rose by more than 40% to become the world’s largest producer and consumer of gold.

From the start of the underperformance in the equity market, low prices of gold and slowdown in the economy are factors responsible for gold demand shooting up in China. China’s robust demand for gold has lent support to the precious metal in year 2013.

In spite of reports that China may be buying gold to diversify its huge foreign exchange reserves, China’s official gold reserves stand at 33.89 million ounces (1,054 tonnes), unchanged since April ’09. So, there is still a huge scope for China’s central bank to accumulate gold.

China’s gold reserves account for 1.2% of its reserves whereas most of the developed world’s gold holding is more than 65% of their foreign exchange reserves. To make yuan fully convertible, China may want to add more gold, which could give support to prices. In the year 2014, we expect investment demand from the yellow metal to remain robust in China due to expectations of slowdown in the economy and demand growth in jewellery not exceeding more than 5% after robust growth in the year 2013.



Non-traditional Factors That Are Important For Determining Outlook Of Gold

US 10 Year Bond Yield US Dollar Index

The US Federal Reserve has launched various quantitative easing programmes, including the bond purchase programme. Till the first half of 2013, robust demand of US treasuries was visible; banks that borrowed money from the Fed invested it in various asset classes including gold. Hence, there were times in the financial markets when equity and gold were seen rallying together.

But gas and oil revolution in the US have got the US economy back on track. Economic reports have started surprising many and once the Federal Reserve hinted at tapering of its bond purchase programme, there was a massive sell off in treasuries, which sent 10-year bond yields to 3% in 2013 from 1.6%.

Investors pulled out their money from safe havens and began investing in riskier assets, which led to a sharp fall in the price of gold. The dollar index started moving up, thus putting more pressure on gold prices. The US economy’s growth is likely to be strong, going forward in 2014. This will send 10-year benchmark bond yields to 3.2% and strengthen the dollar index further.

From the start of the year 2014, the fear of crisis in the emerging markets has led to good demand for US treasuries. However, once it settles, we expect US economic growth to remain strong, which may trigger a sell off in gold prices.

Outlook On Gold

During the first half of 2014, expectations of slowdown in China and likely relaxation of customs duty on gold imports as well as 80:20 schemes in India may boost gold prices in the international markets. Investment demand is likely to remain firm in the first half of the year. But from the second half, we expect US economic recovery to strengthen, leading to a sharp spike in the US dollar.

During the second half of the year we expect producers’ hedging activity to shoot up and investors to take profits in long positions until the outlook of the US economy worsens significantly. It would not be viable for producers to produce gold if it trades below $1,200/ounce. Despite this, we expect gold prices to test $1,100/ounce and our annual outlook on gold remains bearish.

Silver prices have fallen sharply from $32/ounce to $18.50/ounce, a correction of more than 40% in a year. Silver has higher beta than gold; thus in line with correction in gold, silver too crashed in 2013. The major fundamental reasons for correction in silver were massive surplus, diminishing demand prospects and correction in gold prices.

Silver market is in a major surplus since the start of 2012 and it continues to surge. Surplus in silver has been growing at a rapid pace since the start of 2012. The total cash cost of silver mines is expected to be around $9/ounce. But since only 23% total silver production comes from direct silver mines, it’s unimportant.

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SILVER


Source: WBMS, GFMS, World Silver Survey, NB Research




752.744.2

228.5950.41

-1075.95

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191.5653.5399.41

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184.6148.45

118.34908.5

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787.017.36

254.21--

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475.0951.19

192.9947.63

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34.99136.78

1049.14

808.75

218.625

-1057.3

499.748.3

203.949.7

93894.6

-162.7

1057.3

20112010(In Million Oz) 2012 2013F 2014FSupply

Mine ProductionNet Government Sales

Old Silver ScrapProducer Hedging

Implied Net DisinvestmentTotal Supply

DemandIndustrial Applications

PhotographyJewellery

SilverwareCoins And MedalsTotal Fabrication

Producer De-HedgingImplied Net Investment

Total Demand

Demand And Supply

Silver Total Fabrication Demand

Silver Jewellery Demand

Silver Industrial Demand

Silver fabrication demand had peaked in the year 2010 and post that we have seen a sharp decline in 2011 and 2012 due to high prices. But we have seen a gradual recovery in silver fabrication demand in 2013. Manufacturing PMI’s across the globe have been on an up move, leading to recovery in the overall fabrication demand in 2013. We expect moderate recovery in world fabrication demand due to expectation of slowdown in China in 2014.

800820840860880900920940

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ceJewellery demand also inched up in 2013 due to low prices and compression of imports of gold from India. India, China and Middle East saw a spurt in jewellery demand. According to Thomson Reuters GFMS, India imported 4,073 tonnes of silver from January to August, more than double the 1,921 tonnes in the whole of 2012. Due to compression in gold imports, the demand for silver in India has remained strong.

Silver jewellery demand continues to remain strong and going forward in 2014 jewellery demand may remain firm. We may see demand of jewellery fabrication inching up by 6% in 2014.

More than 52% of silver’s total fabrication demand comes from industrial demand. After two years of consecutive fall, industrial demand inched up in the year 2013. Nearly 45% of industrial demand comes from electrical and electronic sector. Also, silver’s usage in chargeable and

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Source: Bloomberg

Holding Of ishares Silver Trust’s Holdings

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esnon-chargeable batteries has been increasing. Further, silver used in solar industry in photovoltaic cells was one of the major demand drivers in 2008. Solar industry consumed 19 million ounces of silver. But in 2012 it consumed over 46 million ounces of silver. This phenomenal rise was one of the major reasons for silver moving up despite increasing surplus.

But post 2012, many governments in Europe cut subsidies, leading to a sharp fall in demand. Photovoltaic demand now constitutes around 6% of silver’s total industrial use. China’s state council has raised its target for solar energy capacity to 35 Gigawatts from 12 Gigawatts in 2012. If China state council meets its target, then we may see a significant rise in demand from the photovoltaic industry.

Nearly 50-55 million ounces of silver is likely to be consumed in solar industry in the year 2014 and a modest uptick in industrial demand should be expected from the developed world. However, Chinese demand, apart from the photovoltaic industry, is likely to remain subdued in the year 2014.

Investment demand has remained strong for silver. When we compare the chart of silver’s largest ETF holdings with gold’s ETF holdings, we realize that despite a massive sell

off in gold ETFs, holding in silver ETFs dropped just by 5%. This was a major aberration in the ETF market. Investments in gold ETFs were robust as compared to silver. Hence, during the sell off we have not seen any sharp drop in holdings in silver ETFs. Going forward, we do not expect any major redemption in silver ETFs but sharp spike in holdings is ruled out for 2014.

Supply

Supply side of silver continues to remain strong and with the recent recovery in prices of zinc, we expect production of silver to move up, going forward. Around 29% of silver production comes from lead and zinc mines. Production from primary silver mines is also expected to move up. Deferral of mining at Pascua Lama and Hycroft leach operation will prevent a further glut in supply.

The silver market was expected to be in surplus of more than 100 million ounces in 2013 and the market has had a major surplus since 2011. A rally in silver prices will be used as a good opportunity to hedge by miners as lag impact of last year’s bear run will continue to haunt producers. The supply side of silver is likely to remain strong in 2014.

OUTLOOK

We see strong floor for silver prices for the year 2014 at $17.5/ounce and the maximum upside is pegged at $22.5-$23/ounce. With the tapering of the bond purchase programme and slowdown in China, we expect silver prices to post moderate gains in the first half of 2014 and if massive wave selling is witnessed in gold during the second half of 2014, then silver can’t be an exception.

The moment silver prices start trading below $18.5/ounce we are going to see buying interest resume from long-term investors and industrial demand may start picking up. We do not expect major crash in silver prices in 2014.

Irrational higher prices may depress demand for natural gas in the coming months

n December ’13, natural gas rose to its highest level due to record low temperatures in Midwest and Eastern parts of the US. Also, in year 2012 and 2013 the annual return of gas was around 12.11% and 26.23%, respectively, which was the highest yearly return in the last six years. The major reason for the sudden rise in the consumption of natural gas is the significant change in the pattern of energy consumption in the US. Earlier coal was the primary I



source for power generation in the US; then slowly natural gas emerged as new and more efficient source of energy and reduced the usage of coal in power generation, which had dominated the energy market for almost 100 years.

A large set of cold outbreaks in the US in the recent winter season has led to record usage of natural gas in heating demand. Storage levels went to the lowest levels not seen in the last five years and may fall further due to the ongoing cold temperatures in major gas consuming regions.

Consumption was high in residential and commercial sectors due to strong heating demand. Record low temperatures were seen in eastern and Midwest parts of the US, which led to production loss due to well freeze-off in parts of the US. On the other hand, production numbers are also at record levels and may maintain the same pace of growth. The average production growth outpaced demand by 0.43 billion cubic feet per day (Bcf/d) in 2013.

The huge growth in production numbers is due to the ongoing exploration of shale oil and gas in the US. Shale gas production has grown a lot recently, posting more than 300 times of growth in 10 years. Higher production growth rate has made the US reconsider its decision on LNG export ban and allow exports of LNG outside the US.

Sources: Reuters, NB Research

Sources: Reuters, NB Research

Supply And Demand

Shale Gas - Total Production

The adjoining chart depicts the supply-demand scenario. The average supply of natural gas overtook demand by 0.42 Bcf/d in 2013. Natural gas demand is purely based on seasonal patterns. The maximum consumption is during the winter season in the US when heating demand in residential and industrial sectors is highest. However, the demand during summer is based on electric power consumption, which has been declining continuously on a year-on-year (y-o-y) basis. The rise in demand during the winter season due to heating demand is offset by poor power demand, resulting into fall in the overall consumption on an annual basis.

Total consumption averaged around 71.31 Bcf/d in line with Energy Information Administration (EIA) expectations of 71.2 Bcf/d. Consumption rose by 1.51 Bcf/d or 2.1% in 2013 as compared to 69.8 Bcf/d in 2012. However, the forecast for demand of natural gas is set to decline by 1.6 Bcf/d or 2.2% in 2014 due to lower natural gas usage by electric power demand. Due to higher natural gas prices, power companies would focus on other sources for power generation in the summer season of 2014.

The total supply of natural gas percentage growth averaged around 2.5% in 2013 and is expected to grow further at an average growth rate of 2.1% in 2014 and 1.3% in 2015.

The exponential growth in production over the years justifies the continuous exploration of shale oil and gas in the US. Shale gas production has shown tremendous growth in the past few years and reached a record level of 28.91 Bcf/d in 2013.

Growing domestic production over the years has helped the US to reduce its pipeline imports from Canada. According to EIA, net imports of gas would fall to 3.0 Bcf/d in 2014 and again to 2.5 Bcf/d in 2015 as compared to 3.5 Bcf/d in 2013, which would be the lowest level since the year 1986.

Also, United States will start exporting gas from 2016 from its various ports. It recently obtained an approval and will be a net exporter of natural gas by 2018.

STATE AND SECTOR CONSUMPTION

The consumption of natural gas varies from state to state in the US. The highest consuming region is Western US, which is around 58% of the total consumption. The consumption in Eastern and Central regions of the US is around 34% and 8%, respectively.

Being the highest consumer in the Western region,

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California consumes approximately 9% of the total demand, while South west’s top consumer Texas consumes around 15%. In eastern region, Florida, New York, Pennsylvania and Alabama are some of the major consumers of natural gas.

Price variation of natural gas is highly dependent on consumption patterns in each region of the US. During the winter season temperatures across regions decide the heating demand across the nation. The year 2013 witnessed record low temperatures in the eastern and Midwest part of the US resulting into more and more consumption of natural gas.

As the Northeast, Southeast and Midwest regions totally account for more than 23.5% of the total demand, colder-than-normal temperatures in these regions helped natural gas stocks to go below five year average storage levels and prices to rise to the levels not seen in the last four years.

Residential and commercial sectors are the highest consuming sectors in winter due to the increased usage of heating demand. Residential demand rose from 7.8 Bcf/d to 26.94 Bcf/d from October ’13 to December ’13 and commercial sector demand rose from 6.75 to 16.14 in the same time frame.

However, power consumption for natural gas generally declines during the winter season due to less power generation. In addition to this, the natural gas usage for power generation in the nation is expected to decline further. Power generation went down to 24.9 Bcf/d in 2012, to 22.3 Bcf/d in 2013 and is expected to go down to 21.7 Bcf/d in 2014.

Further, the demand for natural gas from power sector is expected to slow down during the summer season of 2014. The elevated prices of natural gas would encourage power producers to choose alternative sources of power generation, especially coal.

Power companies prefer gas to generate electricity when prices stay around $3-3.5/Million Metric British Thermal Units (MMbtu) as the rate is competitive with other sources of electricity. However, the severe winter season in the US this year has forced gas prices to higher levels, which is discouraging for power generators. Power companies would prefer coal this summer rather than gas to generate electricity as this is the most common and feasible alternative, pressurizing the natural gas market.

Source: EIA, NB Research

Power Generation Sources

The three major sources for electricity generation in the US are coal, nuclear and natural gas. Earlier coal was considered to be the primary source of electricity generation, which accounted for more than 80% of the total share in power generation. However, slowly nuclear and natural gas power plants came into the picture due to their low raw material and maintenance costs.

The adjoining charts depict the overall change in consumption pattern for electricity generation in the US. Natural gas power plants overtook nuclear as well as coal plants since 2006 till date due to their low maintenance costs. However, the percentage share of these sources keeps changing depending on the price movement of the underlying commodity.

Depending on price movements power generating companies keep on shifting from natural gas to coal to nuclear energy for power generation to minimize their cost of production. The most common shift is from coal to gas and vice versa every year depending on price movements.

The percentage share of coal in power generation dropped from 48% to 38% from 2008 to 2013. On the other hand, the share of natural gas went up from 21% to 30% in the same period. The main reason for the sudden surge in natural gas usage for power generation by companies is the depressed price of the commodity since several years. The phenomenal rise in the production of shale oil and gas in the United States has helped keep prices under pressure, making natural gas more efficient and cost-effective for generating power.

Further, due to high maintenance costs, many coal plants are expected to retire in the coming years and due to higher construction many producers are shifting to natural gas power plants permanently.

In the coming years, we believe that more and more power

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average around 1.3 Tcf by the end of March ’13, the lowest level seen in the last four years.

OUTLOOK

Year 2013 brought some major turnaround in the natural gas market. Till the first half of the year the natural gas market was struggling with higher production numbers and not-so-impressive demand. Storage levels also reached close to the highs of five-year average levels. Slower natural gas consumption from the power sector during the summer season of 2013 also kept the market for natural gas under pressure.

However, late in the second half the US faced some extraordinary colder temperatures across the eastern, central and Midwest regions, which spurred increased consumption of natural gas as winter season in the US is the peak demand season due to higher heating demand in residential as well as commercial sectors.

Record low temperature in the US this winter has forced the total stocks to fall below the five-year average. And as the US government does not have any strategic reserves for natural gas, prices shot up drastically in the spot as well as the futures market.

Further, we believe the natural gas market may see some downturn in the first half of 2014 due to the seasonal low demand. Also, in the summer season we expect power companies to prefer other sources for power generation rather than natural gas as current prices are too expensive. Also, we expect natural gas production to ramp-up in the coming months as record high prices may encourage many producers to come back and produce more of it. This would eventually build-up inventory levels again, eliminating the fear of supply tightness in natural gas.

However, as weather plays the most important role in the gas market, we may see a surge in gas prices again in the fourth quarter of 2014 with the arrival of the winter season in the US.

companies would be shifting to natural gas-based power plants and the record pace of shale gas production would help keep gas prices feasible and competitive as compared to other sources of energy needed for power generation.

However, EIA expects the percentage share of natural-gas-fired generation out of the total generation to be around 26.8%, down from 27.5% in 2013 due to the surge in natural gas prices.

In contrast, the share of generation fuelled by coal will increase from 39.1% in 2013 to 40.2% in 2014. Further, the share is expected to balance in the near future with record levels of natural gas production and retirements of coal power plants, starting 2015. EIA expects the share of coal to fall to 38.6% of the total generation. Similarly, it expects the share of natural gas to rise back to 27.6% in 2015.

STOCKS SCENARIO

As discussed above, the latest cold outbreaks in the US this winter season have caused natural gas storage levels to fall below the five-year average. Storage levels are segregated into three major regions - the consuming east, the consuming west and the producing region.

The lowest temperatures recorded this winter season in the US were in the Northeast, Southeast and Midwest regions. In fact, temperatures fell to their lowest levels not seen in a decade. Due to this, major withdrawals of natural gas stocks took place in the Eastern part of the US.

Natural gas stocks went below five-year storage levels and were the highest in the east region of the US. Current storage levels stood at 2.1 trillion cubic feet (Tcf) in January ’14, with the recent withdrawal of 230 Bcf exceeding the five-year average.

Further, colder-than-normal temperatures in February ’14 would result in higher heating demand, prompting larger-than-normal withdrawals, and the highest withdrawal on record. EIA expects the storage level to

Higher supply may overtake demand for

crude oil in the near future with shale

evolution replacing it as the preferred

commodity among global economies

lobal supply of crude oil is constantly rising year on year. From around 85.35 million barrels per day (mbpd) in 2008, global oil supply averaged to around 89.92 mbpd by the end of 2013, rising by almost 53,000 bpd or 0.59% compared to 2012.

The sharp increase in production numbers was mainly achieved by the US, which was the main contributor as the domestic production in the nation reached record highs. Further, shale evolution, which is underway in the US, has resulted in these higher production numbers.

On the other hand, global demand has not been so impressive. The US, which used to be the top consumer of crude oil, has cut down its oil imports significantly in the recent past. The enduring economic worries in Europe and China’s slowing economic conditions are taking a toll on the demand for crude oil. The pace of China’s oil demand growth appears to be slowing as its economy is struggling with slower growth across sectors.

G

Source: Reuters, EIA, NB Research

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3.1284.77-0.93

200985.35-1.1885.57

2008MBpD 2012 2013 2014(f)Total World Supply% ChangeTotal World Demand% Change

Crude Oil Demand-Supply



non-OECD demand for oil witnessed a growth on the back of increased demand from emerging economies. On the other hand, the demand for crude oil from developed economies has been falling constantly.

According to Energy Information Agency (EIA), the demand from developed economies continues to see a declining trend. The demand for crude oil from OECD nations showed a marginal growth of 0.3% and stood at 46.05 mbpd in 2013 as compared to 45.91 mbpd in 2012.

However, demand from non-OECD nations grew much faster than OECD nations, the demand rose by 2.4% in 2013 and stood at 45.61 mbpd as compared to 44.33 mbpd in 2012. The strong growth in oil consumption was mainly due to higher demand from China, which rose from 10.5 mbpd in 2012 to 11.1 mbpd in 2013.

Further, supply from both OECD and non-OECD nations is expected to rise; as shale exploration in the US, expanding tar sand oil production in Canada, resuming oil production in Libya and Iran and other members maintaining their production at a constant rate would definitely push crude oil production to new highs in the years to come.

The demand is expected to fall in 2014 in both OECD and non-OECD nations as the demand is expected to fall from Asia as well as from developed nations. We expect the same trend to continue in developed nations as global growth is likely to remain slow.

Also, the demand from Asian economies in 2013 was not as impressive as expected. We believe that crude oil demand from non-OECD nations will remain soft in the second and third quarters of 2014 on account of the ongoing slowdown in the global economies.

MAJOR OIL PRODUCERS

UNITED STATES (US)

The US, known as the top importer of crude oil, has shown drastic improvement in its domestic production of oil. Oil production in the US rose from 5 mbpd in 2008 to 8 mbpd in 2013, the most significant increase seen till now. It stood at a record high level of around 8.1 mbpd in December ’13, a level not seen in the last five years.

The extraordinary rise in crude oil production in the US is largely due to the introduction of hydraulic fracturing and vertical drilling, a new method of exploring oil and gas from shale formations.

Continued production growth from US tight oil formations and Canadian oil sands have helped the US to reduce its reliance on oil imports. The US is also expected to cut down on imports of crude oil to virtually zero if the pace of shale oil and gas production growth keeps rising and the demand for crude oil continues to decrease further in future in the nation.

Changes in the demand and supply equation would be felt from the second quarter of 2014 as seasonal demand generally ends in the US and Europe by that time.

OECD AND NON-OECD DEMAND AND SUPPLY

Supply from Organization for Economic Cooperation and Development (OECD) nations has been rising continuously, reaching the highs of 25.15 mbpd in 2013 as compared to 23.78 mbpd in 2012 and 22.5 mbpd in 2011. Supply grew by almost 5.5% on an annual basis. The constant rise in production numbers is due to the outstanding oil output growth from the US and Canada.

The robust oil production from both the nations is due to the exploration of non-conventional tight oil and tar sands production. Owing to the rising oil production in the US and Canada, the decline in oil production from North Sea (UK and Norway) holds neutral impact on the total output. Mexico, one of the other major OECD producers has managed stable oil production of approximately 2.6 mbpd for three years.

However, non-OECD oil production declined by almost 1% in 2013 and stood at 66.14 mbpd when compared to 66.84 mbpd in 2012. Major supply drop was felt from OPEC nations, with total output declining by 0.8 mbpd in 2013 as compared to 2012. OPEC nations’ total output fell from 36.68 mbpd in 2012 to 35.79 in 2013.

The major loss came from Libya and Iran due to economic instability in their respective nations. On the contrary, China and other non-OECD members are continuously posting a rise in their oil production.

The ongoing slowdown in major oil consuming nations in 2014 has led to a reduction in the overall demand for crude oil. Oil demand from OECD countries has declined for the fifth time in the past six years and continues to follow the same trend. The continuing crisis in Europe, the struggling economy of China and higher domestic production in the US has resulted in lower demand for oil.

Our prediction that non-OECD oil demand would remain higher than OECD demand in the first half of 2013. In fact,


The production is set to rise further by 63,000 barrels per day (bpd) in February ’14 and another 64,000 bpd in March ’14 according to the recent forecast by ELA. Oil production in the US will reach 10-11 mbpd in the year 2020, if the production keeps rising at the same pace, according to the EIA.

CANADA

Canadian oil production has been rising steadily since 2008. It currently stands at more than 3 mbpd and is expected to maintain the same pace of oil production in the near future also. Eastern and Western Canada are the two sources of Canadian oil output. Eastern Canada contributes about 6% of the total Canadian crude oil production, that is, 2,02,000 bpd. Western Canada on the other hand accounts for 3 mbpd, combining conventional and oil sands’ total production.

In 2013, total Canadian production increased to 3.6 mbpd in the month of December as compared to 3.31 mbpd in December ’12, an increase of 5,00,000 bpd. The rapid growth in overall production numbers in Canada is mainly coming from tar sands, which contributed around 1.8-2 mbpd. Tar sands production depends on cheap availability of natural gas. As long as cheap natural gas is available, Canadian oil production will continue to grow.

Canadian crude oil production is expected to double to nearly 6.7 mbpd by 2030, which stood at around 3.6 mbpd in December ’13. Of this, tar sands production will be nearly 5.2 mbpd by 2030, up from 1.8 mbpd in 2012. The rapid growth in oil sands and conventional oil production in Canada continues to strengthen the nation’s position as a preferred supplier of crude oil to North American and global energy markets.

MEXICO

Crude oil production from Mexico, which had fallen steeply due to the lack of technology and expertise, has been arrested since 2009, with the introduction of new techniques for oil exploration.

Mexico’s crude oil production stands at around 2.56 mbpd in December ’13, which is same as the production in 2012. However, new energy reforms could change the future of the nation’s crude oil production. Under new reforms, the government proposes to allow foreign investment in Mexico’s oil sector. And the other option it is contemplating is complete privatization of the oil sector.

Mexico has huge oil reserves under water. However,

currently the nation does not have the technology to undertake deep water exploration, for which alliance with the private sector is essential. The government is now planning to privatize its biggest oil company, Pemex, and allow foreign investment to enhance technology for underwater drilling for oil exploration.

However, crude oil will still remain with Mexico. This step would definitely help Mexico to ramp up the country’s production at a higher pace.

NORTH DAKOTA

North Dakota holds a place of significance in the rising US oil output. Rising North Dakota production led to an increase in the overall oil output in the US.

The state’s extraordinary oil production has helped achieve levels of 0.92 million barrels per day in December ’13 as compared to 0.77 mbpd in December ’12. Production rose by almost 3% in 2013 when compared with the production levels at the same period in 2012.

OPEC AND NON-OPEC PRODUCTION

The overall production of crude oil from OPEC and non-OPEC nations has been rising continuously at a higher pace. However, non-OPEC oil production growth rate has outpaced OPEC production growth rate in 2013.

Non-OPEC production grew by 6% and stood at 55.29 in December ’13 as compared to the same period in 2012, whereas OPEC production fell by 3.2% and stood at 29.63 mbpd in December ’13 as compared to December ’12.

The main reason for the surge in non-OPEC oil production is the rise in oil production in the US and Canada. Further, International Energy Agency (IEA) expects non-OPEC oil production to rise to 59.3 mbpd by 2018 from 55.3 in December ’13. The US will contribute around 2.3 mbpd to non-OPEC production, which is nearly half of the total non-OPEC production.

OPEC production stood around 29.63 mbpd in December ’13, which is lower than the oil production quota agreed in the last meeting, that is, in December ’13. The loss in production was mainly due to supply loss from Libya, Saudi Arabia and Iran in the last quarter of 2013.

However, the yearly average is still above the OPEC’s agreed quota and stood at 30.15 mbpd. Further, in 2014, OPEC production is expected to rise again with the three members ramping up their production.


sanctions on the nation and thus generate further revenue for the growth of the country as the nation is totally dependent on revenue from oil exports. Oil production in Iraq too has been rising at a pretty decent rate. Oil production was around 3 mbpd in 2013, 9.8% higher than production levels in January ’12. According to sources in the Iraqi government, the nation’s oil production is expected to jump to 4.5 mbpd by the end of 2014, 45% higher than the current oil production.

Production rise from other members of the nation, including the nations discussed above, would neutralize the small fall in the output from Saudi Arabia. Further, OPEC production is set to rise in 2014 with the help of all other members producing higher oil output.

NORTH SEA OIL AND NORTH SEA LOADINGS

Both North Sea oil production and loadings have been declining since years. The average oil production in North Sea stood at 2.53 mbpd in 2013 as compared to 2.56 mbpd in 2012, a decline of 1.18% approximately. Oil production in North Sea rebounded in the fourth quarter of 2013, rising by almost 9%.

However, oil production saw almost 41% decline compared to the highs of five year average production. One of the main causes for the decline in production numbers is the slowing of drilling activity. Oil exploration through drilling dropped by almost 50% compared with 2010 levels. North Sea is losing its role as the world’s leading oil producer as major oil fields in the North Sea are witnessing a decline in production.

Due to falling oil production, North Sea oil loadings are also falling simultaneously. Loadings dropped by more than 7% on an average in 2013 as compared to the yearly average in 2012. However, with the rising oil production in Q4 2013, North Sea oil loadings also rose from 1.7 mbpd to 2 mbpd in December ’13. Further, North Sea oil production as well as oil loadings is expected to decline on an average basis in the coming years due to the lack of drilling activities and less technology with cyclical upturn and downturn in production numbers due to fields going under maintenance on a periodic basis.

RUSSIA

Russia, the top producer of oil, has constantly shown a year-on-year (y-o-y) increase in oil output. The production was around 10.56 mbpd on an average in 2013, up by 2% when compared to 10.37 mbpd in 2012. Recently, Russian oil production reached an all-time high of 10.8 mbpd in the

Libya faced a drastic fall in its oil production due to the various ports and oil field strikes, disrupting oil production. Production fell to almost 0.2 mbpd, becoming almost neutral. Libya produced around 0.25 mbpd in December ’13, dropping by more than 1 mbpd as compared to December ’12 when the production was around 1.43 mbpd.

However, production rebounded in the first month of 2014 from the lows seen in 2013 and stood at 0.55 mbpd. Further, the production is expected to ramp up and is expected to scale around 1.7-1.8 mbpd, close to its pre-war levels in the second half of 2014.

Crude oil production from Iran and Saudi Arabia also fell by close to 0.3 mbpd and stood at 2.7 and 9.7 mbpd, respectively. Production from Iran continuously declined after the US government enforced various sanctions on the nation to halt the ongoing nuclear programme.

However, in the last quarter of 2013, some relief came when the US and Iran finally reached a deal. The fall in production became slow after that. However, Iran’s production is expected to jump in 2014 due to less

Libya Vs Iran

OPEC Nation’s Output

Saudi Arabia Vs Iraq

Source: Reuters, Bloomberg, NB Research

Source: Reuters, Bloomberg, NB Research

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month of December ’13. Further, oil production in Russia is expected to rise in the near future with the help of increased exploration of new oil fields.

The nation has achieved higher production numbers by applying advanced technology like hydraulic fracturing and horizontal drilling, mainly used by the US for such activities. This has helped Russia to tap oil reserves, which were unreachable previously. Also, new techniques have helped increase production rates in oil fields that were witnessing a decline earlier.

NORWAY

Oil production in Norway too has been declining steadily, although not as fast as the drop in the overall North Sea production. Norway’s crude oil production fell 9.6% in September ’13 to 1.4 mbpd, down from 1.55 mbpd in August ’13. However, production was up 7% in September ’13 when compared to the same period in 2012. Further, it is expected that in the near future Norway would ramp up its oil production with the help of new prospective oil fields, which have not been explored yet and contain more than half of the oil reserves.

SHALE OIL PRODUCTION

Total Crude Oil And Shale Oil Production Major Importers

Total OECD And Non-OECD DemandTight Oil By Geographic Formation

Source: EIA, NB Research Source: Reuters, Bloomberg, NB Research

Source: Reuters, Bloomberg, NB ResearchSource: EIA, NB Research

US shale oil production has also been rising constantly with the implementation of new techniques such as hydraulic fracturing and horizontal drilling. There are huge shale deposits outside North America, which American companies and the government are trying to tap and convert into shale oil and natural gas to boost the energy industry. Basically, shale oil is defined as unconventional oil extracted from shale formations. Earlier, shale oil used to be extracted through vertical drilling. However, now with the introduction of improved hydraulic fracturing and horizontal drilling, exploration of shale oil has become much more feasible.

The current US shale oil production stands at around 8.13 mbpd at the end of 2013, up almost 21% on a year-on-year (y-o-y) basis, which is nothing less than extraordinary. This continuous rise in output data confirms the strong production growth in the US. Out of the total oil production, shale oil output contributes more than 40% of oil and the major contributing geographic regions in the US are Bakken and Eagle Ford. Shale oil production has been rising since 2009, the highest level since 1990. It is expected to reach 11 mbpd by 2020 and the US could become the net exporter of oil.

MAJOR OIL IMPORTERS

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Oil Demand in Non-OECD na ons surpassed the demand of OECD na ons for the rst me in history. m

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Crude oil imports from all major economies have shown lower-than-expected growth in 2013. There are several factors responsible for reduced oil imports from these economies. Major among them could be the slowdown in the overall economic growth. Also, continuous higher domestic oil production across developed economies could be attributed to the same.

The best example is the US whose domestic oil production has reduced its dependency on oil imports. The US, which is believed to be the net importer of crude oil, recently reported a record high domestic oil production. Oil production in the US surpassed imports for the first time since 1997 and stood at 8.1 mbpd 2013 on the back of rising shale oil plays.

The increase in oil production in the US has resulted in reduced volume of the nation’s oil imports. In addition to this, rising oil production from North Dakota, through the use of hydraulic fracturing and horizontal drilling techniques, is helping the US to reduce its dependency on crude oil imports. In December ’13, the overall US oil production outpaced oil imports by 1.2 mbpd.

For the first time in history, the demand from non-OECD nations has outpaced demand from OECD nations. Among the non-OECD nations in Asia, China was the leading contributor in the first half of 2013 in achieving the projected consumption growth. On the other hand, OECD demand growth softened, coupled with slower economic growth and higher domestic production.

However, the pace of oil imports from Asian nations is slowing as economies are struggling due to the slowdown in global economic growth. Oil imports from Asian countries grew at a lesser-than-expected rate and would fall in the first half of 2014 due to unseasonal lower demand and other economic woes.

CHINA AND JAPAN Q-O-Q GROWTH

% Change In Demand Growth In China (Q-o-Q)

% Change In Demand Growth In Japan (Q-o-Q)



China, the biggest Asian buyer of crude oil, has witnessed a sharp contraction in oil imports since the first half of 2013. China bought an average of 5.62 mbpd of crude oil in the first quarter of 2013, 2.2% lower than the first quarter of 2012 when imports averaged 5.75 mbpd.

Further, the country’s oil imports are expected to drift lower as the recent economic slowdown will hit oil demand. Also, China is planning to increase oil production in its own country to cut down on its dependency on other oil producing nations.

Japan, the second largest buyer of oil among Asian nations, had been importing less oil since the start of 2013, except for the last quarter of 2013. However, oil imports fell 1.2% on average basis in 2013 as compared to average imports of 2012.

The Fukushima nuclear disaster of 2011 due to the 9 magnitude earthquake and tsunami significantly disrupted oil imports by Japan and increased the need for gas-fired power output as only two of the nation’s 50 nuclear reactors are operational at present.

In the near future, we expect oil demand from China and Japan to remain low as upsides are likely to be temporary owing to the overall slowdown in these economies.

CRUDE OIL AND CUSHING INVENTORIES

Total oil stocks in the US too felt the heat of rising oil production in the nation. Oil inventories touched an 82-year high in May ’13 as the nation’s production remained at an all-time high.

However, in the last quarter of 2014, overall stocks declined and stood near the five year average as record low temperatures in the US increased fuel consumption for heating demand.

Oil stocks held at Cushing declined drastically in the

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second half of 2013 as the US government partially approved the TransCanada pipeline project. Already three phases of the pipeline have got approval and the fourth one is awaiting approval.

The first two phases that were approved last year have a total capacity to transport 5,90,000 bpd of oil into the Midwest refineries.

The third phase, which got approved recently and started operating in January ’14, has the capacity to transport 70,000 bpd.

The last phase awaiting approval could add up to 3,00,000 bpd more capacity to the total transportation of oil. However, the total flow of oil by the end of 2014 is expected to reach 8,30,000 bdp of oil. GASOLINE AND DISTILLATE STOCKS

Every year, during the winter season in the US, the demand for crude oil as well as gasoline and distillate comes into the market. Also, overall stocks, which generally build during the autumn season due to dim demand and scheduled maintenance, start reducing.

The year 2013, which experienced the coldest weather in the US, brought gasoline as well as distillate stock levels lower. Gasoline stocks stood at 221 mb in December ’13 lower than the highs of five-year average stock levels. Distillate stocks, due to higher consumption, fell to 119 mb in December ’13 equaling the lows of five-year average.

However, once the winter season demand vanishes from the market, overall stocks except Cushing where stock levels are expected to go down because of TransCanada pipeline are expected to rise again due to lower demand and ample supply available in the market.

OUTLOOK

Crude oil market is expected to remain under pressure throughout 2014 considering the robust supply growth and a slower pick-up in demand.

We expect healthy supply to continue from both OECD and non-OECD nations, with China and the US being the largest contributors. Further, OPEC is also expected to ramp-up production with rising oil production by Libya, Iran and Iraq.

However, demand from all major consuming nations is set to fall in the second and third quarter of 2014 owing to

slowdown in macroeconomic conditions.

Further, we believe that the ongoing slowdown in the global economy would pressurize the West Texas Intermediate (WTI) as well as Brent oil prices in the late first half and early second half of 2014.

Note

IN A SEARCH OF THE RIGHT CRUDE OIL BENCHMARK

On the electronic exchange, most liquid contracts are WTI crude oil and Brent crude oil on NYMEX and ICE, respectively. Brent is the leading global price benchmark for Atlantic basin crude oils. It is used to price two thirds of the world’s internationally traded crude oil supplies. Brent crude is sourced from North Sea and comprises of Brent blend, Forties, Oseberg and Ekofisk (BFOE).

BFOE crude oil production has fallen by more than 60% in the last eight years, that is, over 7% per year from around 1.8 mbpd to 0.75 mbpd and two thirds of international suppliers of crude oil consider Brent crude oil (BFOE) as their benchmark.

If production of BFOE is declining gradually every year and now it does not consist even 1% of global supply, it should not be Benchmark for other oil producers as fundamentals of BFOE are not reflecting the global demand and supply of crude oil.

In spite of exponential surge in supply of crude oil and slowdown in China in 2013, crude oil prices did not correct the way they should have. International commodity exchanges can play a major role in creating the right benchmark for crude oil.

For example, DME Oman is the third of the three global crude oil benchmarks and is the most relevant to the rapidly growing East of Suez market since it is the only contract which truly reflects the economics of the Middle East and Asia. Significantly, 40% of crude traded on this exchange goes to China.

Apart from being the world’s largest physically delivered crude oil futures contract with 13 to 15 million barrels of oil delivered each month, the DME Oman also sets the export price of crude oil produced in Oman and Dubai.

There is a need for right benchmark and prices of Brent crude oil does not reflect the true demand and supply scenario of the global crude markeT.

Mr Samir Shah joined NCDEX on 1st Mar ’13, initially as the Deputy CEO and has now been designated as the MD and CEO.

Just before that Mr Shah was the Chief Business Officer of the Dubai Gold and Commodities Exchange (DGCX).

At DGCX he led the growth of the exchange to make it one of the fastest growing exchanges in the world, winning several awards; amongst them were Contract of the Year and the Best Commodity Exchange in 2012.

Shah has two decades of experience in building institutions and market infrastructure. Prior to joining DGCX, he was the CEO of Mumbai-based Universal Commodities Exchange (UCX).

Prior to this, Shah worked at the global information company Thomson Reuters for 17 years. In 2010, he was appointed as the Global Head of Business Planning and Operations for a new inside-Sales unit at Thomson Reuters called Direct.

In 2009, as the Head of Business Operations for Thomson Reuters Asia and a member of the Asian Leadership Team based in Singapore, he successfully transformed the

Mr Samir ShahManaging Director and CEONational Commodity & Derivatives Exchange Ltd(NCDEX)

Following a crisis year, there are early positive signs that can usher in a lot of opportunities for growth ahead.”



business to focus on customer needs.

In 2006, Shah led Reuters’ India operations as the Managing Director for Reuters in South Asia. In this position, he doubled revenue, integrated the Indian Quotation Systems business and merged the India operations of Thomson into Thomson Reuters.

In his previous roles, he led the Treasury and Fixed Income Business for Reuters Asia, and partnered with large global market makers to launch RTFX and RTFI, the dealer-customer FX and Fixed Income Trading Systems in Asia.

Prior to that, as Head of Sales for ASEAN and South Asia for Reuters, Shah developed trusted relationships with several large banking customers, helping them in areas of trading systems, Risk Management, and Foreign Exchange pricing.

Shah began his career as an investment banker in Mumbai, helping companies unlock value through public offerings and buy-out deals.

He is an MBA in Finance, a Mechanical Engineer and has completed an Advanced Management Program from Wharton.

Mr Samir Shah charts out the growth prospects of the commodity industry and discusses the initiatives NCDEX plans to undertake to encourage maximum investor participation in this asset class in an exclusive interview with Beyond Market.

Q. What is the role of a well-developed commodities futures market in a developing

country like India?

Developing countries like India, given their vast population and poverty levels, face challenges in production, processing and marketing of agri commodities. Despite huge employment opportunities, the sector witnesses poor realization and low investment. The advent of futures trading in agri commodities addresses these issues through fair and transparent price signals and there is much consensus that futures trading has transformed and strengthened agriculture in rural India.

The case of guar, which is India’s largest agri export commodity, is a good example in this context where farmers took cues from futures price information and growing export demand and changed their cropping pattern.

Taking a cue from lucrative prices, farmers in various other states like Andhra Pradesh, Madhya Pradesh and Tamil Nadu have started growing guar.

Q. 2013 hasn’t been great for Indian commodities futures market due to many reasons like crisis in NSEL, commodities transaction tax, etc, following which volumes and confidence have both taken a hit. What is in store for commodities market participants in the future?

Last year was indeed challenging for commodities, both globally and domestically.

However, 2014 has opened on a positive note with the launch of our pioneering GOLD and SILVER HEDGE contracts, which are actually promoting financialization

of bullion in India, which is an initiative in sync with the current RBI stance.

We have also launched smaller innovative contracts in chana and castor and reintroduced steel long futures with modifications.

We have also developed and implemented COMTRACK®, the unique commodity accounting system in the country, which is expected to play a pivotal role in enhancing the commodity markets spectrum in India.

Further, there are market reforms initiated by FMC granting continuous approval for trading in futures. It has allowed commodity exchanges to impose different transaction charges for contracts. Following a crisis year, these are all early positive signs that can usher in a lot of opportunities for growth ahead.

Q. What according to you are the major problems that investors face today while trading in commodities futures and what needs to be done to address them?

The degree of awareness about commodity futures is poor and it requires massive investment towards capacity building to develop knowledge and understanding.

Poor liquidity is another problem, which needs urgent attention of the regulator with reforms in the Settlement Guarantee Fund, position limits and daily price limits.

Warehousing is another area that requires reform and investments in capacity building. Further, high margins are driving investors into


dabba trading and measures need to be taken to prevent such practices.

Another major challenge is enhancing market participation effectively by introducing innovative products and attracting participation of different players, coupled with the passing of the proposed Forward Contracts Regulation Amendment (FCRA) Bill.

Strong regulation is also essential for the development of the market as FCRA seeks to strengthen FMC with necessary infrastructure and powers.

Also, our physical markets are fragmented, leading to poor price discovery and poor convergence and demand our prime attention.

Mandi Modernization pioneered by NCDEX Spot Exchange goes a long way in integrating primary markets. On the taxation front, early introduction of GST would help in providing a unified market platform to investors.

Q. Don’t you think there is an urgent need for a well-developed spot market in the country? If yes, why? We will be glad if you could share how NCDEX spot exchange will play a crucial role for market participants and what are your plans for NSPOT?

Yes. Spot markets in India are fragmented, inefficient and opaque. Efficient spot markets enable effective price discovery and price risk management on the futures platform.

NSPOT attempts to integrate markets through a technology platform that offers modern market tools of trading, assaying,

warehousing, procurement, etc. We have very recently launched Unified Market Platform (UMP) in Karnataka in partnership with the state government, which has created a state-wide market place. Going forward, we want to create a nation-wide market place for commodities in India.

Q. What is your opinion on allowing portfolio management services in the Indian commodities market and opening up this market to banks and various financial institutions?

Participation of financial institutions such as banks in the commodity derivatives market will not only add to the depth and width of the market, but also provide huge benefits to market participants. Banks’ participation in the commodity markets will help them better manage their own risks arising from financing of agriculture.

Q. We have not seen any new agro commodities being introduced for trading since a long time. There are many commodities which can be launched on the futures platform. Are you planning to launch any new agro commodities on the futures platform?

We have introduced trading in crude palm oil and cotton seed in the last 3 months and have also introduced innovative products like CHANA1MT and CASTOR1MT last week. Going forward, we intend to introduce trading in tur, urad and rice.

Q. NCDEX has launched GOLDHEDGE and SILVERHEDGE contracts.

Please explain how this contract will help traders and investors who are dealing in bullions? GOLDHEDGE and SILVERHEDGE are very useful, simple and relevant contracts launched by NCDEX. These are effective hedging and risk management tools for importers, traders, jewellers and exporters.

The contracts are the closest in terms of harmony with international bullion prices and allow cost effective trading and are designed as intention-matching contracts where delivery occurs when a buyer and seller decide on price and location in advance. Hence, they are a definite step forward towards RBI’s goal of financialization of bullion.

Q. What initiative is NCDEX taking in the area of investor education and awareness about the commodities market?

Our joint awareness programmes with Forward Markets Commission (FMC) and location-based programmes and workshops help create awareness among farmers/aggregators and other potential hedgers about the economic functions and benefits of the commodity futures market.

Such programmes are designed to meet specific requirements of each category of participants and emphasizes on the utility of markets and educate participants on how to participate in the commodities market.

We also do investor awareness campaigns under NCDEX Investor (Client) Protection Fund Trust through TV channels, mainline financials, regional dailies, magazines, web portals, etC.

Surplus shrinkage and high raw material costs support nickel prices from a near-term

DownsideLimitedIn Nickel



ickel prices have continuously generated negative returns since year 2011. Prices ended in the negative territory, showing 18% fall in 2012-13. Prices declined the most in 2011 on

the back of rising global production, including increase in Chinese NPI production and record high inventories.

DEMAND-SUPPLY OF NICKEL

The nickel market has remained in surplus since the year 2011. During the January-November period of 2013, globally nickel has been in surplus of 1,80,000 tonnes, which is double the surplus from the corresponding period in the year 2012. The surplus has increased due to slowing global demand from the stainless steel sector and due to rising global nickel production as well as Chinese nickel pig iron production.

On the supply side, the global nickel mine production is expected to rise by 8% to 2 million tonnes in 2013 as new nickel projects are coming on stream. In 2014, we forecast the global nickel mine production to grow by 4.2% to 2.15 million tonnes. The global primary nickel production is expected to increase by 6% to 1.87 million tonnes in 2013 although we may see production cuts coming from Indonesia as the country introduced a ban on mineral ore exports from 12th Jan ’14.

From the demand side, the global nickel consumption is expected to increase by 4% to 1.7 million tonnes in 2013 and rise by 5.65% in 2014. The increase in nickel consumption in 2012 was driven primarily by strong 14.2% growth in stainless steel output in China. World stainless steel production set a new record of 35.4 metric tonnes in 2012, up 5.2% from the previous year, according to the International Stainless Steel Forum.

From a long-term perspective, we believe nickel is likely to remain in surplus during 2014. However, the surplus may shrink from 0.15 million tonnes in 2013 to 0.12 million tonnes in 2014 as we see Chinese NPI production slowing after Indonesia bans its export of nickel ore, a substitute to the refined metal used for the production of stainless steel.

INDONESIA EXPORT BAN TO BOOST CHINA’S DEMAND FOR REFINED NICKEL

Indonesia implemented the ban on the export of unprocessed mineral ore such as nickel and bauxite ore on 12th Jan ’14 and wants miners to build smelters/refineries and process ore before exporting to boost the value of country exports. The island nation has no plan to change

N


Chinese Nickel Ore Imports And Chinese NPI Production

the nickel ore export rule, said the country’s Energy and Minerals Minister.

Indonesia’s nickel ore production may drop to 3.5 million tonnes in the year 2014 from 60 million tonnes in 2013 said the Energy and Mineral Resources Ministry due to the export ban. Further, we may see slow production growth in global nickel mined production on expectations that Indonesia may curtail the nickel mine supply.

Indonesia is also one of the largest exporters of nickel ore to China and Japan. Indonesia exported about 41.5 million tonnes of nickel ore in the first nine months of 2013, up from 29.4 million tonnes a year earlier, sourced by the World Bureau of Metal Statistics. Indonesian regulations on ore exports will affect the export of nickel ore, indirectly hurting the NPI production in China.

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China has rapidly increased its NPI production from 95,000 tonnes in 2009 to 4,80,000 tonnes in 2013. Chinese NPI accounts for about 25% of world nickel mine supply of 1.92 million tonnes in the year 2013. China NPI has largely replaced other nickel materials like refined nickel, scrap, ferro-nickel, etc and accounted 50% to the Chinese stainless steel production.

China nickel consumption is around 8,38,000 tonnes per year, which means nearly 50% of global nickel consumption comes from Chinese nickel pig iron production. Chinese nickel pig iron production is expected to remain firm till the second quarter of 2014 as the country has stockpiled huge nickel ore ahead of the Indonesian export ban, which is expected to last for the next six months. China NPI would slow down significantly in the second half of the year due to unavailability of nickel ore, a raw material for producing NPI, pushing the cost of NPI in China.

Indonesia and Philippines are the key sources of laterite ore


for Chinese NPI producers. We expect the demand for nickel to increase on account of rising demand from the stainless steel industry. China’s import of nickel ore and concentrates from Indonesia, the Philippines and Australia accumulatively amounted to 64.71 million tonnes, up 12% from a year earlier.

On 12th Jan ’14, Indonesia officially announced an export ban on mineral ore including nickel and bauxite, a move which will shrink the supply of laterite nickel ore in China, while pushing nickel prices up.

Around 90% of Chinese nickel ore imports come from Indonesia and Philippines. During the year 2013, Chinese imports from Indonesia have risen considerably from 3.98 million tonnes in January ’13 to 6.12 million tonnes in January ’14 while imports from Philippines have increased only 16% during the year 2013. This increase in nickel ore imports from Indonesia is much ahead of the country’s export ban.



China’s Nickel Production And Chinese Imports

LME Inventory And Cancelled Warrants

reaching 2,61,600 tonnes in January ’14.

Going forward, with the Indonesia export ban in place, we believe inventories would start falling in 2014, providing upward pressure to nickel prices.

Cancelled warrants have remained on the rise and it currently stands at 1,05,000 tonnes or 40% of the total LME stocks, suggesting the amount of inventory actually marked for delivery.

MINE DEVELOPMENTS

Anglo American’s Barro Alto nickel plant in Brazil is expected to increase its production, Glencore Xstrata in New Caledonia has started commissioning at its ferro-nickel plant capacity of 60,000 tonnes per year and Vale’s Onca Puma plant of 52,000-tonne per year is expected to start producing again this quarter after last year’s shut down.

New nickel mine supply from Madagasgar’s Ambotovy mine, Papua New Guinea’s Ramu and Philippines is expected to come online this year and would increase the output by another 53,200 tonnes annually.

The total projected refined nickel plants are expected to increase to 1,86,000 tonnes in 2014 and 2,15,000 tonnes in 2015 from 1,50,000 tonnes increase in 2013. The projected nickel mine production would rise by 50,000 tonnes from the previous year.

However, there are also few production curtailments in Indonesia’s PT Inco Sorowako, Australia’s Lake Johnston and Long plant.

Dominican Republic too closed its Falcondo mine in 2013. There would be more production cuts coming from Indonesia once there is more clarity surrounding the Indonesian nickel ore export ban in January next year.

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China nickel production has been steadily rising since 2011. During 2011 nickel production rose by 50% and in 2013 the production is expected to rise by 14%. On the other hand, China’s imports have remained stagnant, showing about 7% rise this year after falling by 26% in the year 2012.

Chinese nickel imports have been consistently lower as compared to the imports of other metals due to the country’s production of NPI domestically.

The lower availability of nickel ore would force the nation to import refined metal increasing the country’s demand and further boosting nickel prices.

LME nickel inventory has been rising steadily since the start of 2012 due to the surge in global nickel production and with increasing Chinese nickel pig iron production. Inventories continued to remain at record high levels,

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OUTLOOK

Nickel prices have fallen the most since 2011 as a result of huge surplus overhang in the market due to the continuous rise in the global nickel production and Chinese NPI. We believe Indonesia export ban could affect nickel on a long-term basis as China is holding more than six months of nickel ore stockpiles. The expectation of slower growth in China in the first half of 2014, the major consumer of nickel, would add to the dismal outlook.

However, nickel prices should remain positive in the third quarter of 2014 with some recovery in Chinese economy and on expectations of higher nickel ore prices because of its non-availability thereby increasing the cost of NPI in China. We expect nickel prices to test $15,500 per tonne in the third quarter of 2014.

Supply glut on the back of rising mine and smelter production looms large in the near future for copper

opper was the third worst performer in the year 2013 among all the base metals, posting approximately 7% negative returns on an annual basis. Various macro and fundamental

factors are responsible for the poor performance of this base metal.

The slowdown in the Chinese economy is one of the major reasons for depressed metal prices throughout the year. As China accounts for more than half of the total consumption of the red metal, any change in the economic condition of the nation directly impacts metal prices.

Also, slowing global growth resulted in slow consumption of the metal, which eventually turned the huge deficit in the copper market into surplus. Major consumption loss accounted from China, Europe, Japan and the United States, easing the supply tightness seen in 2012. Lower consumption is expected to continue in 2014 due to global economic slowdown, leaving the market with a huge surplus not seen in the last five years.

SUPPLY TO OVERTAKE DEMAND

Copper mine production and refined production have been rising constantly on a year-on-year basis, showing 6.71% and 3.94% in 2012 and 2013, respectively. The rise in production is mainly due to capacity expansion and increase in mine production.

C

A DELUGEOF SORTS

Rising mine production from Chile and Peru, top two miners of the world, has resulted in overall growth in the global mine production. Since the past three years, mine production has been growing at a relatively stagnant rate.

However, in 2013 mine production jumped by 6.71% growth rate as compared to 2012. Strong growth in mine production is expected to continue in the year 2014 also, with mine production growing at an annual rate of approximately 7.86%.

Mine production is expected to reach almost 19.2 million tonnes by the end of 2014, which was 17.8 million tonnes in 2013. Mine production has jumped from 15.8 million tonnes to 19.2 million tonnes in a span of five years alone as many projects came into stream. Also, many capacity expansion and project start-ups are expected to continue in the coming years too.

In 2013, refined production also grew at a remarkable rate of 4% as compared to 2012. Being one of the major refined copper producers, China has contributed a lot to the overall growth of refined production.

Further, higher premiums in the second half of 2013 have also encouraged miners to produce more and more. Strong growth rate is expected to continue in 2014, with global refined production growing at an annual rate of 6.1% approximately, not seen in the recent past.



The global refined production is expected to reach almost 22.1 million tonnes in 2014 as compared to 20.9 million tonnes in 2013 and 20 million tonnes in 2012.

However, the global refined consumption growth rate has shown a drastic fall in demand, growing by -0.12% in 2013. The global refined production exceeded refined consumption 3,97,000 tonnes, as demand lags behind production growth.

A major fall in demand was felt from China, the top consumer of the metal due to the ongoing slowdown in the economy. However, in 2014 the demand is expected to improve further with improving global conditions and is expected to reach 21.4 million tonnes. Although recovery in consumption is expected in 2014 even then a higher surplus is likely with increased output from all major producers of copper.

China’s Scenario

China, one of the major producers of refined copper across the world and contributing almost 30% a year to the global refined production, climbed record high production levels in the year 2013 which was not seen in the industry in last five years.


China Refined Production

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China’s refined production grew by 16% in 2013 as compared to 2012 and stood at 6.1 million tonnes versus 5.31 million tonnes in 2012. The robust growth in output is in line with expectations of introduction of new capacity and smelters in the nation.

Further, production was also buoyed by the rising availability of scrap copper in the domestic market. Also, high treatment and refining charges encouraged smelters and refiners to process more concentrates.

China, the top copper consumer, has shown a significant growth in the consumption of refined copper. The total demand for refined copper stood at 9 million tonnes approximately in 2013, 20.3% higher as compared to 2012, when the total consumption was around 7.4 million tonnes.

However, the demand remained subdued in the first quarter of 2013 due to rapid domestic copper production. Although, the demand grew more quickly in the second half of 2013 due to continuous supply strikes and supply disruptions across the globe, raising concerns that the copper market could move into deficit by the end of 2013.

However, the robust domestic production growth overtook demand and left the market with a surplus of 397 million tonnes by the end of 2013. Further, with new capacities coming online, high treatment and refining charges and more supplies from scrap imports is expected to continue in 2014, also boosting the domestic refined copper production further and would keep the copper market under pressure.

Copper refined imports in China remained under pressure throughout 2013 due to robust domestic production and lower demand in the nation due to the economy facing a slower growth. China’s imports of refined copper fell on an average on annual basis due to the slow consumption of refined metal on the availability of metals and scrap copper. China’s refined copper imports averaged 26,715


tonnes in 2013 as compared to 28,305 tonnes in 2012.


Copper Waste And Scrap Imports

On the other hand, copper waste and scrap imports also fell on an annual basis, dropping by almost 9.7% in 2013 as compared to the year 2012 due to lower availability in the global market.

Higher treatment and refining charges also encouraged more copper concentrate imports as processing the metal domestically turned out to be more beneficial rather than importing refined metal.

However, scrap imports rebounded from the lows of 30,000 tonnes to almost 4,00,000 tonnes, a rise of almost 42% from February ’13 to December ’13 after the application of the rule introduced by China’s government known as ‘Green Fence’. The main motive of this step is to stop illegal imports of scrap and waste copper, resulting into a more transparent scrap imports market.

STOCKS SCENARIO

Copper stocks at the London Metal Exchange (LME) touched an all-time high of almost 6.6 lakh tonnes in June last year due to sluggish demand across the globe, especially China.

Stockpiles surged more than double compared with five-year average storage levels. However, in the second half of 2013, stockpiles started easing due to supply disruptions across the globe, increasing worries over tightness in the copper market.

Stocks fell from 6.6 lakh tonnes in June ’13 to almost 3.65 lakh tonnes in December ’13.

However, in 2014 copper stocks held at LME are expected to rise again due to rising mine and refined productions across the globe and sluggish growth in the overall demand

for the red metal.

Shanghai stocks declined drastically in the second half of 2013 after reaching an all-time high in the first quarter of 2013. Stocks fell from 2.4 lakh tonnes in February ’13 to 1.25 lakh tonnes in December ’13, falling by more than half of the total stocks.

The drastic fall in stocks was due to the pick-up in domestic demand in China. However, demand is expected to cool off in the first half of 2014 and stocks are likely to rise again with the struggling Chinese economy.

CANCELLED WARRANTS AND PREMIUMS

In the beginning of 2013, cancelled warrants jumped to the highest level in 15 years amid concerns over strike in Chile, the top producer of copper. LME cancelled warrants, which indicate orders to remove metal from warehouses, climbed to 369,475 tonnes in June 2013, the highest level seen since October ’97.

Seasonal demand was also one of the major reasons for the sudden surge in cancelled warrants. However, in 2014, the cancelled warrant is expected to rise again due to higher production and a slow pick-up in demand.

Premium indicator and premiums at Shanghai-LME also soared to high levels with the anticipation of supply tightness in the metals market due to production disruption in major producing nations with enduring strikes.

OUTLOOK

Considering the factors discussed above we do not expect any major turnaround in copper prices at least in the first half of 2014 and early second half of 2014. Higher mine and refined production and seasonal low demand in the second and third quarters of 2014 would keep the copper market under pressure.

Further, top consumer China is expected to import lower refined and scrap copper as no fresh investment is expected to emerge in the coming quarters. Higher premiums, which were seen in the second half of 2013, are also expected to come down on the back of ramp up in production numbers and a fall in demand from all major consuming economies of the world.

We expect a major correction in copper prices before the end of Q3 2014 due to the change in fundamental as well as macro factors. Copper prices are expected to fall to the levels of $6,500-$6,600/tonne by the third quarter of 2014.

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Mine closures and production cuts in the near future could lend support to aluminium prices

luminium prices have fallen by 13% since last year on account of continuous increase in production, especially from China, pushing the market into surplus every year and due to record high inventories. The markets have remained in huge surplus since the last so many years, thereby, putting downside pressure on aluminium prices.A

ABREATHER



Aluminium prices have remained depressed since the last five years due to global supply glut of the metal. Producers are under pressure to cut expenses as prices on the London Metal Exchange (LME) languish close to or below the cost of production level.

Global alumina production has been continuously on the rise since the last five years. Alumina is the raw material used for the production of primary aluminium. Alumina production is increasing every year by 10% year on year. In 2013, world’s alumina production rose by 14.3% to 116 million tonnes and in 2014 the production is expected to slowly increase by 3.3%.

The world’s bauxite production has risen from 181 million in 2009 to 226.9 million tonnes in 2013, an increase of 25%. Bauxite is the main raw material used in the production of aluminium with 70% to 80% of raw bauxite ultimately processed into aluminium.

The global primary aluminium production has grown by 4% to 49.7 million tonnes from the previous year but we expect production growth to stabilize, rising by 1.7% from the previous year.

During 2014, the surplus is expected to shrink as global production outside China is expected to decline as producers are facing cost burden due to low prices, higher energy costs and environmental issues being experienced at present.

The world’s major aluminium producers are China, which produces more than 50% of the total output, Europe producing around 12% and North America producing around 9% of the world output. But regions such as the Middle East and India are emerging as important producers of primary aluminium.

The demand for aluminium has increased by 3.8% to 47 million tonnes in 2013 and in the coming year the demand is expected to rise further by 4.5%. Major consumers are China, Europe and North America. Automobiles, building

Global aluminium production excluding China is expected to decline in 2014 as the largest producers in Europe, America and Australia plan to curtail its production in 2014. On the other side, China has been increasing its production significantly by 11% over the years. The production in China has increased significantly by 69% from 12.9 million tonnes in 2009 to 21.9 million tonnes in the year 2013.

The reason for massive aluminium production by China is that smelters are enjoying the cost advantage by using coal-fired plants. During 2014, we expect China to slow down its aluminium production as the government is reining in overcapacity sectors.

China will impose tiered power pricing on all aluminium smelters starting from January this year in an attempt to weed out inefficient plants and tackle severe overcapacity in the sector.

Power tariff accounts for about 40% of the smelting cost. The aluminum industry has been suffering from overcapacity since years, depressing prices and forcing many producers to face cost pressure.

Source: IAI, WBMS, NB Research

Source: IAI, NB Research

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2009(In 000' tonnes) 2012 2013(E) 2014(F)Global Alumina Production Global Bauxite ProductionGlobal Aluminium Production (IAI)% Change Global Primary Aluminum Demand% Change Surplus/Deficit

Aluminium Demand-Supply Scenario

Diversion In Global And Chinese Aluminium Production

and transport sectors are the main end users of aluminium products. Therefore, with demand from Europe and the US improving as the economies are expected to drive growth, the demand for aluminium would remain buoyant.

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China accounted for nearly half of the global aluminium production, producing around 22 million tonnes in 2013, rising 11% on a year-on-year (y-o-y) basis. Bauxite is the raw material used to make alumina, which in turn is used in producing aluminum.

With bauxite imports rising, China’s alumina production is increasing by 17% on a y-o-y basis. Alumina imports have also risen dramatically every year, leading to higher refined aluminum production in China. Chinese bauxite imports increased significantly last year as the nation was stocking the raw material ahead of Indonesia bauxite export ban in January ’14, importing 48 million tonnes from Indonesia that may be sufficient for producing alumina for the next eight months of the current year.

With Indonesia’s ban in place, China would curb its alumina production as Indonesia accounted almost 68% of China’s bauxite imports. China would need to import bauxite from other countries like Australia and India. The imports have fallen 28% in 2013 on account of higher domestic alumina and aluminium production.

STOCK SCENARIO

Aluminium inventories in LME warehouses are continuously rising to a record of nearly 5.5 million tonnes, while Shanghai stocks have been declining since April ’13. Currently, Shanghai aluminium stocks stand at 2,00,000 tonnes. Global aluminium stocks including LME, Shanghai and other producer’s stocks are estimated to be at 10-15 million tonnes reflecting that the market has been in surplus due to oversupply.

Cancelled warrants, on the other hand, have also remained high as most inventory has been locked up in financing deals and unavailable to consumers. LME aluminum cancelled warrants rose to the highest level on record at 2.52 million tonnes in January ’14, which represents close to 46% of total LME stocks.



China Production And Bauxite Imports

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US Midwest Free MarketEurope Free MarketJapan Free Market

LME RULES

LME has changed its rules to speed up withdrawal procedure from the warehouse by shortening the waiting time to 50 days from 100 days. These changes are scheduled to take effect from 1st Apr ’14. Among other base metals, aluminium is the only metal where large amounts of the metal are lying at warehouses due to subsequent years of surging production from 2008-09.

PREMIUMS

Aluminium physical premiums in US Midwest have reached record highs of $457.4 per metric tonne, risen by 82% from almost $250 per mt in December ’13 owing to production cuts and, more notably, due to continued demand for physical metal in financing deals. We have also seen premium on aluminium rising in other regions like Europe and Japan.

The new LME rules, which are likely to be effective from April ’14, would speed up the flow of aluminium outside warehouses, thus making more metal available easily, further putting pressure on premiums and prices. We believe this sudden rise in premiums will cool off after the start of new LME rules.

PROJECTED PLANTS

Aluminium market has continuously been in surplus for years due to which prices have remained below the cost of production, forcing many producers to curtail their production capacities. Some of the major aluminium producers have curtailed their loss-making capacity or shut down completely due to lower prices, higher energy costs and surging Chinese production.

Russia, the world’s largest aluminium producer, plans to curtail its production by 3,25,000 tonnes in 2014 to reduce

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nearly 6,00,000 tonnes per year next year with Hindalco stepping up capacity by 1.5 million tonnes per year; Ma’aden smelter in Saudi Arabia will reach full production capacity of 7,40,000 tonnes of best primary aluminium products. The smelter is part of the Ma’aden and Alcoa joint venture, which will be back online by late 2014.

OUTLOOK

We expect aluminium prices to remain in a tight range as prices have stayed well below the cost of production, which may trigger production cuts from Western producers. Owing to the improving macroeconomic environment in the US and Europe, we expect demand for aluminium to pick up and prices to move higher.

However, the slowdown in China and new LME rules to be introduced in April ’14 will put some downside pressure on prices of aluminium. Generally, we are looking for LME aluminium prices to trade in the range of $1,850-$1,650 per tonne and any downward spike below $1,600 per tonne would be good buying opportunity with a target of $1,850-$1,900 per tonnE.

the cost as the firm’s aluminium cost per tonne is $1911 per tonne. Aluminium company, Rusal, has decreased its production by 8% to 3.9 million tonnes in 2013, closing three of its smelters.

MINE CLOSURES

Alcoa, one of the major Australian producers had announced closures or reduced some of its production capacity by 5,51,000 tonnes exceeding the estimation of 4,60,000 tonnes in May ’13. The company has announced plans to close its 50-year Point Henry and its Massena smelter. The company plans to shut its Massena East smelters in the first quarter and reduce its production to 18,000 tonnes in 2014 from 1,15,000 tonnes in 2013.

Australia’s Rio Tinto has closed its 1,00,000 tonne smelter in Quebec last year and has sold various smelters in the US and France.

NEW CAPACITY ADDITIONS

New capacity additions outside China may increase to

Mine supply

constraints to

keep prices of

zinc upbeat in

the medium term

uring 2013, zinc performed fairly better than its peers from the base metals complex, fetching marginally negative return of 0.57%. In the year 2011, zinc prices plummeted by 24%, the most among other base metals on the back of supply surplus and high legacy inventory. D

Source: ILZSG, NB Research

123906.6

1289614.321264915.89

247

126662.23

130801.43

127060.45374

131493.81

12526-4.24

12290-3.27

236

132861.04

131384.89

131987.39-60

135001.61

136503.9

138504.94-200

2011201011623

11281

10915

366

2009(In 000' tonnes) 2012 2013 2014(f)Global Mine Production

Global Zinc Refined Production% ChangeGlobal Zinc Refined Consumption% ChangeSurplus/Deficit

Zinc Demand-Supply

30

ZnZnZinc65.38

28

182

ON AREBOUND

The above table suggests that after four consecutive years of surplus, the zinc market was finally in deficit in 2013. The global refined zinc market is under-supplied by 60,000 tonnes as compared to the surplus of 2,36,000 tonnes last year. In the year 2014, we further expect the zinc market to remain in deficit on the back of mine supply shortages and increase in demand growth.

During the last three years, mine production has increased from 11,620 tonnes in 2009 to 13,149 tonnes in 2012 but this rise on a year-on-year (y-o-y) basis is likely to halt in 2014. Global mine production increased marginally by 1.04% in 2013 and is expected to rise by 1.6% in 2014 due to limited new mine additions and major mine depletion taking place by 2015 and 2016. The new supply of zinc is difficult to replace the loss of production due to small zinc deposits; some mines are at its pre-funding stage facing infrastructure constraints.



Global refined zinc production has risen by 4.9% in 2013 due to production increases in China, India, Korea, Peru and Mexico.

China was the major contributor to the rise in refined zinc production as the nation increased its output by almost 11% from last year. In 2014, the global refined zinc production is forecasted to grow by 3.9%.

Global zinc demand has outpaced production by 60,000 tonnes in 2013. Zinc consumption has increased by 7.4% to 13,198 tonnes in 2013 and is expected to increase by another 5% in 2014.

The demand for zinc is increasing faster than supply, implying that the market would remain tight. Demand from both China and India has increased by 13%. Also, the demand from Japan and Europe, and the US have risen since last year.

Improvements in macroeconomic conditions in the largest consuming nations like the US, Europe and Japan have kept the demand for zinc strong.

DEMAND FROM GALVANIZED STEEL PRODUCTION



China Galvanized Steel Production

Strong Chinese Imports Despite Higher Output

China’s zinc production has risen by almost 10% during 2013 from last year after the drop in production by 6% in 2012. China’s zinc consumption is expected to rise by 5% in 2014 on the back of demand coming from infrastructure and auto sectors. China, which accounts for 40% of refined zinc demand, saw net imports rise 20% in 2013 and currently stand at record high levels since 2009.

During the year 2013, Chinese zinc imports stood at 6,24,047 tonnes, close to the record levels of 2009, rising by 21% on a year-on-year (y-o-y) basis. Imports have risen considerably since September ’13 at an average pace of 67,000 tonnes each month. We expect China to remain a large importer of zinc due to the rise in galvanized steel production despite higher zinc production in the nation.

MINE DEPLETION

Major mine closures are expected to remove around 1.2 million tonnes before 2016 while on the supply side, we have 6,50,000 tonnes of new supply coming into the market. The new projects to be started are on a smaller scale and it would take years to come online at full production capacity

One of the major Australian zinc producers, Century mine is expected to slow down its production in 2014-15 and is completely set for closure by 2016. Century mine produces about 4,80,000-5,00,000 tonnes of zinc annually and in 2014 the production is set to fall by 5%. Canada’s PLC’s Brunswick and Perseverance mines have already been closed in 2013, which together annually produced around 3,35,000 tonnes of zinc in 2011. Lisheen mine in Ireland has closed this year. It used to produce around 1,75,000 tonnes of zinc.

On the other hand, we have small new zinc mining projects, that is, Perkoa mine in Burkina Faso plans to produce 90,000 tonnes of zinc by 2014. Lalor Lake mine in

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Approximately 50% of zinc is consumed to galvanize steel used in industries like construction, infrastructure and automobile. The rising demand from the galvanized steel sector is one of the main reasons why we are bullish on prices of zinc.

Global steel production is forecast to increase 3.3% globally to 1.52 billion tonnes in 2014. Chinese galvanized-steel production has shot up by 12% in 2013 as compared to last year. We expect China galvanized steel output to fall during the next quarter due to lower seasonal demand in this period and expect demand to remain strong from rising galvanized steel production.

EQUITIES | DERIVATIVES | COMMODITIES* | CURRENC Y | MUTUAL FUNDS # | IPOs # | INSURANCE # | DPDisclaimer: Insurance is a subject matter of solicitation. Mutual Fund investments are subject to market risk. Please read the scheme related document carefully before investing. Please read the Do’s and Don’ts prescribed by Commodity Exchange before trading. The PMS Service is not o�ering for commodity segment. *Through Nirmal Bang Commodities Pvt. Ltd. #Distributors

SMS ‘BANG’ to 54646Contact at: 022-3926 9404, E-mail: [email protected]

BSE SEBI REGN No. INB011072759, INF011072759 & INE011072759, NSE SEBI REGN No. INB230939139, INF230939139 & INE230939139 DP SEBI REGN. No NSDL: IN-DP-NSDL-136-2000, CDS(I)l: IN-DP-CDSL-37-99, AMFI REGN. No. arn-49454 NCDEX REGN. NO. 00362, FMC Code-0075, MCX REGN. No. 16590, FMC Code-MCX/TCM/CORP/0490, MCX SX-INE260939139, PMS-INP000002981

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Canada is forecast at 40,000 tonnes in 2014, Australia’s Dugald River may produce around 2,25,000 tonnes by 2015. Glencore Xstrata, Belgium’s Nyrstar and China’s MMG are finding new mines from Africa to Yukon.


Continuous Drawdown In Inventories

increasing since October ’12 and currently stand at about 4,32,725 tonnes, that is, near 46% of the total inventory. Cancelled warrants have well remained above 50% since the start of the year 2013.

OUTLOOK

Zinc is going through a structural shift on the supply side, creating a bullish outlook for zinc prices. During the year 2013 the surplus turned to deficit due to strong consumption growth and mine closures, and we are of the opinion that the surplus would turn into deficit in the current year.

The level of underlying demand for zinc, coupled with the fact that new mine supply is not being added, tightness in supply side is likely to emerge over the next two years. Demand from the US, Europe and China is expected to drive consumption higher as US and Europe are recovering and growing and expect China to slowly recover from the credit crunch and shadow banking concerns after the second half of 2014.

Therefore, we are of the firm view that zinc prices are expected to behave positively and we recommend one to buy LME Zinc around $1,900 per tonne for the annual target of $2,350 per tonnE.

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LME stocks Shanghai Stocks(RHS)

Tonn

esLME inventories reached record high levels of 12,00,000 million tonnes in December ’12. Since then inventories have been declining and currently stand at 8,79,750 tonnes, which is less than the average monthly global zinc consumption. Similarly, we have seen continuous draw in inventory at Shanghai Futures Exchange warehouses.

Zinc stocks on Shanghai warehouse have declined by 23% since December ’12. Cancelled warrants have been

Contact At: 022 3926 9140,e-mail: [email protected]

Expected supply tightness in lead in 2014 is likely to keep markets well-supported

n the year 2013, the lead market posted a 5% negative return, approximately on an annual basis. This could probably be due to the surplus in the market last year. In 2012, the lead market’s annual return was around 14.5% due to tighter supply conditions in the market. A surplus of 1,74,000 tonnes in 2011 was reduced to just a small surplus of 64,000 tonnes in 2012, which kept the market well-supported throughout the year. Further, in 2014, the I

A FIRMING TREND



lead market is expected to move into deficit due to the rise in demand from a small surplus seen in 2013, which will again keep the markets well-supported.

DEMAND AND SUPPLY

Global mine production as well as refined production have constantly shown a year-on-year (y-o-y) increase in production numbers. On the other hand refined lead consumption also increased by more than 4.2% in 2013, which is 0.4% more than the refined production growth.

Global mine production increased by 11.74% and 7.18% in 2012 and 2013, respectively. Exploration of new mines and capacity additions has resulted in robust output growth globally, mainly because of China and India. Further, the global mine production is expected to grow by 4.14% in 2014 on the back of anticipated higher production numbers from Australia, which has benefited from the reopening of Ivernia’s Paroo Station, the largest lead mine in the island nation, in March ’13, which was under maintenance since April ’11.

The global refined lead production rose 9.37% and 3.8% in 2012 and 2013, respectively. The rise in production is fairly justified with the rise in domestic production of lead in China, Peru, Italy and the United States due to increased smelters and refineries’ capacities.

Despite the continuous closure of old and inefficient plants, China’s production is expected to increase further and expand its smelter and refineries’ activity in 2014 also. Refined production is expected to reach 11.48 million tonnes in 2014, reporting almost a rise of 4.17%, Australia, China, Peru and India will remain the major contributors to production rise.

The global refined consumption rose by 4.93% and 4.24% approximately in 2012 and 2013, respectively. Furthermore, the demand is expected to rise by 4.64% in 2014 reaching to 11.51, driven mainly by rises in usage of 4.2% in Europe, 18.5% in the United States, 5.1% in China and 12.2% in the Republic of Korea. The demand is expected to rise primarily due to improving US and China vehicle sales and robust growth in the auto sector, encouraging lead-acid battery producers to boost output.

The global lead market was left with little surplus after taking into consideration the demand and supply of refined metal in 2013. Refined metal production rose to 11.02 million tonnes as compared to 11 million tonnes of refined demand, leaving the market with a small surplus of 22,000 tonnes. Further, the surplus is expected to move into a



Total Demand And Refined Imports

China Lead Production And Total Demand

deficit despite production rising at a continuous pace. The lead market is expected to face a deficit of 30,000 tonnes in 2014 due to an exponential rise in demand, especially from China and the United States.

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Total Imports (RHS) Total Demand

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The above chart depicts the trend in China’s refined production as well as consumption. Due to robust growth in the domestic output of the metal, Chinese imports have slowed moderately in the past few years.

China’s domestic production fell 15.5% in November ’13 as compared to the corresponding period in 2012. The drop in production is mainly due to the closure of small recycled lead plants and old plants. Earlier, China’s government had ordered small lead plants with an annual capacity of 30,000 tonnes to either shut down by year-end or upgrade their facilities to have a minimum annual capacity of 50,000 tonnes.

Due to this China will lose less than half a million tonnes, which is not as significant in a 5 million tonne market. However, many plants are planning to expand their business rather than shutting down their businesses completely. However, production is expected to rebound in the coming months due to capacity expansion and restarting of many lead plants in various nations.

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Disclaimer: Insurance is a subject matter of solicitation. Mutual Fund investments are subject to market risk. Please read the scheme related document carefully before investing. Please read the Do’s and Don’ts prescribed by Commodity Exchange before trading. The PMS Service is not o�ering for commodity segment. *Through Nirmal Bang Securities Pvt. Ltd. ^Distributors #Prepared by Research Analyst of Nirmal Bang Commodities Pvt. Ltd.


On the other hand, imports of refined lead in China have declined from the highs of 36,357 tonnes to almost neutral as per the latest import figures of November ’13. The drop in imports is justified with the significant rise in domestic production of the metal.

Also, China’s consumption is expected to grow in 2014 due to the expansion of the mobile phone industry and primarily because of the rise in automotive and e-bike production. Consumption is expected to rise 6.3% and reach to the levels of 5.26 million tonnes in 2014 as compared to 4.95 million tonnes in 2013, which will support the lead market throughout the year.

STOCKS AND CANCELLED WARRANTS

Lead stocks held at both LME and Shanghai warehouse have been on a declining trend since the start of 2013. Lead stockpiles at LME declined almost 24.5% since the start of 2013 and 31% approximately on a year-on-year (y-o-y) basis. On the other hand, Shanghai lead stocks are also declining at a rapid pace since the start of 2013 and fell almost 17% since January ’13.

However, stocks continue to be above the five-year averages. The decline in stocks at these warehouses

signifies the strong demand growth in the lead market.

If we analyze the cancelled warrants scenario of the metal then the trend in 2013 is totally opposite as compared to 2012. Cancelled warrants declined almost 76% in 2013 as compared to 2012 and stood at 43,600 tonnes near the 2011 levels. Falling cancelled warrants also show signs of improvement in the lead market and the increase in demand, of late.

LEAD OUTLOOK

Lead is expected to perform better among the base metals complex on the back of factors discussed here. A squeeze in supply side is likely to occur in 2014, which would turn the surplus market into deficit, which was not expected earlier. High consumption of lead in lead-acid batteries and improving vehicle sales across the globe has helped bring down the surplus of 1,74,000 tonnes of lead in 2012 to a small surplus of 20,000 tonnes in 2013. Further, the surplus in the lead market would turn into a deficit of 30,000 tonnes in 2014, supporting the lead market.

We expect lead prices to reach to the levels of $2,300/tonne by Q3 2014 when the market would be facing tighter supply conditionS.

DISCLAIMERIn the preparation of the content of this magazine, Nirmal Bang Securities Private Limited has used information that is publicly available, including information developed in-house. Such information has not been independently verified and we make no representation or warranty as to its accuracy, completeness or correctness. Any opinions or estimates herein reflect the judgement of Nirmal Bang Securities Private Limited at the date of this publication/ communication and are subject to change at any point without notice. This is not a solicitation or any offer to buy or sell. This publication/ communication is for information purposes only and is not intended to provide professional, investment or any other type of advice or recommendation and does not take into account the particular investment objectives, financial situation or needs of individual recipients. For data reference to any third party in this material no such party will assume any liability for the same. Further, all opinion included in this magazine are as of date and are subject to change without any notice. All recipients of this magazine should seek appropriate professional advice and carefully read the offer document and before dealing and/ or transacting in any of the products referred to in this material make their own investigation. Nirmal Bang Securities Private Limited, its directors, officers, employees and other personnel shall not be liable for any loss (financial or otherwise), damage of any nature, including but not limited to direct, indirect, punitive, special, exemplary and consequential, as also any loss of profit in any way arising from the use of this material in any manner whatsoever. The recipient alone shall be fully responsible/ are liable for any decision taken on the basis of this material. This magazine is prepared for private circulation only. Nirmal Bang Securities Private Limited, its affiliates and their employees may from time to time hold positions in securities referred to herein. Nirmal Bang Securities Private Limited or its affiliates may from time to time solicit from or perform investment banking or other services for any company mentioned in this document.

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