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1 GLOBAL LME cash price % change US$/tonne day on day Aluminium 1, Copper 6,783.2 Lead 2, Nickel 18,412.5 Tin 23, Zinc 2, Cobalt 3,37. Molybdenum 28,25. Other prices % change day on day Gold (US$/oz) 1,31.8 Silver (US$/oz) Platinum (US$/oz) 1, Palladium (US$/oz) Oil WTI USD:EUR exchange rate AUD:USD exchange rate LME/COMEX stocks Tonnes Change Aluminium 5,339,325 11,875 LME copper 238,95-1, Comex copper 17, Lead 193,275-1,5 Nickel 277, Tin 9,45 5 Zinc 786,475-3,1 Source: LME, Comex, Nymex, SHFE, Metal Bulletin, Reuters, LBMA, Macquarie Research, April 215 Articles of the week ICSG & ILZSG Study Group data: Stocks, scrap, supply, demand China steel survey: Sales rebounding China Copper Survey: Better mood; more orders; tighter supply 28 April 214 Answering the key nickel questions Feature article LME nickel prices are up 32% since the start of this year and are up 12% since our 9 April piece: Nickel prices up 25% in 214 you ain t seen nothing yet. Our Senior Commodities Consultant, Jim Lennon, took part in a Reuters forum Q&A on Wednesday, providing an update on all the key talking points in the nickel market. We reproduce this in today s note. Latest news Nickel was the outperformer among the base metals last week, gaining 3% WoW, while copper gained 1.8% on the week. Tin also rose, up 1.2% WoW, and more than half of all LME tin stocks are now cancelled, for the first time since October 212. Copper stocks in SHFE warehouses slid another 27,321t to 15,156t in the week leading up to 24 April. This follows significant outflows in the previous four weeks, with the result that copper inventory has halved since 2 March. We mainly attribute this to tighter domestic conditions: Increased seasonal demand from fabricators is coinciding with tighter supply from Chinese smelters as the big seven are said to be exporting metal to the bonded warehouses at present to take advantage of the SHFE-LME arbitrage, reducing sales to local consumers. A strong indicator of the tightness is the fact that domestic cathode continues to trade at a premium to the SHFE price, with levels soaring to around RMB1,725/t in recent days, according to CRU. In addition, the widely suspected SRB buying activity in the last month is also likely to be a factor in SHFE drawdowns, whether directly or indirectly. In contrast, SHFE aluminium stocks continue to build, rising 1,159t on the week to 46,667t, which is the highest level since end-june 213. Although domestic Chinese demand is estimated to have been sluggish through 1Q, we believe that ultimately this is more of a supply issue, with the market still needing to digest an evident market surplus despite smelter capacity cuts. Two weeks ago, Chinalco announced that it was idling 6kt of electrolytic aluminium capacity due to low market prices and high power costs. Interestingly, state media outlet China Daily ran a piece on Friday listing the top ten recipients of government subsidies in 213, including Chinalco in sixth place with RMB824m ($133m at current exchange rates) of subsidies in 213. Such a story is unlikely to be published without the tacit acceptance of the authorities, and so we see this as yet another signal that official attitudes toward supporting state enterprises is becoming less tolerant. For the aluminium industry at least, this could mean further cutbacks. Chinese domestic (#4 Liulin) hard coking coal prices fell to just 85 RMB/t last week, down 7 RMB/t from levels a week earlier. We think that this is a reflection of the fact that steel mill destocking appears not to have been fully concluded (although it has slowed substantially) and the fact that, even at these new levels, equivalent seaborne spot HCC is still $15 2/t cheaper. However, as our proprietary steel survey highlights, mills are planning to increase coking purchases going forward, while at these price levels Chinese domestic production should also react. As a result, we remain of the view that short-term downside to seaborne met coal prices remains limited. Please refer to the important disclosures and analyst certification on inside back cover of this document, or on our website

2 Open Interest (' lots) LME 3-Month Price ($/t) ' tonnes Answering the key nickel questions LME nickel prices are up 32% since the start of this year and 12% since our 9 April piece: Nickel prices up 25% in 214 you ain t seen nothing yet. Our Senior Commodities Consultant, Jim Lennon, took part in a Reuters forum Q&A on Wednesday, providing an update on all the key talking points in the nickel market. We reproduce this in today s note. Fig 1 LME open interest data indicates large speculative longs Fig 2 LME nickel stocks showing first signs of falling Open Interest Nickel Price (rhs) 2, 19, 35 3 stocks Cancelled , 17, 16, 15, , , Jan 11 Jan 12 Jan 13 Jan 14 Source: LME, Macquarie Research, April 214 Source: LME, Macquarie Research, April 214 Nickel prices are currently at their highest level in over 14 months, while LME inventories are still fairly high. Has the price moved ahead of fundamentals? The price is probably running ahead of the fundamentals, but that is how markets work. We are seeing first signs of a decline in LME stocks, while Chinese non-reported stocks of nickel ore and probably metal are now falling, so the market overall is moving from very large surplus into deficit. Non-Chinese demand, especially in Europe and the USA, has surged since December, and although Chinese demand has weakened a little, it is still strong. As Chinese nickel pig iron producers start to close in the coming months, the global deficit will widen. Open interest on the LME has surged, indicating large speculative longs and the potential for a price correction remains, but the price trend is now firmly up. Moving to some details of those fundamentals, what is the latest on the impact of the Indonesia ore ban? Exports from Indonesia of nickel in nickel ore were over 67kt of recoverable nickel last year, of which 62kt or so went to China. Of this over 2kt was stockpiled and around 45kt was used, of which around 41kt was in China and 4kt elsewhere. Replacing 45kt of nickel is well-nigh impossible. We might get an extra 3 5kt Ni in ore from the Philippines (maximum), 5 1kt from New Caledonia and maybe 1 2kt Ni from a new mine in Guatemala, but that's about it. Destocking of ore this year and next will cushion the fall in Chinese nickel pig iron production, but the falls will be huge in 215 and 216. It is also worth noting that reported Chinese imports from Indonesia in March were just delayed Customs' reporting from January exports...there is no break in the ban. What has been the response by those Chinese NPI producers? Some are buying primary nickel to blend with NPI to keep going as long as possible. Chinese nickel prices were $2,/t lower than LME until recently. The smaller producers, especially in Inner Mongolia, are struggling, and we think widespread closures are imminent. 28 April 214 2

3 Jan-1 Mar-1 May-1 Jul-1 Sep-1 Nov-1 Jan-11 Mar-11 May-11 Jul-11 Sep-11 Nov-11 Mar-12 May-12 Price: $US/tonne Ni ex-vat $/tonne ex-vat Fig 3 Chinese nickel prices at big discount to LME Fig 4 Chinese NPI price vs costs: Non RKEF losing money Price: 8-13% NPI Costs: 12% Ni - Conventional Costs: 12% Ni - RKEF 8-13% Ni - LME price LME minus Jinchuan metal price Source: SMM, LME, Macquarie Research, April 214 Source: SMM, Macquarie Research, April 214 How quickly can NPI producers launch operations in Indonesia? Not that quickly. Around 12ktpa of capacity is reportedly under construction but will not start up until mid-215 at earliest. Others are waiting until after the Indonesian elections to decide whether to commit money, just in case policy changes again. We assume that around 5ktpa will be added in the coming years to production, nowhere near the losses. The main problem is you have to build power plants and all the infrastructure, as well as NPI plants. It is not easy in these very isolated areas. There has been some talk of building just blast furnaces or some partial processing to get to 4% Ni (the minimum), but we don t see this as economic. Speaking of the elections, the whole situation would be upended if the ban was withdrawn. What are the prospects of a new government doing this? Once plants are committed to be built in Indonesia, it will be difficult to do an about-face and change the policy. The main political parties all seem committed to maintaining a ban. We don't expect a change. One possibility would be that a new government may allow some exports from companies building NPI plants in Indonesia, but even if this happens, the tonnages permitted to be exported would probably be small (maybe less than 2mtpa compared to 65mt last year). In addition taxes on exports would be high. This would keep ore prices high and raise the floor for nickel prices toward $2,/t in any case. What is your estimate of the global nickel market balance and global inventories? The market is likely to move into deficit in the second half of this year and be in large deficits from 215 onwards. We foresee a deficit of up to 25kt in 215/16 combined. At the moment we can't identify what will rebalance the market... all the way out to 22! Inventories are high with around 2kt in China, 275kt on LME and probably another 15 2kt outside China held by producers and traders. There are also the ore stocks. However, these stocks will deplete rapidly and by end-216 will be at 26/7 levels in weeks' of use, which back then caused nickel prices to spike above $3,/t. You said earlier there's potential for a price correction. What's your price outlook? We think the general trend is now up, but said price corrections are always possible with such large speculative longs in the market. We would recommend buying the dips. Previously we said that we foresaw $2,/t by the end of this year and we wonder whether that is too conservative now. In 215 we think we might see $3,/t and in 216 we will see $3,! 28 April 214 3

4 LME stocks: tonnes Price: $/tonne What will be the effect of the ore ban on the Japanese ferronickel producers for 214 and the future? The Japanese ferronickel producers have largely covered the lost Indonesian tonnage (around 2kt Ni) with extra tonnage from the Philippines and New Caledonia. The largest Japanese producer, Pacific Metals, is losing around 5kt production this year due to a maintenance outage of one furnace for six months, so that also helps. There is limited high-grade ore from the Philippines, so 2% Ni grade is being replaced with 1.7% grade. This will raise production costs in Japan (along with the higher ore prices). How financialised are refined nickel stocks, particularly in China? Are they effectively "locked up" in collateral deals? You would expect financing deals to be in place on these stocks, but the deals roll off all the time, so if the price is right, this material will find its way into the market. LME stocks are also financed. This creates "stickiness" in availability... If Indonesia becomes a major NPI producer, can NPI become an international product instead of Chinese product for the Chinese market? If so, would there be any impact on the stainless steel industry? Yes is the short answer. China has a 25% export tax on NPI, so that made it impossible to export. A new Indonesian exporter can sell to anyone in the world. The problem will be building the capacity... Regarding stainless steel, the Chinese stainless mills had a competitive advantage over their rivals by getting "free iron" in their NPI, whereas non-chinese stainless mills had to pay for iron in stainless steel scrap. Over time, Chinese stainless exports may fall as they lose competitiveness. If your deficit forecasts are right and all that stock will be needed, what price will be needed to liberate it? I'm thinking of Chinese investors who bought physical with a historical target of $5k. The world is uncertain and "targets" can change. I would be surprised if everyone holding stock in China and elsewhere has such aggressive targets. But the principle is right as prices rise the holders of stocks grip them more tightly! Fig 5 While prices have rallied, the rally is still small in the historical context LME stocks LME price Source: LME, Macquarie Research, April April 214 4

5 Friday 25 April 214 Commodities Prices Closing price * Closing price * % ch. day 214 YTD Ave 213 US$/tonne US /lb US$/tonne US /lb on day US$/tonne US$/tonne LME Cash Aluminium 1, , ,73 1,845 Aluminium Alloy 1, , ,827 1,8 NAASAC 2, , ,877 1,831 Copper 6, , ,96 7,322 Lead 2, , ,1 2,141 Nickel 18, , ,146 15,3 Tin 23,756 1,78 23,872 1, ,796 22,35 Zinc 2, , ,28 1,99 Cobalt 3,37 1,378 3,379 1,378. 3,343 27,326 Molybdenum 28,25 1,281 28,25 1, ,475 22,925 LME 3 Month Aluminium 1, , ,772 1,887 Aluminium Alloy 1, , ,861 1,828 NAASAC 2, , ,95 1,861 Copper 6, , ,934 7,346 Lead 2, , ,122 2,157 Nickel 18, , ,197 15,78 Tin 23,625 1,72 23,75 1, ,763 22,318 Zinc 2, , ,28 1,94 Cobalt 3,5 1,383 3,5 1,383. 3,414 27,515 Molybdenum 28,25 1,281 28,25 1, ,475 22,927 * LME closing price - 17 hrs London time. Year-to-date averages calculated from official fixes. Gold - London PM Fix (US$/oz) Silver - London AM Fix (US$/oz) Platinum - London PM Fix (US$/oz) Palladium - London PM Fix (US$/oz) Oil WTI - NYMEX latest (US$/bbl) EUR : USD exchange rate - latest AUD : USD exchange rate - latest 1,31 1, ,294 1, ,418 1, ,43 1, Exchange Stocks Change since last report Cancelled End-13 Ch. since (tonnes) Volume Percent warrants stocks end-13 LME Aluminium 5,339,325 5,327,45 11,875.2% 2,92,8 5,458,75-118,75 Shanghai Aluminium 46,667 45,58 1,159.3% - 181, ,23 Aluminium 5,745,992 5,732,958 13,34.2% - 5,639,719 16,273 LME Copper 238,95 239,95-1, -.4% 11,4 366, ,475 Comex Copper 17,133 16, % - 15,73 2,6 Shanghai Copper 15, ,477-27, % - 125,849-2,693 Copper 361, ,69-27,83-7.2% - 57, ,18 LME Zinc 786, ,575-3,1 -.4% 149, , , Shanghai Zinc 247, ,626-5, % - 238,723 9,22 Zinc 1,34,22 1,43,21-8, % - 1,172, ,978 LME Lead 193, ,775-1,5 -.8% 21, ,45-21,175 Shanghai Lead 76,738 77,848-1,11-1.4% - 9,29-13,471 Lead 27,13 272,623-2,61-1.% - 34,659-34,646 Aluminium Alloy 54,44 54,44.% 12,42 56,44-2, NASAAC 63,2 63, % 38,54 84,86-21,84 Nickel 277, , % 128,94 261,636 16,98 Tin 9,45 9, % 5,225 9, Source: Comex, LBMA, LME, Nymex, Reuters, SHFE, Macquarie Research 28 April 214 5

6 Summary of changes, week ended 25 April LME metal prices (%) Cash 3-Month Aluminium -.8% -.7% Aluminium Alloy 1.8% 1.8% NAASAC -3.2% -3.3% Copper 1.8% 1.7% Lead.7%.9% Nickel 3.% 2.9% Tin 1.2%.9% Zinc.1% -.2% Cobalt 3.4% 3.4% Molybdenum.9%.9% Other prices (%) Gold.2% Silver.2% Platinum -1.3% Palladium.5% Oil WTI -3.2% EUR : USD exchange rate.1% AUD : USD exchange rate -.6% Exchange stocks tonnes % LME aluminium 23,75.4% Shanghai aluminium 9, % aluminium 33,714.6% LME copper -3,35-1.4% Comex copper 157.9% Shanghai copper -37, % copper -4,78-1.1% LME zinc -15,25-1.9% Shanghai zinc -13, % zinc -28, % LME lead -7, % Shanghai lead -1, % lead -8,65-3.1% LME aluminium alloy % LME NAASAC -2,72-4.1% LME nickel 3.1% LME tin % Source: Comex, LBMA, LME, Nymex, Reuters, SHFE, Macquarie Research 28 April 214 6

7 Macquarie s commodities matrix 3-6 month view Bulk Commodities 3-6 month view Supply Growth Demand Inventory Coking Coal OK Strong Stable Mixed Steel OK OK Stable High Iron ore OK Strong Good Low Thermal Coal Good OK Stable Mixed Looks set to trade at <$15/t for the coming year. Q2 contract likely to be the low however - we expect apparent demand to increase We expect an expansion in steel margins during 214 as sequential utilisation rates rise. Too much steel mill inventory in China however Still concerns over pollution related cutbacks and sentiment weak, but mill inventories have been destocked Supply growth slowing sharply, but still a lot required to fully rebalance this market. However, policy is skewing risk to the upside Base Metals 3-6 month view Supply Growth Demand Inventory Tin OK Poor Stable Low Demand conditions showing improvement after 2 stagnant years. Myanmar has come from leftfield as an alternative supply option Copper OK Strong Good Mixed Uranium OK Poor Weak High Concentrate surplus persists and inventories in bonded warehouses provide overhang, but much of the price fall is in the past. High inventories continue to overhang the market - another which needs China to soak up surplus Lead Poor OK Weak Mixed Poor demand contitions ex-china a headwind, looks well supplied through H1 Aluminium Poor OK Stable High The reversal of the LME rule change should see higher premiums and also a higher all-in price, but has run ahead of itself in the near term Zinc OK Poor Stable High Market looking tighter, with ex-china mine supply dropping. Still some concerns over Q2 demand Nickel Good OK Good High The one commodity market where there is an emerging raw material constraint. We expect an ongoing upward price trend Precious Metals 3-6 month view Supply Growth Demand Inventory Platinum OK Poor Stable Mixed Palladium Good Poor Stable Mixed Silver Poor Stable Stable High Gold Poor Stable Stable High Growing evidence of supply shortages as strike starts to bite. European car market no longer negative Underlying strengths, eg Chinese car sales, should keep palladium firm while strike limits supply. Silver still looks to gold for direction but we think greater risk of investor liqudiation given ample stocks. Gold gets boost from Crimea but potential for improving US economic data to weigh. Source: Macquarie Research, April April 214 7

8 Macquarie s commodities matrix longer term view 12-month view 3-5 year view Coking Coal Neutral Good Despite current woes, the lack of supply growth potential sets it apart in the bulks. $18/t a medium-term norm Steel Poor Poor Global steel market continues to suffer with chronic overcapacity, which will take years to restructure Iron ore Neutral Poor Supply is set to grow, though will underperform expectations. Has more longevity than thought, and will struggle to berak $1/t sustainably Thermal Coal Neutral Neutral Demand is not a problem, but on paper plenty of supply to keep up. Commodity 12-month view 3-5 year view Tin Good Good Differentiated due the the lack of large, scaleable supply which keeps market fundamentals tight into medium term Copper Poor Good Uranium Poor Neutral Market is in surplus However, steep gradient at the top end of the cost curve is underestimated offering medium-term pricing >$7,5/t The market will need more primary uranium supply - just not yet. In the interim any sustained pullback in Chinese imports is a big risk Lead Neutral Good Demand outlook ok if not stellar, but ex-china mine supply struggling to cope Aluminium Poor Poor Do not underestimate the prolonged negative impact of LME Warehousing rule changes coupled with high inventories Zinc Good Neutral Concentrate surplus set to end, elasticity of Chinese mine supply caps upside Nickel Good Good Plentiful nickel ore and NPI capacity set to see a surplus, however there is no easy or inexpensive way to fill an Indonesian ore void Commodity 12-month view 3-5 year view Platinum Good Good Palladium Good Good Silver Poor Neutral Gold Poor Neutral Stronger European demand and weak supply should ensure price gains in 214. Emerging market auto demand offers more demand support than peer platinum, while supply problems are the same Question for silver is whether its greater use in industry can allow it to decouple from gold. We think not, at least on a 12m view. The normalisation of US monetary policy remains a sword over gold's head. Medium-term outlook poor until other sectors shift sufficiently to offset investor fatigue. Source: Macquarie Research, April April 214 8

9 Macquarie commodity price forecasts (from Q2 214) Unit CY CY Q1 Q2 Q3 Q4 CY CY CY CY CY LT $213 Copper $/tonne 7,95 7,322 7,41 6,6 6,5 6,7 6,71 6,625 7,525 7,875 7,963 6,54 Aluminium $/tonne 2,18 1,845 1,78 1,73 1,78 1,85 1,767 1,863 2,75 2,2 2,375 2,2 Zinc $/tonne 1,946 1,99 2,29 1,9 2, 2,1 2,7 2,25 2,4 2,35 2,35 1,875 Nickel $/tonne 17,527 15,3 14,643 16, 16,5 16,5 15,911 17,5 2, 22, 24, 22, Lead $/tonne 2,61 2,141 2,16 1,975 2,18 2,2 2,115 2,344 2,45 2,45 2,4 1,875 Tin $/tonne 21,92 22,35 22,648 21,75 22, 22, 22,1 22,75 22, 23,5 25, 2, LT $213 Unit CY CY Q1 Q2 Q3 Q4 CY CY CY CY CY Manganese ore c/mtu CIF FeCr (EU contract) c/lb Molybdenum oxide $/lb Cobalt (99.8%) $/lb Steel - Average HRC $/tonne Steel Scrap - average #1HMS $/tonne LT $213 Unit CY CY Q1 Q2 Q3 Q4 CY CY CY CY CY Long term Iron ore - Australian fines c/mtu fob Iron ore - Australian lump c/mtu fob Spot 62% Fe iron ore China $/t cfr LT $213 Unit CY CY Q1 Q2 Q3 Q4 CY CY CY CY CY Long term Thermal coal - Australian Spot $/t fob Thermal coal - S.African Spot $/t fob Thermal coal - JFY contract $/t fob Hard coking coal $/t fob Semi-soft coking coal $/t fob LV PCI coal $/t fob Coke - China export spot $/t fob Unit LT $213 CY CY Q1 Q2 Q3 Q4 CY CY CY CY CY Long term Gold $/oz 1,669 1,41 1,293 1,185 1,225 1,215 1,229 1,269 1,39 1,44 1,473 1,25 Silver $/oz Platinum $/oz 1,548 1,486 1,428 1,45 1,55 1,6 1,57 1,75 1,888 1,96 1,975 1,8 Palladium $/oz Uranium spot $/lb Source: CRU, LME, McCloskey, Metal Bulletin, Platts, TEX Report, Macquarie Research, April April 214 9

10 ICSG & ILZSG Study Group data: Stocks, scrap, supply, demand Fig 1 ICSG World Copper Supply and Demand ( tonnes) Jan Jan Change Change 't YoY 't YoY % Mine production 1,539 1, % Capacity Utilisation % 83.2% 83.6% - - Refined Capacity 2,334 2, % Refined production 1,814 1, % Capacity Utilisation % 77.7% 78.5% - - Primary refined 1,173 1, % Secondary refined % SXEW Refined usage 1,866 1, % Raw market balance ICSG "Refined balance adjusted for bonded stock change" Source: ICSG, Macquarie Research, April 214 Slight copper deficit in the first month of the year: ICSG s latest figures have January refined copper output at just over 1.81Mt, which represents 4.1% YoY growth. Consumption was estimated at 1.87Mt implying a raw deficit in January of 53kt. As Figure 2 shows, this is a continuation of the general pattern shown in the data since last April of either deficits or tight balances in the market. Fig 2 Raw balance shows a deficit... Fig 3...but how do bonded stocks impact availability? Kt ICSG raw ref ined copper balance Comparing stock adjustment methods: ICSG v. MQ 3Kt stocks gain goes where?? ICSG Macquarie Production Consumption Bonded stock gain Raw balance Adjusted balance Source: ICSG, Macquarie Research, April 214 Source: ICSG, Macquarie Research, April 214 China bonded stock build loosens ICSG balance...in response to growing evidence of the impact on the market of Chinese bonded stock changes, the ICSG in 214 initiated the inclusion of these stock changes into its numbers in its Refined balance adjusted for bonded stock change. However, Macquarie questions the side of the balance to which this datapoint is being tallied. Due to its mandate of using official data wherever possible, the ICSG (and other metal study groups) must use an apparent consumption figure for China. This logic continues in ICSG s inference that a gain in China s bonded stocks implies lower apparent demand, while a drawdown implies additional consumption. The net result is that a bonded stocking will loosen ICSG s global balance, while a drawdown will tighten it. This seems counterintuitive. 28 April 214 1

11 ..but tightens Macquarie s... Macquarie with many other market analysts builds up a demand view with reference to but not reliance on apparent demand, and so the raw balance already comprises a best estimate of Chinese demand. We therefore see bonded stocking as a markettightening factor, and a drawdown as a move which improves availability. To do the reverse would be to assume that any material drawn out must have been consumed (as opposed to entering any other form of stockpile), while any inflows reduces China s (but no one else s) consumption....leading to divergence on the adjusted balance: As Figure 3 highlights, this leads to divergent views on the state of the balance. A stock change of just 3kt in either direction will lead to a discrepancy of just 6kt, but we believe it is not uncommon for the bonded warehouse volumes to gain or lose 1-15kt in a month. In these circumstances, analysts could potentially find each other with similar raw balances but vastly different views on the adjusted balance. Fig 4 European copper usage vs IP growth Fig 5 Scrap usage steady in 213 European copper usage vs IP growth 2.% 1.%.% -1.% -2.% -3.% European refined copper usage YoY European IP (CPB) 2% % scrap-f ed cathode output 19% 18% 17% 16% 15% 14% 13% 12% 11% 1% Jan-9 Oct-9 Jul-1 Apr-11 % scrap 6M mov. avg. Source: CPB, ICSG, Macquarie Research, April 214 Source: ICSG, Macquarie Research, April 214 European demand continues looking healthier: On the demand side, the European refined copper usage growth figure struck a particularly positive tone, at 5.5% YoY in January. This was the third consecutive month of YoY usage growth exceeding 4.% - supporting Macquarie s positive views on European demand for 214. The continent increasingly appears to have put the worst of the financial crisis behind it, and we are expecting to see growth of 2.7% for the full year. While this pales in comparison to faster growing regions, Europe remains significant as the second-largest consuming region: While recovery here is unlikely to set the global market alight, it should act to fortify copper demand as China transitions to lower growth rates. How tight was scrap really in 213? Referring to Figure 5, the other point we wish to draw attention to was that scrap usage as a percentage of cathode output was steady in 213, albeit with a usage slump in Q2 in the immediate aftermath of the price shocks of March/April. According to ICSG s figures, overall the percentage of cathode produced from scrap amounted to 18.1% in 213, up from 17.8% in 212. Scrap tightness was widely reported last year, particularly in China, so this result seems perhaps surprising. Indeed, Chinese scrap use increased in the second half which matches the timing of the easing of the green fence cargo inspection measures. 28 April

12 1 Jan 213 = 1 Zinc and Lead The refined zinc market recorded a small 6kt deficit in Jan-Feb 214, while the refined lead market posted a 16kt deficit, according to numbers published by the International Lead and Zinc Study Group (ILZSG) on Tuesday. YoY the net swing in the zinc balance was -59kt, while in lead it was -14kt; suggesting that positive momentum has been on the side of zinc. Relative price performance, both since the start of 213 and since the start of this year, supports this thesis. Fig 6 ILZSG world zinc and lead production, consumption and market balances ( tonnes) Zinc market Lead market Jan-Feb 213 Jan-Feb 214 YoY ch Jan-Feb 213 Jan-Feb 214 YoY ch World total Mine production 1,871 1, % % Refined metal production 2,27 2, % 1,697 1,71.7% Refined metal consumption 1,974 2, % 1,699 1, % Refined metal market balance Refined metal market balance 2.7% -.3% -.1% -.9% China Mine production % % Refined metal production % % Refined metal consumption % % Rest of world Mine production 1,355 1, % % Refined metal production 1,274 1, % 1,3 1,33 3.% Refined metal consumption 1,166 1, % 1,55 1,45 -.9% Source: ILZSG, Macquarie Research, April 214 The LME lead price has fallen 2.7% YTD, while the zinc price has dropped.6%. This has meant that the lead/zinc price ratio is now close to parity, having broken below that level for a brief period at the start of March. There are good fundamental reasons to believe that in short-term, this relative zinc price strength can be maintained (even if this involves the zinc price falling by less than lead). We look at the key fundamental conditions for both metals below. Fig 7 LME Zinc significantly outperforms sister metal and base complex Fig 8 The lead/zinc price ratio moving towards parity Zinc Lead LMEX Jan 13 Apr 13 Jul 13 Oct 13 Jan 14 Apr 14 Jan 13 Apr 13 Jul 13 Oct 13 Jan 14 Apr 14 Source: LME, Macquarie Research, April 214 Source: LME, Macquarie Research, April April

13 3MMA, YoY % change US$/tonne 211 Q1 211 Q2 211 Q3 211 Q4 212 Q1 212 Q2 212 Q3 212 Q4 213 Q1 213 Q2 213 Q3 213 Q4 214 Q1 YoY % change m tonnes, 12MMA annualised Fig 9 World galvanised steel sheet output 14% Fig 1 Global zinc mine and refined output 14 12% 1% 13 8% 12 6% 4% 11 2% % 1 Mine output Refined output 9 Jan 7 Jan 9 Jan 11 Jan 13 Source: CRU, Macquarie Research, April 214 Source: ILZSG, Macquarie Research, April 214 ILZSG estimates that global zinc consumption rose 8.3% YoY over the first two months, led by Chinese consumption growth of 14.1% YoY. There is a possibility that this number is overstated, given that the ILZSG data account for refined stock moves only, but nevertheless world galvanised steel sheet output is estimated to have grown by ~5% YoY in 1Q and other consuming sectors, such as tyres, might have benefitted from a recovering global autos market. As we move into the Northern hemisphere spring, demand conditions for zinc should get incrementally more positive in line with seasonally stronger steel production. This is as against just 1.5% YoY growth in lead usage, of which Chinese consumption is estimated to have risen 5.5% YoY and ex-china fallen by.9% YoY, according to ILZSG. This ex- China drag comes despite the polar vortex in North America, which should have propped up replacement battery demand (although the ILZSG usage data doesn t reflect that), while demand conditions in Europe were weak owing to an extremely mild winter. Unlike zinc, consumption should be incrementally more negative as the Northern hemisphere spring brings with it warmer weather and fewer battery failures. Mine supply growth for both zinc and lead surprised to the upside in Jan-Feb, with zinc up 6.2% and lead up 8.3%. Both China and ex-china posted strong numbers. We would caution against reading too much into this data, given that January and February tend to be the weakest months for mine output seasonally, amplifying base effects. However, given the much larger relative importance of zinc mine output, this will be important to watch going forward. While the effects of ex-china mine supply shutdowns on zinc are well documented, Chinese mine supply remains the black box. Antaike estimate that almost 3kt zinc contained of new mine capacity will be added in 214, mostly in Inner Mongolia, representing around 6% YoY growth. Fig 11 North American battery shipments benefit from polar vortex Fig 12 Lead spot premiums point towards a market that is not tight at present 15% 1% 5% % -5% -1% Jan 1 Jan 11 Jan 12 Jan 13 Jan 14 Jan 11 Jul 11 Jan 12 Jul 12 Jan 13 Jul 13 Jan 14 Source: BCI, Macquarie Research, April 214 Source: ILZSG, Macquarie Research, April Singapore USA del. Eur EXW 28 April

14 Zinc metal production outperformed. Zinc metal production is estimated to have outperformed lead in the first two months, though the negative YoY growth in Chinese refined lead output does not reconcile well with alternative information sources. Strong zinc metal production growth should be seen within the context of current TCs providing sufficient incentive for smelters to process concentrates into metal (unlike in 212 when concentrate availability was plentiful but process fees were low), as well as a market that is still more than adequately supplied with raw material. In many ways, this is the primary reason to not get bullish too soon on zinc, while large global stocks of metal will also have to be worked through (including on LME). 28 April

15 Jul-11 Aug-11 Sep-11 Oct-11 Nov-11 Dec-11 Feb-12 Mar-12 Apr-12 May-12 Jul-11 Aug-11 Sep-11 Oct-11 Nov-11 Dec-11 Feb-12 Mar-12 Apr-12 May-12 Jul-11 Aug-11 Sep-11 Oct-11 Nov-11 Dec-11 Feb-12 Mar-12 Apr-12 May-12 China steel survey: Sales rebounding After several months of poor data, the April results of our proprietary steel sector survey (in which we interview 4 steel mills, 3 steel traders and 3 iron ore traders) are showing signs of recovery. The steel traders are reporting a significant uptick in sales, profitability at the smaller mills has rebounded strongly and inventory is starting to normalise. Fig 1 Sentiment has improved in April the steel traders are the most positive 1 Are you positive or negative on the market over the next three months? Increasing number of respondents positive Mills Steel traders Increasing number of respondents negative Iron ore traders Source: Macquarie Research, April 214 Sales and orders: Steel traders seem to have been the first to feel the improvement in market conditions and are registering a strong improvement in sales in April compared to March. Steel mills orders are still reported to be contracting although by a lesser degree than March. Fig 2 Steel traders have seen a strong rebound in sales Fig 3 Orders at mills are recovering more slowly Have sales volumes increased or decreased? Large Traders (>1mtpa) Medium Traders (.5-1mtpa) Small Traders (<.5mtpa) Increasing no. of traders seeing sales rise Have domestic orders increased or decreased over the last month? Increasing no. of mills seeing orders rise Increasing no. of traders seeing sales fall Large Mills (>1mtpa) Medium Mills (5-1mtpa) Small Mills (<5mtpa) Increasing no. of mills seeing orders fall Source: Macquarie Research, April 214 Source: Macquarie Research, April 214 One of the key differences in orders between the mills and traders has been sales to other traders. While traders report a strong rebound in sales to their peers, mills are yet to see any improvement in these orders. One explanation for this is that the whole-sale traders that buy from the mills are still in destocking mode and as such they are happy to see sales increase without going back to the mills to top up (this would also fit with Mysteel data that shows an extremely fast draw down of steel trader inventory over 214 to date). Meanwhile, smaller retail traders that purchase steel from the larger traders and that were perhaps less active over the turbulent and cash strapped first quarter may now be getting more active. 28 April

16 Jul-11 Aug-11 Sep-11 Oct-11 Nov-11 Dec-11 Feb-12 Mar-12 Apr-12 May-12 3Q8 4Q8 1Q9 2Q9 3Q9 4Q9 1Q1 2Q1 3Q1 4Q1 1Q11 2Q11 3Q11 4q11 1Q12 2Q12 3Q12 4q12 1Q13 2Q13 3Q13 4Q13 1Q14 Real steel demand, mtpa YoY Jul-11 Sep-11 Nov-11 Mar-12 May-12 Jul-11 Sep-11 Nov-11 Mar-12 May-12 Fig 4 Steel traders have seen a sharp increase in orders from other traders Fig 5 Meanwhile mills have not yet seen a meaningful uptick in orders from traders 2 15 Net change in orders at traders - downstream and traders Downstream steel processing Traders 15 1 Net change in orders at mills - downstream and traders Downstream steel processing Traders Source: Macquarie Research, April 214 Source: Macquarie Research, April 214 Looking at the other end use sectors, construction and infrastructure have driven sequential strength in demand over the last two months. Other sectors have been more muted although we note this contrasts with feedback from our own discussions with mills and also the results of our copper survey that pointed to improving demand from the manufacturing sectors as well as strong construction orders. Overall, despite the negative sentiment over the first quarter, steel demand looks to have been fairly robust over the start of 214. Taking the official NBS production numbers which have shown growth of 2-2.5% YoY over 1Q, adjusting for trade and factoring in changes in steel inventory (a much smaller build over January and February than in previous years and a drawdown since that has been much faster) we estimate real steel demand (perhaps more accurately thought of as end user purchasing) grew 5-7% YoY over 1Q14. We arrive at similar numbers using the CISA estimates of production and inventory change at its member mills. Fig 6 Construction and infrastructure orders have driven the sequential improvement in demand Fig 7 Steel demand growth has beaten expectations over 1Q Net change in orders at mills and traders - end use sectors "Real" Consumption YoY Chinese steel demand 5% 4% 3% 5 2% Construction Infrastructure Machinery Autos -4 White goods Shipbuilding % % -1% -2% Source: Macquarie Research, April 214 Source: NBS, China Customs, Mysteel, Macquarie Research, April 214 Production and profitability: Despite relatively modest increases in steel prices over the last month (rebar prices have only risen.5% MoM), steel spot prices have significantly outperformed a combined basket of raw material inputs mostly due to collapsing coking coal prices. This has had a very positive impact on the profitability of the smaller mills that are holding low levels of inventory they have gone from being the least profitable in recent months to the most profitable in the April data. 28 April

17 Jul-11 Aug-11 Sep-11 Oct-11 Nov-11 Dec-11 Feb-12 Mar-12 Apr-12 May-12 Jul-11 Aug-11 Sep-11 Oct-11 Nov-11 Dec-11 Feb-12 Mar-12 Apr-12 May-12 Days of sales - traders Days of sales - mills Apr-12 Jul-11 Aug-11 Sep-11 Oct-11 Nov-11 Dec-11 Feb-12 Mar-12 Apr-12 May-12 US$/tonne Fig 8 Steel prices have outperformed combined raw material costs Fig 9 improving the profitability of smaller mills Implied cash margins at Chinese mills What is the current level of profitability? 1 Increasing no. of mills making money 9 7 Rebar HRC Large Mills (>1mtpa) Medium Mills (5-1mtpa) Small Mills (<5mtpa) Increasing no. of mills losing money Source: Macquarie Research, April 214 Source: Macquarie Research, April 214 With profitability improving at the mills, production is now starting to tick up. Indeed if the official reported March production number is anything to go by, output has already been rising. Given that steel margins have opened and inventory has fallen (see below), it is hard to argue that production is excessive at this point. Fig 1 Utilisation rates are heading higher in April Fig 11 Steel trader inventory has been falling, although mills inventory is still elevated What is your current capacity utilisation rate? - % basis What level of steel inventory are you currently holding? 1% 26 Traders 16 95% Mills % % 8% 75% Large Mills (>1mtpa) Medium Mills (5-1mtpa) Small Mills (<5mtpa) Source: Macquarie Research, April 214 Source: Macquarie Research, April 214 Raw materials: Given the improvements in sentiment and profitability, it is not surprising that mills are planning to step up purchases of both iron ore and coking coal. Over the last month, mills report stable inventory for iron ore and some continued destocking for coking coal. As we have previously argued, the end of destocking should be positive for raw material prices over the coming months, although with steel demand looking stronger than expectations and with continued production restrictions still in place, we wonder whether steel mills might be the biggest beneficiaries of the apparent upturn in market conditions. 28 April

18 Jul-11 Aug-11 Sep-11 Oct-11 Nov-11 Dec-11 Feb-12 Mar-12 Apr-12 May-12 Jul-11 Aug-11 Sep-11 Oct-11 Nov-11 Dec-11 Feb-12 Mar-12 Apr-12 May-12 Fig 12 Coking coal continues to be destocked while iron ore inventory is stable Fig 13 Mills are reporting plans to moderately increase purchases of both iron ore and coking coal Is raw material inventory rising or falling? Increasing no. of mills with falling inventory Do you plan to increase or decrease raw material purchases? Iron ore Coking coal Increasing no. of mills planning to raise purchases 2 Iron ore 2 1 Coking coal Increasing no. of mills with rising inventory 1 Increasing no. of mills planning to reduce purchases Source: Macquarie Research, April 214 Source: Macquarie Research, April April

19 Copper Survey April 214: better mood; more orders; tighter supply Macquarie s proprietary copper survey for April reveals a continuous improvement in copper demand from end-use sectors and expects a further strengthening in demand moving into the next few months. Meanwhile, relatively modest availability of refined copper supply is tightening up the domestic market, which should ultimately attract more copper inflows from the bonded areas. Market participants have been turning more positive in their views in April. However, the challenging financing conditions are still pressuring small and medium-sized copper fabricators and traders, which undermines purchasing capability for copper from downstream consumers. End-use demand recovering Our proprietary copper survey shows Chinese copper demand has continued to improve sequentially in April. Copper fabricators are receiving increasing orders from end-use sectors such as power, construction, white goods and transportation this month presenting a brighter picture than that seen in March. The uplift in copper demand is mostly coming from power and construction sectors as we move into the traditional peak season; with a notable pickup in orders from the white goods sector also helping to support demand. Fig 1 Orders from end-use sectors are rising Fig 2 Fabricators expect a further sales rise in May Net change in orders at copper fabricators - end use sectors Power Construction Machinery White goods Transportation Others Do you expect sales to rise next month? Increasing no. of fabricators expecting sales to rise Large Fabricators (>2ktpa) Medium Fabricators (1-2ktpa) Small Fabricators (<1ktpa) Increasing no. of fabricators expecting sales fall Source: Macquarie China Copper Survey, April 214 Source: Macquarie China Copper Survey, April 214 Consistent with the survey results, our further channel-check with major cable producers suggested an uplift in their capacity utilization from sub-6% in March to 88-9% at present, up around 5% YoY. Most of the orders are coming from ongoing construction projects and power grid projects (especially high-voltage projects, but orders from medium-voltage projects are not very strong). The State Grid has completed its first round of tendering for grid projects in mid-april, with most of the contracts being high-voltage projects whose delivery period starts in June and lasts into 2H14. However, individual cable producers retain conservative views on copper demand for this year, with the main reasons including; the absence of an obvious increase in orders from new construction projects; and the tight credit availability undermining the cable producers appetite for extra restocking. Major wire rod fabricators still maintain their run-rate above 85% in April and expect the current strength to continue into the upcoming month. As the industry has been consolidating, this year has seen increasing cases of bankruptcy/shutdowns in the industry. Many small wire rod plants in the Eastern region have been forced out of business due to financial chain fracture and their weakening competitiveness in a market with more entrants of bigger size and integrated upstream supply. However, the fast capacity expansion by larger wire rod fabricators implies that even a flat YoY growth in their capacity utilization rate means an increase in the total copper consumption. 28 April

20 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Household air-conditioner (A/C) production has been grew by 1% YoY in 1Q14, according to China Industry Online an industry portal. A/C production peaked at 13.4m units in March, up 7% YoY naturally production will normalize after the traditional peak in March for production but the de facto schedule depends on the sales from March to May. This year, the A/C sales recorded a 1.5% YoY and 72.3% MoM growth in March, as a result of which, A/C inventory declined by 6% MoM to 7.2m units by end-march. In line with the seasonal performance of the A/C sector, major tube fabricators are currently running their capacity at full swing as they have reported a rising order book from downstream customers in April. Fig 3 A/C production running robustly in 1Q14... Fig 4...and inventory has been drawn down ' units 14, 12, 1, Household Air-conditioner Output ' units Househouse Air-conditioner Inventory 12, 1, 8, 8, 6, 6, 4, 4, 2, 2, Source: IndustryOnline, Macquarie Research, April 214 Source: IndustryOnline, Macquarie Research, April 214 Facing a rising order book, copper fabricators increased their inventory of raw materials. With a higher capacity utilization rate, a stable inventory level in terms of weeks of use means increasing purchases for raw materials in absolute terms. Major cable producers and some fabricators raised their raw materials inventory from less than three days of use in March to one week of use this month, although some tube fabricators reported 1-2 weeks of stocks as usual. With relatively low inventory of raw materials, smaller fabricators should be more inclined to purchase more raw materials than larger ones. Being pressured by tight credit, however, few of these fabricators have a strong appetite for restocking. Fig 5 Copper inventory is rising at fabricators Fig 6 smaller fabricators are planning to buy more Is refined copper inventory higher or lower than normal? Increasing no. of fabricators reporting low inventory Large Fabricators (>2ktpa) Medium Fabricators (1-2ktpa) Small Fabricators (<1ktpa) Increasing no. of fabricators reporting high inventory Do you plan to increase or decrease refined copper inventory? Large Fabricators (>2ktpa) Medium Fabricators (1-2ktpa) Small Fabricators (<1ktpa) Increase inventory Decrease inventory Source: Macquarie China Copper Survey, April 214 Source: Macquarie China Copper Survey, April April 214 2

21 Q112 Q212 Q312 Q412 Q113 Q213 Q313 Q413 Q114 Q214 Q314 Q414 Tight available supply of refined copper in domestic market The National Bureau of Statistics (NBS) reported that China produced 1.65mt of refined copper in 1Q14, up 7% YoY. While we acknowledge the upward trend, we have made some adjustments to the data based on considerations for double-counting and over-reporting issues. We estimate that 1.53mt is more reasonable for refined copper production in 1Q14, up 6.7% YoY (from our 1Q 213 base number, also adjusted compared to the NBS data). Fig 7 Relatively modest production in 1Q14 Fig 8 Rising capacity utilization for copper smelters ' tonnes 2,5 2, 1,5 1, 5 - Chinese refined copper production Refined copper production, quarterly (LHS) YoY growth % (RHS) % 95% 9% 85% 8% 75% 7% 65% What is your current level of capacity utilisation? Large Smelters Medium smelters Small Smelters Source: Macquarie China Copper Survey, April 214 Source: CNIA, Antaike, BGRIMM, Macquarie Research, April 214 From March to April, our survey result shows a flattish trend in copper smelters capacity utilization, which seems a bit understated due to the limitations of our sample size. We understand that one of the responding large smelters hasn t really restarted their furnace after maintenance work yet (a furnace in central China was halted for maintenance in March). Meanwhile, a medium-sized smelter has reduced production by around 6% due to technical problems since late March. Such cases tend to distort the de facto production activity for refined copper in our survey. However, our separate channel-check suggests a higher capacity utilization rate in April for the copper smelting industry as a whole. Apart from those major smelters who have already realised good margins from exporting copper to the bonded areas, smaller ones that are not qualified to export copper under tolling business are also making an improving margin from a surging domestic premium in April. Fig 9 Smelters motivated to export copper... Fig 1 which tightens up domestic market Have export orders increased or decreased? Increasing no. of smelters seeing orders increase Large Smelters (>5ktpa) Medium Smelters (25-5ktpa) Small Smelters (<25ktpa) Increasing no. of smelters seeing orders decrease ' tonnes (1) (2) SHFE stock change (LHS) (3) Domestic physical premium, RMB/t (RHS) (4) (1) (2) (3) Source: Macquarie China Copper Survey, April 214 Source: SHFE, SMM, Macquarie Research, April April