Metal Miner: The Impact of Brexit

Brexit isn’t a big factor in the U.S., said Reisman, but what is important is to watch is the spread between domestic and foreign steel prices which could trigger more imports. If service centers restock with foreign imports there will be more pressure on prices.

The U.S. dollar is strong right now but that may not be sustained long term. The Federal Reserve is holding off on raising interest rates. After the initial storm through the EU and UK, currencies will eventually find stabilization, said Reisman.

Overall, Brexit will cause a short term effect on commodities due to the link with the US dollar. But longer term supply and demand dynamic will drive prices and Metal Miner doesn’t expect Brexit to have a significant impact on ferrous metals or other industrial metals.

“Brexit was a long time in the making,” said Reisman. Some think the seeds of the EU’s unmaking were sown 15 years ago. “The issue to us is the decoupling of that unfettered labor market from the single trading market and a lot of the vote was around immigration.”

The other piece of the equation, said Reisman, is that the architecture of the financial system is flawed. “Quantitative easing has created these very large spikes or other black swan events like the great recession.”

“We believe Brexit will have far reaching implications for a broad range of industries,” said Reisman.

Aircraft makers will be affected by the lack of regulatory clarity, and launch aid, funded by the EU to set up aerospace investment, could be jeopardized.

The energy sector could be affected if the EU bans the UK from selling surplus electric capacity back to Europe.

One of the most significant manufacturing impacts may be in the chemical industry. The EU REACH framework, which allows for shared standards and central registration that permits the sale of chemicals to all member states, will have significant supply chain complications that could cause companies to refrain from trading with UK suppliers.

Currency swings are a concern for the food and automotive industries.

From a commodity perspective, the UK hasn’t mattered for a long time, said Reisman, since almost all the major commodities are traded in US dollars. The UK is not a global giant in terms of commodity demand, but there is interplay between the UK and EU and the effect on global commodity demand. It is likely to be insignificant, however, unless the aftermath of Brexit triggers some broader macro- economic meltdown, but that doesn’t seem to be the case. The global stock market seems to be recovering.

Following the Brexit vote the British pound and euro fell sharply and the dollar gained against the currencies. Commodities are priced on the US dollar and thus are negatively correlated to dollar fluctuations. A rising dollar has added some pressure to the market in the past week, said Reisman.

Industrial metals, including non-ferrous metals, are currently outperforming commodities. Industrial metals continued to climb after the initial panic. On the demand side, China is the biggest consumer of industrial metals and is the driver of the industrial metal bull market.

Precious metals gained due to their perception as a safe haven. If the global stock market turmoil continues, that should benefit performance of precious metals. The actions taken by world banks will also have a big impact on the dollar.

Stuart Burns, a UK national, gave his perspective on how Brexit will affect the UK and Europe. The United Kingdom will need to formulate some new trade agreements, he said. Exports to the EU from the United Kingdom are a much greater percentage of GDP than the reverse would be to the EU, putting the UK at somewhat of a disadvantage in negotiations. Trade is lopsided with trade from the EU mostly with Germany and France.

The process of exiting the EU will take two years but the formation of new trade agreements may take longer, said Burns. A free trade agreement with the US could be an advantage to the UK as well as free trade agreements with other countries outside of the EU.

The possibility of other exits from the EU is a major concern for Brussels. France and Germany, the EU’s largest core states, are holding general elections next year. The financial strain of the Northern states bailing out the southern states could result in separatist movements that could unravel the EU.

The short term risk is currency volatility. The European banking system is under strain and banking stability is a major concern. Italy is the furthest in debt and many Italian banks would fail a stress test today, said Burns. Bank failures are likely and the question is how many and how soon?

Britain was a moderating influence in the EU which favors control, regulation and relatively higher taxation. Burns said there may be a less business friendly culture in the EU over time.

There are a number of risks for procurement.

Trade conditions will not immediately change due to the referendum. EU prices will become less favorable and the UK may use more domestic sources. A decision to tighten borders will increase regulations for labor and business travel. Such changes could have far reaching impacts on supply chains. Import prices could be pushed up, although many businesses may have hedged until the end of the year at which time there will be a depreciation of the UK currency. Administration of imports could become more complex.

According to Metal Miner, surveys have shown that 75 percent of approximately 500 procurement firms were firmly on the side of the “remain” campaign. Few thought an alternative relation with the EU would be easier or lower cost than a single market on a day to day basis, said Burns.

Another issue is that the UK has been successful in harmonizing standards, many of which were set by the EU. If British companies want to remain compliant with EU standards and trade freely on those standards, they will need to establish an EU entity in Britain, said Burns. British firms that are reliant on EU trade will find a way to stay compliant and maintain harmonization, they just won’t be required to by law, said Burns.

Even after currency stabilizes, import tariffs and regulation will cause import costs to remain higher than they would have been relative to Europe as whole.

The impact on procurement and prices will depend on what kind of trade agreement model the UK negotiates with Europe.

Metal Miner discussed three likely possibilities. The first is the Norwegian EAA model which is the favorite of the business community and least disruptive. Norway is not part of the EU but has access to the single market. It pays into the EU budget and must allow free trade of labor with no say in establishing regulations it must stay compliant with. The lack of control over immigration from the EU may not be agreeable to the UK.

The second would be to negotiate a free trade model. This is the least bad option, said Burns. While having a certain level of tariffs, if structured favorably it would allow the UK to work with the EU and to also lower tariffs with countries outside the EU.

The third possibility is a hard exit, which no one is seriously contemplating. It would involve no deal and would rely on WTO trade rules

During the question and answer period Burns was asked if the EU will be better off or worse by 2020. By then the UK will have exited the EU and established some kind of new relationship. Whether the EU will be better or worse, no one knows, said Burns. If the UK establishes a free trade model with relatively low levels of tariffs for imports and exports (or duty free), and is not badly penalized in other ways, the UK has a chance to flourish outside the EU by 2020-2022. Burns however says it is more likely the UK will face a hit and possible recession between now and then. “I think we will be well into the next decade before we can tell,” said Burns.

Another question concerned the long term outlook for the euro. “The euro model is flawed,” said Burns. “To succeed you need a federalized Europe.” Most of the population of Europe is against a federalized Europe, he said. When the economy was better people were more relaxed about a closer union, but with the northern states having to bail out the southern states it has changed public sentiment. Also the influx of immigrants, particularly from Syria, was a culture shock that has diluted the population’s trust of politicians. “Without a closer union I don’t think the euro will survive,” said Burns.

Reisman summed up her thoughts on Brexit with a warning to buyers: “Brexit and its aftermath will likely add volatility to markets and for buyers, which makes it even more critical for buying organizations to really have a strong purchasing strategy and to know how they will possibly react to changes in market dynamics.”

SMU Note: Lisa Reisman will be speaking and providing steel and metals forecasts at our 6th Steel Summit Conference on August 29-31, 2016. Details as to the exact timing of her speech and information about our full program can be found on our website: www.SteelMarketUpdate.com.