FOCUS - Falling yuan eases pressure for Chinese production cuts - JP Morgan

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Kathleen Retournekathleen.retourne@fastmarkets.comJoint News Editor - Europe+44 (0) 20 7337 2144

London 08/01/2016 - The weakening of the yuan since the start of 2016 may ease the pressure that prompted some Chinese producers to announce output cuts, JP Morgan said.

After a record yearly loss against the dollar in 2015, the Chinese currency has fallen more than 1.5 percent in this week alone, unsettling the market by coinciding with an equity crash there.

The Chinese currency hit a five-year low of 6.5956 on Thursday and could fall another three percent by mid-2016 and five percent by the end of the year, JP Morgan warned in a note on Friday.

"The yuan depreciation skews bearish for industrial metals, as it diminishes the purchasing power of Chinese buyers and lowers the dollar-denominated costs of Chinese producers," it said.

The base metals have been beset by oversupply and a slowdown in global growth, which has pushed prices to multi-year lows.

As 2015 ended, it became clear that the trend was not going to reverse, prompting several Chinese producers to vow to cut production of copper, aluminium, zinc and nickel.

But the yuan devaluation makes Chinese mining and production costs relatively cheaper in dollar terms, further insulating base metal producers from margin pressures brought about by lower prices, JP Morgan said.

"As some Chinese producers have costs near marginal levels, any decrease in dollar-denominated costs works to lower the broader price support floor," the broker added.

But even before the yuan started to decline, market participants were sceptical that these cuts would even take place.

As well, a further depreciation in the yuan could trigger depreciation in other emerging currencies, which in turn could lead to further yuan depreciation against the dollar.

The continued devaluation of the yuan - whether tacitly allowed or explicitly decreed by Beijing - has resulted in investors questioning if it is motivated by and/or evidence of persistent economic weakness in China, JP Morgan said.

Adding to concerns is the slump in equity markets this week. Seven-percent drops on the SCI on two days this week triggered a recently implemented circuit breaker. With short selling in shares having been banned last summer, traders took to shorting the copper market instead, sending the red metal to its softest since May 2009.

Following mass uncertainty and the onset of panic, China suspended the use of the circuit breaker. Markets reacted favourably - the SCI ended 1.97 percent higher at 3,186.412 - but concerns persist.

"The uncertainty and anxiety that has been created both in equity and currency markets by new Chinese policy has likely exacerbated selloffs of stocks and the yuan devaluation," JP Morgan said.

There is little to cheer for the first quarter, it added. China will be absent from February 8 for the New Year, which will weigh on metal demand. Oversupply will be the catalyst for the poor quarter, compounded by macro factors and currency devaluation, the broker said.

It continues to forecast an average cash copper price of $4,300 per tonne over the quarter, implying further downside in spot prices.

Aluminium and zinc will both trade into the $1,300s on a spot basis, it predicted, with aluminium averaging $1,400 and zinc $1,450 over the quarter. Nickel will average $8,000 in the first quarter, it forecast.


(Editing by Mark Shaw)



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