INSIGHT: Leading indicator signals downturn in chemicals

06 June 2013 16:04  [Source: ICIS news]

By Joseph Chang

NEW YORK (ICIS)--Identifying key market turning points is the holy grail for buyers and sellers of chemicals. And one important leading indicator is signalling a global downturn in commodity chemical demand in the near-to-medium term, according to one equity analyst.

“Following its recent marked upswing, the Chemicals Volume Proxy has now peaked and returned to a downtrend. While the change is reasonably broadly based, we note that the intrinsically volatile aromatics and intermediates component has been a substantial factor in the latest move,” said Paul Satchell, UK-based analyst at global investment bank Canaccord Genuity.

“In contrast, the polymers segment remains on an uptrend, which is often a bullish signal. But in the current context, this could indicate ongoing trader activity,” he added.

The Chemicals Volume Proxy is a leading indicator developed by Satchell based on weekly changes in spot prices of 33 products across the US, Asia and Europe, as assessed by ICIS. The index is simply calculated by the number of rising prices minus the number of falling prices.

“Our basic premise is that the trends of petrochemicals spot prices can be usefully indicative of the volume trends in basic chemicals more broadly,” said Satchell.

Chemicals Volume Proxy by Product Index Chemicals Volume Proxy by Region Index

Since most chemical trade is done on a contract basis, sudden changes in demand will have a more profound and immediate impact on spot prices, he explains.

“Therefore, when most spot prices are rising, it indicates strong demand. When most prices are falling, demand softening is indicated,” Satchell said.

Now the Chemicals Volume Proxy is signalling a turn as it moves lower and dips into negative territory.

“We see no logical grounds for optimism on demand for basic chemicals in the near term, outside the US. From a top-down perspective, the macro picture in key markets, Europe and China, remains bleak and uncertain, respectively,” said Satchell. “With austerity in Europe and little appetite for stimulus in the key Chinese market, credible drivers for demand recovery outside the US appear somewhat scarce.”

But interestingly, on a regional basis, the US is showing the sharpest downturn in the Chemicals Volume Proxy.

This coincides with a fall in the key ISM US Manufacturing PMI (Purchasing Managers’ Index), which came in at 49.0% for May (released 3 June) – down 1.7 percentage points from April and indicating contraction in the US manufacturing economy for the first time since November 2012.

Any reading of the PMI under 50% indicates contraction while any reading over 50 indicates expansion.

Of the six industries reporting contraction in the PMI, two were Chemical Products, and Plastics & Rubber Products.

“Customers are anticipating resin price decreases and holding back orders,” said one ISM survey respondent in the Plastics & Rubber Products sector.

Another respondent in the Chemical Products sector reported softer year-on-year demand in both domestic and export markets.

Interpreting the Chemicals Volume Proxy movements this year, Satchell pointed out that following a moderately positive start to the first quarter (though less than usual seasonal strength), the index took a sudden turn down into materially negative territory.

The downtrend bottomed in late March when a volatile global benzene market drove a surprise reversal of the trend, though it remained in negative territory.

The uptrend since then was “sustained, in our view, by trader activity in Asia – essentially speculation on a recovery in genuine industrial demand,” said Satchell. Now it has peaked and turned down again.

The Chemicals Volume Proxy has signalled key market turns in the past, noted Satchell. The index fell sharply on 24 May 2011, ahead of a major downturn in chemical share prices. The analyst also made a call on a downturn on 2 April 2012.

“Since the methodology was originally conceived in 2004, it has proved to be a reliable, real-time indicator for trends in volume demand in petrochemicals markets,” said Satchell.

Ahead of the devastating downturn in the fall of 2008, the Chemicals Volume Proxy turned down sharply into negative territory in July 2008. In the midst of the collapse, the low point in the index was reached in November 2008 when it fell below -30 for the first and only time.

“Timing is a crucial factor in interpreting the data. Spot prices offer a good window on immediate demand for the specific products. However, they inevitably lag the root causes of the movement, whether it be oil price movements or shifts in end-use demands,” said Satchell.

“We would not claim this approach to be absolute or definitive. It is an intentionally blunt instrument, in that it aggregates a reasonably large number of product movements,” he added.

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By: Joseph Chang
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