News focus: Key chemical leading indicator turns down

07 June 2013 09:59  [Source: ICB]

The global chemical market may be at a key turning point, according to equity analyst Paul Satchell

Identifying key market turning points is the holy grail of buyers and sellers of chemicals. 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," said Paul Satchell, UK-based analyst at global investment bank Canaccord Genuity. "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.

"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 said.

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 calculated simply by subtracting the number of falling prices from the number of rising 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.

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 explained.

"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 falls 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 was 49.0% for May (released 3 June) - down 1.7 percentage points from April and indicating contraction for the first time since November 2012.

Any PMI reading under 50% indicates contraction, while a reading over 50% shows expansion.

The six industries reporting contraction in the PMI included chemical products, and plastics and rubber products.

"Customers are anticipating resin price decreases and holding back orders," said one ISM survey respondent in the plastics and 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, albeit weaker than the 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, although 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 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. Satchell also called 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 downturn in autumn 2008, the Chemicals Volume Proxy turned down sharply into negative territory in July. The low point came in November 2008, when the index fell below -30 for the first and only time.

"Timing is a crucial factor in interpreting the data," said Satchell. "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. 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."

By: Joseph Chang
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