China's growing COVID-19 wave hits metal supply chain

Surging infections after China scrapped most of its COVID-19 restrictions in early December 2022 have dealt a blow to the metal supply chain and are likely to depress commodity demand in the first half of 2023.

The disruptions are leading companies to shut down or slash production earlier than normal ahead of the Lunar New Year break as downstream industries reduce orders. The public holiday starts Jan. 21.

China's official Manufacturing Purchasing Managers Index, a key gauge of factory activity, fell to 47.0 in December 2022, indicating a contraction and the lowest level since February 2020.

An increasing number of electric arc furnace, or EAF, plants, which mainly melt scrap steel, have begun early holiday shutdowns since mid-December 2022 as the COVID-19 surge affected raw material supplies and shipments. The operating rate of EAF plants that mainly produce steel for construction sank 28.26 percentage points year over year to 21.97% as of Jan. 3, according to Shanghai Metals Market.

The COVID-19 wave has further constrained aluminum bar production, which was already under pressure from power rationing. Aluminum bar manufacturers had an operating rate of 46.06% in December 2022, down 6.16 percentage points year over year, according to AZ China. Given the COVID-19 uncertainties and fewer new orders, some medium and small aluminum profiles producers in Shandong and Jiangsu provinces set early cutoff dates in late December 2022, more than 20 days before the Lunar New Year holiday period, while some small producers in Foshan city in Guangdong province asked migrant workers to return home, according to AZ China's Dec. 29, 2022, report.

Demand for rebar steel, which is used in the construction sector, is forecast to drop 27% year over year in January, as around 41% of downstream companies plan to start their holiday break more than two weeks earlier, according to a survey by Mysteel on Dec. 28, 2022.

"The economic shocks from the COVID waves are likely to gradually ease only after the first quarter, or even [the] second quarter," Li Shuang, a researcher at Mysteel, said at a Jan. 3 conference.

Demand recovery, especially for ferrous metals, will be slow despite China's property stimulus measures, Li said. The property sector accounts for more than 20% of China's industrial metals demand. In the most optimistic scenario, commercial property sales could improve after the second quarter and then drive commodity demand.

Global economic risks

COVID-19 infections have peaked in some of China's largest cities, but many think the worst is yet to come.

"We believe the incoming migration around the [Chinese New Year] holiday in late January could bring about an unprecedented spread of COVID and severe disruptions to the economy," Nomura analysts wrote in a Dec. 28, 2022, note.

Known as Chunyun, the world's largest annual mass human migration will span Jan. 7 to Feb. 15, and millions of migrant workers will travel between large cities and hometowns in the countryside. At the same time, China is ending all quarantine requirements for inbound travelers from Jan. 8.

"Despite the substantial resources devoted to the heavy-handed zero-COVID policy over the past two years, China appears unprepared for a massive wave of COVID infections, and it may find itself in a difficult situation owing to its procrastination on embracing a 'living with COVID' approach," the Nomura note said.

Economic contraction outside China would also slow the commodity demand recovery.

"Even though the Chinese government is working hard to open the domestic economy with an easing of COVID measures or even eliminating most of them, the timing is not perfect," Iris Pang, chief China economist at ING Bank, said in a Dec. 28, 2022, note.

A mild recession in the U.S. and Europe, expected in the first half of 2023, would hit demand for China's exports, which could "derail the recovery of the Chinese economy," Pang said. While industrial metals will benefit from Beijing's stimulus of the property sector, the U.S. and European recessions will weigh on metal prices, the analysts said.

China accounts for about 50% of global demand for industrial metals, including aluminum, copper and zinc, although at least 25% of domestic consumption is processed as metal products and other end products for export, Guosen Securities wrote in a Jan. 3 report.