Too far, too fast?

The report period Sept 25-29 saw a retracement for metals prices from their recent highs. Funds are still the main supplier of volume to the base metals markets and, despite further declines in London Metal Exchange inventories for copper and aluminum, the main influence on price continues to be technical. Copper and aluminum are trending down to test nearby support at US$1,980 and US$1,580 per tonne, respectively while nickel and zinc are also trading at the lower end of recent price ranges.

It is difficult to escape the conclusion that prices may have risen a little too far too fast in early September, and October may see some consolidation at lower levels. One reason for this is that with the U.S. economy slowing, demand prospects are a little uncertain following a strong first-half of the year. However, one positive sign is what appears to be the beginning of a concerted recovery in Japanese metals consumption. Although the local construction industry is still weak, industrial production is growing strongly and is boosted by healthy demand in the electrical and electronics sector.

Copper demand forecasts by Japanese fabricators have been revised up to 6% for the current financial year. If this level is achieved, it would mark the strongest growth in Japanese copper consumption in 10 years. In aluminum, a sharp decline in local product inventories has improved prospects for a rebound in shipments.

Copper prices, under pressure from light fund liquidation, continued to adjust lower during the report period. There is still no sign of a slowdown in the rate of LME stock withdrawals, which were down another 9,800 tonnes. However, the market is moving into better balance as demand slows and supply grows in the fourth quarter, and this may undermine prospects for even higher prices in the next few months. During the week of Oct. 2, the 10-day moving average of US$1,995 per tonne is likely to provide the first level of resistance on the upside. Nonetheless, we favour the downside, with initial support at US$1,980 per tonne and a probably test of US$1,950-1,960 per tonne.

Looking further ahead, prospects for the early part of next year are positive, and we expect a significant market deficit in the first quarter of 2001. Recent news of a big upward revision to Japan’s copper demand prospects only enhance this view. Buoyed by exceptionally strong demand in the electrical and electronics sector, Japanese brass-manufacturers revised upward their forecasts for copper demand growth to 6% for the financial year ending March 31, 2001, from a previous estimate of 3.7%.

A strong recovery in Japanese wire and cable shipments in August lends weight to the projection, though continued weakness in the Japanese construction sector is worrying (data for August showed a 3.8% fall for housing starts and a 5.4% drop in construction orders). The last time Japan’s annual copper demand grew at anywhere near this level was 1990, when it climbed 9% year-on-year.

Another risk for the copper market comes from the amount of scrap available. Higher copper prices tend to cause more scrap to enter into the market, and the recent increase in scrap discounts suggests that scrap is becoming cheaper. This could encourage some consumers to substitute cathode. So far this year, China has been a big importer of copper scrap (60% more than in 1999), though the Chinese have not bought much in recent weeks. Meanwhile, Russia’s imposition of a 50% export duty on scrap is unlikely to result in anything more than a temporary hiatus in its lucrative shipments to the West.

Aluminum prices continued to perform disappointingly. The well-trailed announcement of a production cutback by Golden Northwest Aluminum enabled 3-month prices to climb briefly above the US$1,620-per-tonne level; however, selling after the fact pushed prices back below the US$1,600 level by the end of the report period. The only other notable development in aluminum prices was a small amount of consumer buying that saw the average price for 2002 increase to US$1,560 from US$1,540 per tonne, at the same time that the front end of the price curve was falling. If this causes further producer selling, front-end prices could come under downward pressure, leading to a possible test of support at US$1,570-1,580 per tonne.

Aluminum prices are still failing to respond to the steady whittling-down of production capacity in the American Pacific Northwest. Golden Northwest’s 100,000-tonne-per-year cut brings the total amount of off-lined capacity in the region to 455,000 tonnes per year (equivalent to almost 2% of global aluminum production) and means that our projected market deficit for 2001 now stands at more than 400,000 tonnes. There are rumours that further cuts are imminent, but it is doubtful that these will amount to more than 30,000-40,000 tonnes at most.

Data from the U.S. Aluminum Association show that orders contracted 5% in August, but in Japan the situation is brighter: inventories have fallen almost 15% below year-ago levels. Nonetheless, the process of de-stocking must be almost over, in which case aluminum consumption may be about to climb rapidly again.

Nickel prices fell sharply after Falconbridge announced it was not in imminent danger of declaring force majeure at its strike-plagued operations in Sudbury, Ont. Prior to the announcement, an increasingly nervous market had bid the LME 3-month price up to more than US$8,600 per tonne, the cash-to-3-month backwardation had widened to more than US$400 per tonne, and cash for a day traded at in excess of US$50 per tonne. After the announcement, an easier market saw the LME 3-month price fall back to end the report period at US$8,295 per tonne, with cash for a day narrowing to US$3-5 back. Short-term market sentiment will continue to be determined by the strike, but also by an escalating wage dispute at Amplats in South Africa, which produces 20,000 tonnes of nickel per year.

The market has been monitoring the increasingly confusing situation in Sudbury. Early in the report period, news that Norwegian workers at Falconbridge’s Nikkelverk refinery would strike rather than treat “scab” blister from Sudbury was followed by a Reuters poll that suggested most nickel-market participants thought the company would have to declare force majeure on nickel deliveries within the next two weeks. However, it soon became clear that the Norwegian workers had virtually no legal grounds on which to strike. Falco then claimed it would be able to supply its customers until the end of the year, saying it had bought nickel from merchants to keep its customers supplied. Earlier in the strike, the company had said it expected to be able to meet its customer requirements until the end of October.

Falconbridge has declared force majeure on its cobalt shipments from the beginning of November onwards for European customers, and from the beginning of December for Asian customers. The major produces about 4,000 tonnes of cobalt per year. It has already declared partial force majeure on copper deliveries, reducing shipments to 1,600 from 2,600 tonnes per month.

For the time being, Nikkelverk is operating at around 60% of its 77,000-tonne-per-year capacity, but workers are continuing to explore strike options, with the possibility of action beginning in November. In Sudbury, Falco is considering starting up a second mine in order to ensure that feed levels to its smelter are maintained. However, the local union leaders have warned that if this option is followed, it will inflame the situation and possibly lead to an absolute shutdown.

Under such conditions, we find it difficult to give much credence to Falco’s claims that it will be able to supply its customers to the end of the year. As long as the strike remains unresolved, nickel prices will stay volatile.

Zinc prices managed only a lacklustre performance and relied on the continued tightness in nearby spreads for support at US$1,150 per tonne, though downward momentum and the absence of fund interest pushed prices below this level on Sept. 28. The following day saw a modest recovery of earlier losses, as the market in London closed at US$1,155 per tonne.

Stock levels continued edging higher, gaining 275 tonnes, and cancelled warrants slipped to their lowest level since mid-August, suggesting that the stock falls that took LME inventories to their lowest level in more than eight years have come to an end.

Chinese exports fell slightly in August to just 41,000 tonnes (25% below year-ago levels) but are expected to rebound over the next few months as smelter maintenance programs are completed. The programs are credited with having reduced Chinese production levels.

China’s zinc exports are still almost 30% ahead of year-ago levels, and this growth goes some way toward explaining the relative ease with which the zinc market has accepted the tightness of supply and declining LME stocks of the year to date. With production in China during the first half of 2000 rising by 9% and with production over the next five years forecast to rise by an additional 692,000 tonnes per year, strong zinc demand growth in the West will be essential to absorb even higher exports.

Gold prices rose to their highest level since July, hitting a high of US$279.3 per oz. on Sept. 26. The increase was due to turbulence in the foreign exchange markets and does not reflect any improvement in market fundamentals or change in sentiment. By Sept. 29, prices had lost most of the gains made earlier in the week as they drifted down to end the report period in London at US$273.8 per oz.

The rise in prices had its roots in the foreign exchange markets. This has been increasingly the case throughout this year as the strengthening U.S. dollar is backed up with a strong dollar policy by the Federal Reserve Board.

The strengthening of the Euro in the first part of the report period clearly supported gold prices. However, our medium-term forecast for the Euro is not bullish. U.S. dollar-denominated assets continue to offer more attractions to investors than those within the euro-zone. Signs of further concerted efforts on the part of the European Central Bank to prevent even greater losses by the Euro will provide more immediate support than an improvement in investor sentiment in the Euro economy. Until that view is changed, further downward drift against the U.S. dollar can be expected, putting downward pressure on gold prices as a result.

— The opinions presented are solely the author’s and do not necessarily represent those of the Barclays group.