High oil prices trigger fund liquidation in base metals markets

The period Oct. 9-13 saw no improvement in base metals markets. After the previous week’s falls, prices continued to slide across the board as oil and stock market shocks caused further fund liquidation.

Nickel and zinc prices were hardest-hit, with average cash prices shedding 4.6% and 3.6%, respectively. Copper and aluminium prices tested medium-term support early in the week but, by the end, were looking healthier after firm closes on Oct. 13.

With many senior market participants in the U.K. for London Metal Exchange (LME) Week, volumes were thin, and downward price moves, exaggerated. There was a strong chance prices would stabilize and then recover over the week of Oct. 16. However, the major theme of LME Week was uncertainty — over base metals markets, high oil prices, and the general state of the U.S. economy. And until this uncertainty decreases, prices are unlikely to reach new highs. Nearby spreads tightened in both copper and aluminum during the report period, showing that the market remains nervous about short-term metal availability. Given all the recent talk of off-warrant stocks in aluminum and copper, it will be interesting to see if the tightness in spreads attracts metal back to LME warehouses, which would serve to offset the steady outflow of the past few months.

Copper prices came under selling pressure as sentiment turned bearish in the face of high oil prices and fears that the U.S. economy is slowing down more quickly than expected. The main factor behind the price fall was long liquidation by Commodity Trading Advisors in the U.S., and, as a result, volumes were thin. Prices slipped to a low of US$1,902 per tonne on Oct. 13 but rebounded encouragingly from that low. Some of the larger fund-holders rolled positions forward, and selling of the January-to-October spread brought some easing of the tightness that had been developing since early September. The cash-to-3-month contango ended the report period at US$15 per tonne, compared with a low of US$8 per tonne a few days before.

A temporary interruption in the steady fall in LME stocks occurred mid-week, thanks to an increase in Liverpool warehouse stocks. Shanghai copper stocks climbed 2,000 tonnes, and total exchange stocks fell by only 596 tonnes.

There are reports that much of the LME stock decline over the past three months (165,000 tonnes) has found its way into off-warrant inventory, and this could well be true. However, copper market fundamentals are good and provide the potential for prices to climb sharply higher early next year. For the time being, the market is moving in to surplus, and although U.S. demand would seem to be holding up well, Europe has yet to recover the strength seen earlier in the year. Meanwhile, in Asia, Chinese buying interest has dropped off.

Aluminum prices trended down, though the fall was less than that suffered by copper. Nearby spreads remain tight, with the cash-to-3-month contango narrow at just US$12 per tonne at presstime. There appears to be good support for the LME 3-month aluminum price at around the US$1,510-to-1,515-per-tonne level, with aggressive buying emerging on dips to this level.

E-metra’s announcement that it has 1.2 million tonnes of metal “in its system” has a lot of aluminum market participants worried that a significant portion of this tonnage could reflect a build-up of off-warrant aluminum stocks. Our estimates of the aluminum market balance for the year to September show a deficit of around 450,000 tonnes, compared with a fall in LME stocks of 411,000 tonnes, suggesting that non-LME stocks have actually fallen overall in 2000. However, following a strong first half of the year, the market appears to have moved into surplus in the third quarter, during which time LME stocks continued to fall. This suggests that non-LME stocks may have risen by around 250,000 tonnes in the third quarter.

Some of this has already started to show up in other reported stocks figures. The 66,000-tonne increase in August stocks, as reported by the International Primary Aluminium Institute, brings the total increase since June 2000 to 127,000 tonnes, and we expect a further increase in the September figures. Shanghai Metal Exchange stocks have risen by 10,000 tonnes since June, and Japanese port stocks were up by 27,000 tonnes in July.

Nickel prices continued to slide during the report period, ending up just above support levels at US$7,400 per tonne. Although LME stocks continue to fall and nearby spreads are still in backwardation, sentiment toward nickel is deteriorating.

This is partly because the rebound in Asian stainless steel demand that was widely expected in the fourth quarter has shown little sign of materializing. In addition, there are signs of weaker stainless demand in the U.S. and Europe. Indeed, WMC of Australia says it expects stainless steel demand to grow by around 8.2% this year before slowing to its historic trend growth rate of around 5% next year.

Given the sharp increase in the availability of stainless steel scrap this year, these figures translate into primary nickel consumption growth of somewhere around 5%. And assuming stainless steel scrap supply eases somewhat, the figure for next year should be about 4%. This is close to our own forecast and suggests that the nickel market is heading for a deficit of around 15,000 tonnes this year, followed by a small surplus of 3,000 tonnes in 2001.

The announcement by Noril’sk of Russia that its exports will fall by 15-20% to 175,000 tonnes this year has failed to give much support to prices, the reason being that production is likely to be the same as last year — around 220,000 tonnes. What this means is that the shortfall in exports will simply be stockpiled, and then exported if and when prices improve.

The heavy fund-selling and long liquidation that hit the base metals complex at the start of the report period hammered zinc prices downwards on Oct. 9, and by Oct. 11, almost US$60 per tonne had been wiped off the LME 3-month price. LME stock increases of 1,975 tonnes also dampened sentiment. Support at US$1,100 per tonne provided a safety net, and prices closed encouragingly on Oct. 13 at US$1,110 per tonne. However, upside recovery appears limited if LME stocks continue to rise.

Japan’s leading refiner of zinc, Mitsui Mining & Smelting, said recently that the main concern for both the Japanese zinc industry and the global zinc market is rising output in China. Pointing out the variance in growth rates between Chinese consumption and production, Mitsui said the 600,000 tonnes of refined zinc that Chinese exports annually will likely increase over the next five years, and that this would naturally increase the likelihood of zinc oversupply.

In the short term, zinc prices should continue to find support at current levels. Many may see the present dip as a buying opportunity, lending some support to the market.

Gold prices have been benefiting somewhat from the metal’s traditional role as a safe haven in times of political or economic turmoil. Concerns that the escalating instability and ensuing violence between Israel and Palestine would spill over into other parts of the Middle East placed upward pressure on prices on Oct. 12, sparking a rally to a high of US$276.80 per oz.

The rise was largely due to short-covering amid investor worries that higher oil prices would help push up prices for the yellow metal (Brent crude peaked on Oct. 12 at a new 10-year high of US$35.30 per barrel). There has tended to be a close correlation between the two markets in the past. Heavy falls on both the U.S. Dow Jones Industrial Average and the Nasdaq also fuelled fears that some of the investor funds searching for a safe haven may be directed to gold. As it happened, the rally was short-lived, having been fuelled by anticipation of safe-haven-buying rather than safe-haven-buying itself (very little of which actually occurred). By Oct. 13, prices had fallen back to the US$272-per-oz. level one again.

For the week ahead, support at US$270-272 per oz. is unlikely to be broken. Further weakness in the Australian dollar may create some downside potential as local prices provide greater selling opportunities for producers. So far, however, little selling has emerged, as it is widely expected that the Australian dollar has farther to fall before it reaches its nadir against the U.S. greenback.

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