Some market-watchers continue to suspect that the first-quarter rally in base metals prices was premature and overdone. Prices fell sharply under the pressure of long liquidation by funds on March 22, registering their largest losses of the year so far. Although short-term support held, the sell-off may represent the first sign of poor fundamentals catching up with the market.
At a copper conference in Chile, a representative of BHP Billiton, the world’s largest diversified miner, remarked that the market had got ahead of itself, pointing in particular to sluggish global growth in the purchases of metals-intensive capital goods such as computer accessories and industrial machinery. Although there are some signs now that demand is growing, stocks continue to rise steadily. Global exchange inventory of copper and aluminum has climbed 284,000 and 246,000 tonnes, respectively, so far in 2002, and aluminum stocks on the London Metal Exchange (LME) are back above 1 million tonnes for the first time since 1995. We still expect the market to build, in the second quarter, on the gains it has made so far this year, but unless we see some sign that inventory levels are falling as metals consumption picks up, then recent fund liquidation could quickly turn to short-selling, and without consumer buying to meet it, the pullback could be sharp.
Copper ended the week just below short-term support, at around US$1,640 per tonne, falling sharply on March 22 after descending gradually from a peak of US$1,677 per tonne early in the report period that began March 18. If funds have tired of copper, further losses could be made, but a pull-back to US$1,580 per tonne would still leave intact the uptrend that has occurred since the November 2001 low.
A bearish factor for copper has been the rapid increase in stock levels in Shanghai, now up by more than 115,000 tonnes since the start of the year. The main reason for the increase is the surge in copper imports into China, particularly at the end of last year and early in 2002. Unusually high levels of imports have been flowing into northern China (more than 150,000 tonnes in the first two months of 2002, according to local sources) from Kazakstan and Russia. Metal from these countries receives preferential tariffs and value-added-tax treatment, making it much cheaper for local consumers. However, there have been persistent rumours that the preferential treatment will soon end, and we suspect that the import surge reflects an attempt to bring in as much cheap copper as possible before the door is closed.
Big increases in Chinese copper production (up 6% last year and 16% in January-Februay) have also contributed to the build-up in stocks, but lower concentrate imports (down 14% in January-February), on which China heavily depends, may be the precursor of lower levels of local copper output. Despite this, a decline in Chinese import levels for the next few months looks inevitable while current high stocks are digested.
Aluminum prices also suffered big losses in the second half of the report period, after hitting, early on, a peak of US$1,460 per tonne for the year to date. On March 22, the LME 3-month price closed just below short-term support at US$1,400 per tonne, following the week’s largest volume of trading. Scale-down buying should support prices between US$1,365 and US$1,400 per tonne.
With spread tightness now easing considerably (the LME cash-to-3-month contango now being more than US$20 per tonne, compared with just US$4 per tonne in late February), the rate of LME stock increases should slow from the average weekly rate of around 25,000 tonnes in March, particularly since the busy second quarter is approaching.
Zinc prices pre-empted the move elsewhere in the base metals complex, falling sharply on March 21, a day before the big losses occurred elsewhere. Support appears to be holding at around the US$840-per-tonne level for now, but if this gives way, a move back down to US$820 per tonne looks probable. The big fall in LME stocks on March 22 (minus 1,200 tonnes) appears to be something of an aberration. Since the beginning of March, they’ve risen by more than 33,000 tonnes, and we expect the uptrend to continue until more production is slashed.
The latest data from China illustrates just how weak the zinc market remains, from a fundamental perspective, and reinforces the belief that zinc is the least-deserving of the first-quarter increases in price that have buoyed up all the base metals markets. Despite the fact that Chinese zinc production was down 15.4%, year over year, in February and 10% for January-February, Chinese zinc exports are only marginally down (minus 1.8%) from last year’s levels, at 60,794 tonnes.
Although there have been considerable mine production cuts in the Western World, China does not appear to be having much difficulty in sourcing zinc concentrates imports for its smelters. They climbed by almost 400% in January-February to reach just over 95,000 tonnes, helping to fill the hole in domestic supply caused by the crackdown on illegal mining late in 2001. China has almost certainly been supplementing its zinc metal exports from stocks accumulated last year, when prices on international markets were at low levels. However, the surge in zinc concentrate exports in January-February suggests that its own metal production may recover in the forthcoming months.
Nickel tends to move more violently than the rest of the complex when base metals, as a whole, are active. Recently, prices hit fresh highs in the current recovery cycle of more than US$6,900 per tonne. This only strengthens what was already a strong performance, with prices breaking through resistance at US$6,200, US$6,400 and US$6,600 per tonne in recent weeks, and finally, during the report period, at US$6,800 per tonne. How much of this increase is just hot air in a speculative bubble? Short-covering and buy-stops are part of the increase, but encouraging fundamental developments have also been emerging. If the price gains of the past month are to prove more than a premature, short-covering spike, continued signs of improved fundamentals are needed, and although this may happen, the demand- and supply-side issues continue to look like a handicap.
The stainless steel sector continues to show small signs of improvement. The latest news suggests that the outlook in South Korea, Asia’s second-largest producer, is firmer. Output is expected to increase by almost 5% this year to 845,000 tonnes. There have also been reports that POSCO, the country’s largest producer, has increased its second-quarter profit target by 13%, owing to an improved outlook for the sector. On the supply-side, however, the pace of LME stock withdrawals slowed to just over 500 tonnes during the report period, while the level of cancelled warrants has fallen to a fresh low since November 2001, suggesting stocks may soon begin registering net increases.
Short-term influences on gold price movements have been few and far between. Prices on March 22 were able to squeeze out of the narrow trading range of US$291-293 per oz. and break the technical “pennant,” but we expect follow-through buying interest to be subdued.
The short-term outlook for prices still looks reasonably encouraging. Prices toward US$290 per oz. are well-supported, while expectations of fresh Japanese buying as the yen retraces its steps (in relation to the U.S. dollar) appear sufficient to deter aggressive attempts to push gold below the US$288-per-oz. level. With the Bank of Japan’s monthly report still talking about a “deteriorating” economy and press articles reporting that 12 of Japan’s major banks are expected to report net losses in the current financial year, as a result of bad debts, there still seems to be plenty of scope for safe-haven buying. Even after the implementation of legislation, on April 1, removing government guarantees on savings accounts, investor uncertainty looks likely to favour gold as well as platinum. However, the question remains: does this really make a substantial differenc
e? The latest data on Japanese gold imports show impressive year-over-year changes of more than 600%. On the other hand, actual figures indicate the comparative insignificance of this in terms of marking any fundamental shift, as gold imports in February reached only 20 tonnes. As an indicator of interest in bullion investment in the world’s second-largest economy, it remains a derisory level.
Meanwhile, beyond the here and now, we suspect the tide will begin to turn against gold price prospects over the coming months. Not only does the monetary loosening cycle appear to be over, but the period of neutrality will be brief. By June, we expect Federal Reserve Board interest rates to start increasing; by the end of the year, we expect rates to be up by 100 basis points; and beyond the second quarter, risks remain skewed to the upside. This could have a negative impact on gold prices over the medium-term.
— The opinions presented are the author’s and do not necessarily represent those of the Barclays group.
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