Fund liquidation takes toll on copper, aluminum

Prices on the London Metal Exchange (LME) were hit hard by fund liquidation during the report period April 2-5, pushing aluminum and copper prices to their lowest levels in more than four weeks. According to data released by the LME, overall market volume fell 9% in the first quarter to its lowest level since 1998. The decline illustrates just how dependent on speculative buying the base metals markets have been for their gains so far this year. With funds now losing their patience, the depth of the price fall will be set by the level at which consumer buying interest begins to pick up.

Most of the major economic data releases were positive, adding further strength to the recovery. However, the funds appear to have been spooked by a rise in oil prices to their late September 2001 high of just above US$28 a barrel. The consensus is that little harm will be done to the global economic recovery unless oil prices climb back above US$30 and stay there for some time, though given the weak state of industrial production (a key driver of base metals prices), this is far from a foregone conclusion. More promising are the signs of consumer buying interest that have emerged in aluminum, notably from cansheet and automotive sectors. If these are indicative of a broader trend to come, as we head into the seasonally strong second quarter, then prices may soon regain their recent peaks.

Copper prices shed US$85 per tonne as funds finally liquidated the big long positions they had been building since the start of the year. LME data show that, among base metals, copper was hit hardest by the decline in LME volumes in the first quarter (down 37% year over year), underscoring just how dependent on fund-buying the market has become.

One worrying factor for copper is the persistently poor performance of Europe’s largest consumer, Germany. Demand for refined copper in that country fell 14% in 2001 and has yet to show any sign of recovery. Production of semi-fabricated copper products fell 21% in January, according to data released by the Federal economics agency, and several local copper consumers recently shortened their working hours. Meanwhile, Norddeutsche Affinerie, Europe’s largest producer announced it expects further poor results as a result of a significant reduction in copper volumes sold in the January-to-March period.

Although there are distinct signs of a pickup in other parts of the eurozone, the German economy remains depressed. In March, the Purchasing Managers’ Index (PMI) for the eurozone rose to 50, ending 11 consecutive months of contraction. The increase suggests that industrial production is likely to begin expanding again soon. However, of the three major eurozone economies, Germany experienced the smallest rise in the PMI.

The copper market received a temporary boost in late March, when Noranda announced that a previously announced 6-month closure of its 120,000-tonne-per-year Gaspe smelter would be made permanent. However, this development will have no impact on refined supply; rather, it is a symptom of the tighter concentrate market, resulting from mine cuts already made. Noranda’s 360,000-tonne-per-year CCR refinery will now receive extra blister from the recently expanded Altonorte smelter in Chile.

Aluminum prices fell sharply late on April 5, slipping to a 5-week low of US$1,372 per tonne, dragged down by copper. Earlier in the week, LME 3-month prices had found good support at around US$1,385 per tonne, thanks to consumer buying, and consequently proved far more robust than prices for copper. However, few were surprised that when copper was hit by fund liquidation on April 5, aluminum suffered too. In the short term, we expect aluminum prices to continue to trade in the range of US$1,370-1,410 per tonne but with a bias to the upside.

Zinc prices displayed vulnerability after falling almost US$40 per tonne even before the late selloff on April 5. The main catalyst of the price fall was the end of the strike at European producer Umicore (see below). It is worth noting, however, that upside gains following the initial announcement of the strike were considerably more modest than downside losses incurred by zinc after the strike’s successful conclusion. Although this does not rule out the possibility of fresh gains over the short term and the remainder of the second quarter, it indicates the downside risks prices are expected to face at higher levels. The emergence of forward buying on the price dips is encouraging and offers some support. The 200-day moving average support area, at US$820 per tonne, is the next crucial support area for zinc prices. A fall through this area may be avoided by price correction on the upside and a firmer base metals complex, whereas a drift below this level would signal a return to the region of US$800 per tonne.

Zinc’s faltering response to the strike that hit Umicore’s 260,000-tonne-per-year smelter in Auby, France, illustrates once again how weak the market is at present, and is hardly surprising given the relentless rise in exchange stocks. Although recent mine production cuts total almost 750,000 tonnes (8% of global mine capacity), there is little sign yet of price-related cuts being made on a similar scale in the smelting sector. A small handful of smelters have extended summer maintenance programs (Teck Cominco at Trail, B.C., and Cajamarquila, Peru; Outokumpu at Kokkola, Finland; and Big River at Sauget, Ill.), resulting in the loss of around 100,000 tonnes of output in 2002. But it will take a lot more than this to bring the market back into balance.

Without further production cuts, we estimate that zinc demand will need to grow by more than 7% simply to balance the market in 2002. Even if this does happen (which appears unlikely given that zinc’s long-term trend rate of growth is just 2%), the market will still be left with an uncomfortably high level of inventory, currently touching almost eight weeks of consumption.

On the other hand, the macroeconomic outlook has certainly improved. We have strengthened our forecast for the U.S. gross domestic product this year, and the strong recovery in manufacturing is starting to expand into other sectors. Zinc’s supply-side fundamentals, however, highlight the reason to be cautious about the overall length of its price “recovery.” The large surplus of last year is expected to be augmented in 2002, even assuming a healthy consumption growth rate of 3.3%. Until this surplus is worked off, zinc’s recovery looks likely to remain a faltering one.

Nickel‘s move back above US$6,800 per tonne is keeping its long-term uptrend intact, and another test of US$6,950 per tonne looks likely. On dips, the 10-day moving average, currently just above US$6,700 per tonne, looks likely to provide solid support. The market welcomed the announcement by Russia’s Noril’sk that it will use, annually, 60,000 tonnes of its “strategic reserves” as collateral for a 3-year loan by a syndicate of foreign banks. The deal will, in effect, tie up the material, preventing any of it from reaching the market until 2005.

With gold prices established at around US$300 per oz., the question now concerns the longevity of this strength. There is a growing belief, even among the more popular sections of the business press, that after being pushed to the periphery of the world’s financial markets over the past 20 years, fundamentals in the gold market have changed to such an extent that the “bear run” can now be considered over. Although fundamentals have arguably altered over recent months, it is debatable whether they have profoundly improved to the extent to which some commentators have suggested. With this in mind, we see current prices as representing the higher range of gold’s price recovery and remain cautious about the “gold bull” scenario.

One growing area of intrigue is the apparent posturing that seems to be taking place by central banks. Since the conclusion of the Bank of England sales in the first quarter, we seem to have heard more about the Washington Accord than ever before. First, the Bu
ndesbank comments checked some of the more optimistic price expectations; then Willem Duisenberg, president of the European Central Bank, made some ambiguous comments about central banks being free to diversify portfolios within the agreed constraints of the accord. Central banks will not be oblivious to the changing fundamentals of the gold market. Nor will they be oblivious to reports that mine production is to fall, that safe-haven buying has increased, and that mining companies have cut hedging volumes. These are the factors that have driven gold and its related assets to current levels. One factor that still has not changed, however, is that central banks are seeking ways to lower their gold reserves. If the current sales limit of 400 tonnes per year was derived from the perceived gold market deficit in 1999, could not this limit be raised if the deficit increases? It is only possible to speculate at this stage, but such speculation illustrates the porosity of the gold bull’s argument.

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