Copper, aluminum lead base metals

A late rally on Friday, June 14, prevented copper and aluminum from giving up all of the gains made over the previous two weeks, but they still look set to lead the base metals complex lower over the next month or so as the market enters its seasonally quiet period for demand.

Worse-than-expected U.S. economic data were the cue for speculators to exit early in the report period June 10-14, and with time running out before the holiday season begins, it’s unlikely that consumers will emerge to take up the running until they return in early September.

The poor U.S. economic data dampened market sentiment but could not obscure a steady improvement in leading indicators for metals; this improvement continues to suggest that a substantial improvement in prices is not far off. The trend was emphasized most recently in the US Aluminum Association’s orders index, which is now suggesting a substantial pickup in primary demand during the second half of the year. The 12.9% increase in China’s industrial production (the strongest year-over-year increase since 1996) also augurs well for the base metals sector. A growing number of producers certainly appear to believe that the demand outlook is improving. During the report period, Corporacion Nacional Cobre de Chile (Codelco) announced it would make no more production cuts, while Alcan justified the restart of 60,000 tonnes per year of aluminum capacity by citing better conditions.

Copper prices fell victim to a wave of fund long liquidation late in the report period, which was hardly surprising given the massive buildup of speculative positions since early May, coupled with little in the way of positive fundamentals. London Metal Exchange stocks continued to fall (minus 11,450 tonnes) and are now almost 80,000 tonnes below their mid-May peak. However, this decline is having little positive impact on prices, the reason being that the market has interpreted it as part of a one-off delivery of metal to Chinese strategic stockpiles rather than a sign of improvement in underlying global demand. The fact that cancelled LME warrants have fallen from more than 90,000 tonnes at the start of the period of stock withdrawal to less than half this level at the time of writing (June 17) supports this view and suggests that, soon, the phase of falling LME stocks will peter out.

On the supply side, comments from major producers suggest that there is little likelihood of any further voluntary production cuts. Grupo Mexico tried to put a positive spin on a conflict with unions over wages at its 150,000-tonne-per-day La Caridad mine in Sonora state, saying the mine could stay closed to support copper prices over the medium term. However, the company quickly changed its mind when it became clear a settlement would be reached, announcing the mine would continue to operate as normal.

Now that most of the weak longs are out of the market, copper prices should stabilize over the short term, though upside potential will be limited. We expect a trading range of US$1,640-1,660 per tonne for the LME 3-month price.

Aluminum prices followed the softer trend of the base metals complex, despite encouraging signs that fundamentals are improving. The positive trend in the closely watched U.S. aluminum orders index continued to gather momentum. Orders for fabricated products rose for the fourth consecutive month in May, by 17% year over year, to the highest level since January 2000. The data now point to a substantial improvement in demand for primary aluminum in the second half of the year.

Meanwhile, in April, primary producer stocks on the International Aluminum Institute fell to their lowest level since new reporting procedures were introduced in 1999. This decline, combined with a smaller fall in Japanese port stocks, is serving to offset the continued increase in LME stocks so that, overall, there are now signs that the rise in total reported stocks has levelled out. At around 8.5 weeks of consumption, this is only half the level that reported stocks reached during the slowdown of the mid-1990s. We take this to be a positive trend since, post-Enron, the level of unreported inventory held by merchants is also likely to be much lower than for many years.

Alcan’s decision to restart 60,000 tonnes per year of idled capacity at its 280,000-tonne-per-year Kitimat smelter in northern British Columbia was not surprising given the widely reported improved outlook for water levels in the Nechako Reservoir. Because of the phasing of the restart, it is unlikely to have much impact on market fundamentals in 2002.

On June 14, after a lacklustre week, nickel soared to its highest close of the year at just over US$7,300 per tonne. Although we do not expect these gains to last, it is a reminder of the exposure to price volatility still inherent in the nickel market. Amid a generally weak complex, the price strength seen at these levels has been particularly surprising. Throw in the issue of rising LME stock levels (a gain of 510 tonnes during the report period), a widening in the cash-to-3-month contango (up to US$30 per tonne) and a sharp easing in nearby supply issues, and the support that has been holding nickel above US$7,000 per tonne begins to crumble.

If, as we expect, short-term bias to the downside begins to creep back into the metals complex, the downward pressures on nickel will further increase and a return to the familiar trading ground of US$6,800-6,950 per tonne could soon follow. Furthermore, if recent increases in Russian supplies have not in fact been fully factored into prices, a fall below US$7,000 per tonne could simply precipitate a move toward US$6,600 per tonne.

Although the second quarter is seasonally the strongest in terms of physical demand, it must be remembered that most of this period is now behind us and the quieter summer months loom ahead. The explosion in Russian exports of nickel has therefore hit the market at a vulnerable time. However, the market has clearly arrived at its own conclusions, discounting the significance of these exports and linking them to the 60,000 tonnes that Noril’sk tied up as part of a financing deal in the first quarter of 2002. Exports have already hit almost 100,000 tonnes for March-April, so obviously this is not a watertight assumption, and we suspect only some of the 60,000 tonnes are attributable to this massive increase. Despite the short-covering rally on June 14, such a large increase in exports runs the risk of limiting price prospects during the quieter summer months and returning prices to the US$7,000-per-tonne area.

Although much of the supply-side news has been supportive for zinc prices, the corresponding price weakness and US$10-per-tonne slide on June 14 reflect well the market’s interpretation of these developments. Despite news of lower Chinese production levels, strike action in Europe and an output reduction by Japanese producer, Sumitomo, the lack of clear and sizeable supply-side corrections in the zinc market continues to undermine price prospects. Recent news of a restart at Outokumpu’s Tara zinc mine, Europe’s largest, is enough to dwarf any recent developments, and consequently we expect to see price consolidation in the US$760-to-$780-per-tonne range over the short term, near the current LME zinc contract’s lowest recorded close of US$748 per tonne on Nov. 7 of last year. Tara is near Navan in County Meath, Ireland.

News of a strike action at Umicore’s Overpelt zinc plant in Belgium quickly followed the company’s announcement that production would be cut by 30,000 tonnes per year. The resulting loss of around 70 jobs soon brought a stoppage at the plant, and talks have so far failed to bring a resolution. Sumitomo of Japan also announced a production cut, of 10,000 tonnes per year, or 9%. The combined impact of this news is to increase western zinc production cuts to around 125,000 tonnes this year. Compare this to a forecast surplus of some 350,000 tonnes this year and the reopening of the 200,000-tonne-per-year Tara mine in September, and the reasons for zinc’s continued pr
ice deterioration become clear.

As with most central bank selling, the announcement on June 7 that the Russians had sold almost 50 tonnes of gold during May can be interpreted in two ways. Is it bearish — a reaffirmation of the likely reactions of central banks to gold price rallies and their tendencies to sell into them rather than buy into them? Or is it bullish — a sign of the increased activity in the gold market in recent months and its ability not only to absorb the fresh material but also to absorb the news of fresh selling from a bank external to the Washington Accord.

Judging by the price reaction on June 7, the news has been received relatively well. The very gold market itself seems to have mastered the Midas touch, turning news that would otherwise be bearish into signs of positive optimism. News of weak fundamentals has been ignored while the spectre of U.S. dollar and U.S. equity weakness have taken centre stage. Any poor demand data or rumours of official sales have been quickly absorbed, adding to the view that the renewed strength of the gold market was capable of taking any negative developments in its stride.

Is the gold price rally faltering? A glance at the daily gold price chart would suggest it is. But caution should be exercised before relegating the latest gold price rally to the annals of gold market history. Although many of the more spurious claims of capital flights to safe-haven quality have subsided, the material factors that, we believe, pushed prices to current levels remain largely in place. What is surprising, however, is the relatively downbeat tone we experienced from many of the delegates at the recent conference of the London Bullion Market Association in San Francisco. In place of the expected euphoria, there appeared to be a general acceptance that prices at these levels were unsustainable. Although we’ve held this view for some time, we did not expect it to be shared by the delegates. However, before setting a downside price target, a break of resistance at higher levels is still conceivable.

The initial area of price support comes from the foreign-exchange markets, in particular developments in the U.S. dollar and the euro. The latest economic data from the U.S. are failing to convince sceptical investors that recovery is securely in place, so there would still appear to be further room, over the short term at least, for renewed bouts of U.S. dollar weakness. Based on recent gold price trends, this should be sufficient to encourage fresh speculative interest from funds and proprietary commodity trading advisors. There still also appears to be disquiet concerning the value of equities. Prospects of any substantial turnaround are being discounted, while confidence in the U.S. corporate sectors is still reeling from recent damaging news. We do not believe that weakness in the greenback and fragile confidence in U.S. equities have, in themselves, directly pushed gold prices higher, yet we concede that, in this environment, selling volumes are likely to remain thin despite the persistence of one of the largest net speculative long positions on record.

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