Analyst bullish on base metals

When we entered the current recession seems not to be an issue, but when we started to come out of it is, writes metals analyst Ray Goldie of securities firm Richardson Greenshields:

In March 1990, the Western world entered a recession. After a false start, a recovery appears to have begun in April, 1991. No one seems to want to argue with us that we entered a recession in March, 1990.

However, our conclusion that the global recession has ended, and that it ended in March, 1991, is a controversial one — even though, by the fourth quarter of 1991, global consumption of aluminum, copper and zinc had increased by 5.2% from the average levels in the first quarter. (This is equivalent to growth of 7% per annum.) Typically, people respond to our conclusion by asking, “So, where is all this extra demand coming from?” Well, someone is consuming more goods than a year ago, and it’s not the U.S., Germany, Japan or Korea. Who? We’ve talked with people in different commodity markets and have gained the strong impression that, since mid-1991, the Chinese have been spending big dollars on raw materials such as aluminum, copper, nickel, kraft pulp, polyethylene and wool. Indeed, in what Toronto’s Globe and Mail describes as a bid to become the fifth Asian “tiger,” China’s Guangdong province is booming.

In North America, the worst is probably behind us. Japan’s new program to rebuild infrastructure probably means that Japan’s consumption of raw materials will increase this year. Germany seems to be going nowhere, neither up or down. Add China’s contribution and, during the next few months, we look for a resumption of growth in global consumption of base metals. How much growth? As pointed out above, consumption grew at 7% per annum in the last three quarters of 1991. However, in the last global economic recovery (January, 1983, to March, 1990), the average rate of growth was more modest: 4.2% per annum. This fact, and today’s sluggish prospects in North America, Europe and Japan, suggest that, during the next two years, we will see growth in demand for each of the base metals at about 3% per annum. The balance of copper supply and demand indicates that copper prices have little upward potential in 1992 or 1993. On the other hand, “pinch-point” analysis suggests that copper prices have little downward risk. We conclude that copper prices will stay around where they are today.

Here is a summary of our price forecasts ($US/lb.):

1991 1992 1993

Actual Projected Projected

Aluminum 0.543 0.562 0.525

Copper 1.063 1.025 1.175

Nickel 3.699 3.50 4.00

Zinc 0.507 0.575 0.650

Nickel prices are the toughest to forecast, largely because of the fact that the former East Bloc supplies 16.5% of the West’s requirements. With only small changes in assumptions, one can justify either an $8-per-lb. price or a $2.25 price. Nevertheless, my best guess is that prices are headed higher, with average London Metal Exchange prices of $3.50 in 1992 and $4 in 1993. The key to our bullish view of zinc is the supply side. There are two reasons why zinc could be in short supply:

(a) there are heavy environmental pressures on zinc refineries in Europe, causing them to close permanently (as at Overpelt, Belgium), to shut down for renovations (as at Crotone, Sardinia), or to wonder what to do (as at Avonmouth, U.K., and Budelco, the Netherlands);

(b) no new zinc refineries are planned until late 1994 (when a 120,000-tonne-per-year plant is scheduled to come on stream in Japan) and, although three refineries are expanding, history suggests that such expansions take longer than expected and that they often initially result in a decline in output.

Base metals and base metal equities don’t always move together. In the early stages of an economic recovery, equity prices tend to move as the demand for base metals picks up; the prices of the base metals themselves tend to lag. Thus, because they tend to follow base metal demand rather than base metal prices, Canada’s base metal equities provide investors with a way to “play” the emergence of China as a global economic leader.

The relative performance of the shares of different Canadian base metal companies depends on two main factors:

(a) liquidity — In the early stages of a recovery in global base metal demand, big, liquid issues (such as the shares of Alcan and Inco) tend to outperform other base metal equities, regardless of the commodities which they produce;

(b) surprises — Equity prices aren’t really driven by what metal prices do. They are driven by the difference between what metal prices do, and what investors had expected them to do. For example, at the beginning of this year, there was a widespread expectation that copper prices would drop sharply in the first quarter of 1992. When copper prices failed to drop (in fact, they went nowhere), the stock market was pleasantly surprised, and the shares of the world’s prime copper “play,” Phelps Dodge, performed handsomely. — Excerpted from a recent Richardson Greenshields publication.