Metals in review

Metals prices have had a pretty good run since the end of the recession. Nickel, for example, touching the US$10.80 mark. Copper edging US$1.69 per lb. But what now? The 1982-83 recession isn’t distant enough for anyone in mining to dismiss it as a once-in-a-lifetime phenomenon. Not now, with the world wading into an economic trough again. But the modern industrial world was not the creation of the weak-kneed: nabobs of negativity (see U.S. Vice-President Spiro Agnew ca. 1960) will not be nattering in this space. Rather, we sought the bold views of Julian Baldry (left), mining engineer and metals analyst for brokerage house Nesbitt Thomson Securities.

TNMM: Since the devastating recession of the early 1980s, we have traversed a period of strong base metals prices and a mini-boom in gold. The bloom is definitely off the golden rose. But let’s keep gold out of this. We don’t believe anyone can forecast the future price of such a fickle, unfundamental metal. But what can base metals miners and explorers expect going into this new economic downturn?

BALDRY: At the outset, let me explain that my analysis stems from the fundamentals of the metals markets. From that, I extrapolate out a few years to arrive at a probable price for metals. But I do not have a crystal ball.

TNMM: Fine. No crystal ball, no Ouija board. Just a computer and reams of data. When you punch in the numbers, do you see a rerun of the 1980s?

BALDRY: No, the big mining companies were bitten too hard that last time. The period of “good times” in the metal industry that followed the horror of the recession allowed companies like Cominco and Alcan to clean up their balance sheets and eliminate debt. Generally speaking, they didn’t use that period to expand production in any meaningful way.

TNMM: Is the Canadian experience representative of a worldwide trend?

BALDRY: It’s true for metals producers around the world. We saw acquisitions, such as RTZ’s buying the assets of BP-Selco and Noranda-Trelleborg’s joining to acquire Falconbridge. But major new mine developments were not common. Even Cominco’s Red Dog deposit in Alassa is essentially a replacement orebody for depleting smelter feed. So, with the exception of the aluminum sector, and to some extent copper where Chilean mines have come on-stream, there is no huge overhang of capacity.

TNMM: Are there other mitigating factors?

BALDRY: Yes. It’s apparent the companies are willing to change production plans quickly.

TNMM: As both Inco and Falconbridge did when nickel prices suddenly dropped in the first quarter of this year?

BALDRY: Except that Inco’s production cuts were result of changes to mining methods that had been previously scheduled. But Falconbridge did react to a cut in prices. And if that’s the kind of action that occurs across the board during a recession, it will prevent a prolonged downturn.

TNMM: What was past practice? Didn’t the miners respond in previous downturns?

BALDRY: You’ve got to remember that the last recession wasn’t just a blip on the screen. The screen just about went blank. The major mining companies tried to tough it out at first. But as the price slump dragged on, they finally relented. Remember Falconbridge? Bill James gutted the mining and civil engineering departments and got rid of a raft of other middle managers. Inco’s house-cleaning preceded Falconbridge’s and then the other majors grasped the new reality and followed suit.

TNMM: Those were trying times.

BALDRY: Indeed. But today, to use Inco as an example, it is producing about 9% more metal per annum with something like 19,300 employees worldwide. In 1980, the figure was, I believe, about 34,000. Most of the majors in this country are in a similar position.

TNMM: But haven’t the easy times of the past few years contributed to inefficiencies again.

BALDRY: To some extent, yes. If I can lean on Inco again, its cash production costs are about US$3 per lb. of nickel. Only a few years back, it could boast of production costs at US$2. What has happened is this: When metals prices are up, the president of every mining company issues an edict to his mine managers to increase output. When prices are down, the pressure is on the operating people to decrease costs. But on the way down, there will be a squeeze on earnings. So going into a recession, we will see, in fact we have been seeing, declining earnings.

TNMM: You are bullish in the long term on lead, nickel and zinc, and less favorably inclined towards copper. (Readers should refer to the accompanying story on Baldry’s price forecasts of specific metals.) Why?

BALDRY: Yes, I’m bullish on the long-term prospects, but rather pessimistic about the short term. In lead, nickel and zinc, there is no expansion, in terms of new metal supply, to eat through. I don’t see significant stockpiles of any of the three metals you mentioned. And every metal went to a new high in terms of demand during this last cycle. From the point-of-view of the stock market and mining shares once this recession or economic downturn is over, we might even see a reversal of the last cycle. Stock market prices for the metal mining companies were practically the last as a group to move up in the stock market boom of the 1980s. It may happen that stock prices go higher earlier this time and the price strength lasts longer. As an investor, if you’re in the right commodity, you’re really going to win. The metal miners move (down or up in price) as a family, but the winning companies — and I’m thinking especially of Inco in the last cycle — move much more.

TNMM: You reserve your strongest commodity recommendation for lead.

BALDRY: Yes. The lead market has absorbed plenty. More than 50% of lead metal is recycled. Not so long ago, gasoline accounted for 16% of the annual metal offtake in the U.S. It is now only 2%. And yet, underneath these declining uses of primary metal, growth in consumption has occurred.

TNMM: From what sector?

BALDRY: The replacement automotive battery market. The world vehicle population continues to grow. Where you and I have two cars now, rather than one, the guy in Korea has just bought his first car. It’s beginning to happen in many other countries. So the customer base for lead in replacement batteries is increasing, barring huge economic catastrophe. I conclude that the growth in lead consumption is practically independent of economic conditions — and keep in mind that there are no lead battery substitutes.

TNMM: How bullish are you?

BALDRY: Sooner or later, we’re going to see a serious shortage in lead. I predict lead will do what nickel has done in the last three years.

TNMM: Should we start stockpiling a basement hoard?

BALDRY: Sure, but don’t let the environmentalists hear about it.

COPPER

* Supply — Refined copper supply increased 4.5% in 1989 and another 2.5.% in the first six months of 1990. Production growth in Chile, Western Europe and the U.S. more than offset declines from Peru, Africa (excluding Zambia) and Canada. Production capacity is expected to continue increasing through the remainder of 1990, while demand has stalled. This surplus would normally result in higher inventories and lower prices, except for the effect of unpredictable production problems in Zaire, Peru, Mexico and other countries.

* Inventories — Inventories remain equivalent to five weeks of consumption, which represent near record low levels. The scarcity of readily available metal and the effect of supply disruptions keep prices near all-time high levels.

* Price and Inventories — The price-inventory relationship currently lies on the steepest part of the curve (where inventories are tight and, naturally, prices are high). Therefore, slight changes in inventory through fluctuating production levels will continue to have a dramatic impact on metal prices.

* Prediction — Copper prices should ease in the short term, but going into 1991, these prices will hinge on the outcome of a battle involving supply disruptions, new production coming on-stream and demand.

LEAD

This metal has the most favorable outloook in the base metals sector over the short term, plus an excellent long-term picture. Demand is primarily linked to the replacement of auto batteries, which is a steadily growing and recession-insensitive market. Supply should remain in deficit over the short term because of various short-term production problems.

Longer-term expansions will be extremely limited because of the environmental restraints on producers and because there has been virtually no exploration in the past 10 years. Lead has not yet participated in the metals price boom of the past two years. However, even the continuation of the slow and steady price increases we have seen could make lead the big winner as we peer into the future.

* Supply — Lead supply has been in deficit since early 1989. The surplus was originally sparked by higher demand, but recent strength can be attributed to production problems.

* Inventories — Refined lead stockpiles have declined steadily since early 1988 and now stand at 4.5 weeks of consumption. London Metal Exchange (lme) prices have correspondingly risen from from US$30 cents to US40 cents per lb. with a brief spike up to 60 cents in March. Expected lower inventories should keep prices moving upwards. There is potential for another sharp price increase in the event of increased demand or production disruptions.

* Seasonality — Lead demand traditionally reaches its peak in the fourth quarter, when battery makers gear up for the winter battery-buying season. Seasonal consumption strength could be more pronounced because of the effect of various production problems and low inventory levels.

* Price and Inventory Curve — The price-inventory curve for lead is one of the flattest in the base metals group. This explains why prices have crept slowly upwards with lower inventories, instead of exhibiting the dramatic price fluctuations of the other metals.

Lead’s “trigger point” (the inventory level that sparks large price increases) has not yet been passed. Where is this trigger point level? The price spike earlier this year suggests that if inventories fall below four weeks of consumption, we could see the price curve steepen, and sharply higher lead prices would result.

NICKEL

Nickel prices have shown a dramatic resurgence from their lows of US$2.75 per lb. earlier this year, helped more from supply disruptions and lower inventories than from demand. A number of events played their part — strong second-quarter demand from Japan, stainless scrap shortages, uncertain Soviet supplies and an LME squeeze — but a 36-day strike at SLN’s New Caledonia operations (which accounts for 8% of world supply) was a deciding factor in the rise to more than US$5.

The resumption of supply and a weaker U.S. economy should lead to lower prices in the fourth quarter. In the longer term, nickel’s outlook is “stainless” — a result of its sensitivity toward high demand, an improved economy plus limited planned capacity expansion.

* Supply — A supply surplus since the fourth quarter of 1989 is evident, suggesting a downward trend for nickel prices over the medium term. However, booming second-quarter demand in Japan and shortages of stainless steel scrap created a short-term price spike when buyers were faced with the 12% shutdown of the western world’s supply in July and August. Production has returned to normal levels with the end of Falcondo’s maintenance shutdown and SLN’s strike problems. This higher production, plus the end of the seasonal summer shutdowns in Canada and increased scrap from higher stainless production, should meet weaker demand from a slowing U.S. economy to keep nickel in surplus and raise inventory levels.

* Inventories — Inventory levels have increased by 17,000 tonnes, or 23%, since their lows in early 1989. Prices reacted by falling 50% to an average of US$3.93 per lb. in the second quarter.

Production disruptions and low inventories then drove prices back over US$5 per lb. in August. Higher inventories and lower prices can be expected in the fourth quarter as the intermediate-term trend of surplus supply reasserts itself.

* Seasonality — Nickel demand rebounded strongly from its traditionally weak summer season this year. Production should rebound in the fourth quarter as seasonal shutdowns end and unseasonal disruptions are sorted out. The increase in supply is expected to more than cover demand.

* Price and inventory relationship — Nickel has shown the most dramatic price fluctuations among the base metals over the past two years. Part of the reason may be the steepness of the price-inventory curve. Also, the LME nickel market is an “illiquid” market compared with other metal rings on the LME, allowing low transaction volumes to create strong price responses. Nickel price movements should continue to be volatile upwards and downwards.

ZINC

* Demand — Weakening of the U.S. economy is primarily responsible for the decline in zinc consumption since early 1989. Interest rates are a negative factor in the construction and automotive industries, which are responsible for a significant percentage of U.S. demand. America, in turn, consumes 20% of the non-communist world’s zinc supply, and growth in other countries has not been strong enough to offset weak U.S. demand.

* Supply — Disruptions have affected supplies of concentrates more than supplies of refined metals. The major source of refined zinc problems has been Canada, with Noranda’s CEZ smelter and Cominco’s Trail smelter both experiencing problems in the past year. CEZ’s production should remain at normal levels, provided the Brunswick strike does create a concentrate shortfall. Trail’s problems are more severe and could continue until early next year. Return to normal production levels by December requires a restart of the new QSL lead smelter and successful adaptation to Red Dog concentrates.

Concentrate supplies are a slightly longer-term problem and could last until Arctic concentrates begin to arrive in the third and fourth quarters of 1991. Pine Point’s zinc supply is exhausted, the Sullivan mine will not resume production until December, Red Dog is shipping 100,000 tonnes less contained zinc than originally planned, the Brunswick mine’s strike has reduced supply and Peru’s problems continue.

The concentrate shortfall will be temporarily alleviated by the seasonal arrival of Arctic concentrates. However, these could be consumed by early 1991, requiring smelter production cutback or higher concentrate prices. Refined zinc prices will benefit in either case.

* Price and inventories — Supply deficits in the first half of 1990 have resulted in lower inventories. Prices responded by rising to US85 cents per lb., helped in part by expectations of a strike at Trail. Seasonal weakness can be expected to dampen prices until autumn, when demand traditionally increases and often is not matched by adequate supply.

Inventories remain at a low 5.4 weeks of consumption and prices lie on the steep part of the curve. That means small changes in stockpiles caused by such events as production disruptions or weaker demand will have a significant impact on prices.