Nickel’s fickle, zinc sinks

Aug. 6-10 was another poor week for base and precious metals prices, characterized by declines right across the board and week-on-week losses in all markets except gold. After tin (which registered a 7.3% fall in its weekly average cash price), nickel was the worst-hit of the major traded metals (minus 5.5%). The fall crowns a disastrous period for nickel during which it has gone from being the best-performing base metal in 2001 to the worst, in the space of just three months.

In the aftermath of the recent U.S. Beige Book Report, markets around the world are bracing themselves for another leg down in the global economic decline. The report showed worrying signs that the appetite of the American consumer may at long last be waning, dealing a blow to U.S. dollar bulls and placing question marks around the consensus view for a bottoming-out, during the current quarter, of metals prices and of industrial production from the Organization for Economic Co-operation and Development (OECD). Until recently, it appeared that the building blocks for a U.S. recovery were falling into place (albeit a little more slowly than many had hoped). With recent data showing that the industrial sectors of Germany, Italy and the U.K. have all slipped into recession, much depends on the ability of the U.S. manufacturing sector to return to some semblance of growth over the remainder of 2001. But any U.S. recovery will be muted if it takes place in an environment where consumers are ratcheting back their expenditures.

After trending steadily downward for most of the week, copper prices steadied on light fund short-covering on Aug. 10 to finish at US$1,463 per tonne, US$25 below the previous week’s close. Given the size of the fund short position in copper (data from the Commodity Futures Trading Commission show U.S. funds still 19,000 lots net short), short-covering rallies are to be expected, though the main price trend remains downward. The cause of the short-covering may well have been a much-larger-than-expected drop in the July U.S. Producers Price Index on Aug. 10 (minus 0.9% was the steepest since 1993), which may give Federal Reserve Board Chairman Alan Greenspan extra room to cut interest rates at the next Federal Open Market Committee meeting on Aug 21. Uncertainty over this issue may slow the copper price descent, suggesting that recent support at US$1,460 per tonne could hold for the time being. However, prices are now less than US$100 per tonne away from the 1999 low of US$1,365 per tonne, and this appears to be a realistic target for the funds.

With copper demand still poor, it is no surprise that global stock levels continue to rise (exchange stocks climbed 16,400 tonnes during the period under review). However, cancelled warrants (metal booked to leave London Metal Exchange warehouses) rose by 18,000 tonnes during the report period. Admittedly, this is from a low level, but it may signify that the steady net increase in LME stocks could be about to slow as the market heads for the usual pick-up in September. Tightness around the September date has shown little sign of intensifying, and so the threat of further big deliveries into LME warehouses in response to a backwardation also appears to be receding.

A slowdown in visible inventory accumulation would certainly help market sentiment, which has been poor following the release of worse-than-expected industrial production data which indicate that British, German and Italian industrial sectors all slipped into recession. A close relationship exists between changes in OECD industrial production and copper prices (the correlation is 62%). Leading indicators for OECD industrial production suggest further deterioration over the next few months at least, and on this basis copper prices may still be some way from their trough.

The International Copper Study Group (ICSG) released its estimates of the global copper market balance for the year to May 2001, showing a 120,000-tonne surplus, compared with a 351,000-tonne deficit for the corresponding period a year earlier. The ICSG’s estimate of the global surplus is roughly in line with our own: 160,000 tonnes for the first half of 2001.

After testing support at US$1,380 per tonne earlier in the week, the price for LME 3-month aluminum picked up on Aug. 10. The upward move was fuelled by short-covering, sparked off by the announcement of further power-related production cuts in Brazil and a surprisingly large drop in International Aluminum Institute (IAI) producer stocks of aluminum. However, given the size of the fund short-position in aluminum (rumoured to be more than 1 million tonnes), the fact that prices were unable to push significantly higher than the 10-day moving average at just below US$1,400 per tonne was disappointing. It suggests that, for the time, the trend-following commodity trading advisors are quite happy to stick with playing the aluminum market from the short side. Forward buying for 2002 and beyond continues to provide some support to the market, but we would not be surprised to see US$1,380 per tonne broken in the short term. On the upside, a break above US$1,420 per tonne is required to signal the start of fresh upward momentum.

During the report period, the IAI stock report showed a surprisingly large 129,000-tonne fall in producer unwrought inventory — the second-largest fall on record since the IAI’s new reporting procedures were introduced at the beginning of 1999. Producer stocks are now at their lowest since July 1999.

Zinc prices continued to slide lower, dipping to yet another fresh low for the current LME zinc contract of just US$841 per tonne for the LME 3-month price. Prices trended slightly higher over the second half of the report period before falling back again on Aug. 10 to end the week at US$845 per tonne, looking capable of further losses in the days ahead.

One positive factor for zinc is a recent slowdown in the rate of inventory accumulation on the London Metal Exchange. LME stocks ended the report period at just over 307,000 tonnes, more than 2,500 tonnes below the recent peak hit in late July. A key reason for this is the slowdown, since late July, in the rate of deliveries into the Singapore warehouse. Indeed, Singapore stocks of zinc have fallen back from a peak of 112,500 tonnes to just over 11,000 tonnes over the same period, after rising by 55,000 tonnes since the start of the year.

A slowdown in Chinese exports is almost certainly the main reason for this. However, though Chinese exports may have fallen, probably as a result of low Western prices, we think it unlikely that production has been cut substantially. Recent data from the Chinese Non-Ferrous Metals Association show that production in the first half of the year was running at 17% above year-ago levels while demand was growing by only 12%. Given the massive gap between Chinese consumption and production (almost 350,000 tonnes in the first half of 2001), it would take a sizable cut in output to reduce China’s exportable surplus of zinc, and we expect exports to remain at high levels for the rest of this year.

Recent days have not been kind to the nickel market. The downtrend has remained in place and, moreover, was peppered with a sharp fall on Aug. 8 of more than US$200 per tonne, pushing prices down to the current range of US$5,200 per tonne. Furthermore, two of the key areas of support for prices failed to provide any good news: levels of LME stocks rose again, while the long-term cash-to-3-months backwardation was eradicated and turned into a contango of US$35 per tonne. To cap the disappointment, a story based on Canadian producer Falconbridge was misinterpreted by the market as affecting levels of nickel production when it, in fact, concerned one of its copper/zinc plants. Meanwhile, the figures which did affect the market showed a supply surplus and a sharp drop in global consumption. Given these developments, we expect prices to target US$5,200-per-tonne support in the very short term, with a chance of a test of support at US$5,000 per tonne.

Figures released from the
International Nickel Study Group provided firm evidence of the deterioration in the nickel market. The data show that the level of world production had risen by more than 8%, year-over-year, in June to 99,600 tonnes, bringing the increase during the first half of the year to more than 3%, year-over-year, at 578,700 tonnes. Meanwhile, consumption levels fell by 6% in June, year-over-year, to 89,600 tonnes. For the first half of the year, consumption declined by 8.6%, year-over-year, to 529,800 tonnes.

There were two sides to the gold market during the period under review. The first was characterized by typically dull summer trading patterns, which left prices stuck in 2- or 3-dollar ranges. The sharp falls in the other precious metals markets — silver, platinum and palladium — failed to lead gold prices lower, as did figures from the Comex division of the New York Mercantile Exchange, showing the first net speculative short position in gold in almost three months.

However, the second half of the week caused a flurry of unexpected activity, which took prices on Aug. 10 to their highest close since late June.

In recent weeks, gold price movements have been looking for a sense of their own direction without having much success. One of the main focuses has been the FX markets and the progress of the U.S. dollar. The greenback made significant losses against the euro and the Japanese yen. Against the former, the losses come following a 10-week period in which the U.S. dollar steadily deteriorated amid mounting concerns over the state of the U.S. economy and the speed of any potential recovery this year. These concerns were also reflected in a much weaker Dow Jones index, which, by the Aug. 10 close in London, was trading at its lowest level in a month.

A weaker U.S. dollar, a poorly performing U.S. stock market and worries over developments in the U.S. industrial slowdown all provided a positive backdrop to prices. It is doubtful, however, that improvements can be be solely attributed to these factors. We have always been skeptical of the view that a sufficient proportion of the contemporary and professional investor community would turn to gold when faced with uncertainty. In a similar light, the weaker euro does not itself lead to a significantly higher gold price when markets are so thin and fund interest is in the summer doldrums.

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