Prices weak despite recovery prospects

The metals markets all gave way to price weakness during the report period April 29-May 3, even though manufacturing data from both the U.S. and the eurozone are providing clear evidence that improvements in demand from industrial sectors are in the pipeline.

The major base metals have, in all cases, drifted through key support areas despite a strong euro (which should prompt European consumers with buying opportunities) and the weaker U.S. dollar (which provides some relief for the American manufacturing sector and thereby strengthens the recovery scenario).

Why the apparent contradiction? The latest forward-looking demand indicators for copper and aluminum from the U.S. suggest a rapid increase in consumption prospects during the first quarter, and figures from the International Nickel Study Group suggest nickel is heading for near market balance this year. Still, the failure, in commodity markets, to build on the successes of the first quarter does not suggest that, after a period of growth, we are now entering a period of sustained weakness. It seems more likely, judging from recent figures from the Institute for Supply Management (ISM), that a period of moderate price movements and consolidation is upon us.

The expectations with which many of the speculative funds bought into base metals markets in early 2002 have yet to be confirmed by a sharp turnaround in metals consumption. Although demand indicators continue to point higher, commodity markets are now pricing-in both sides of the market equation and matching supply negatives with demand-related positives. This does not necessarily point to a quarter of negative price growth, but it does suggest that, going into the seasonally quiet summer period, base metals markets may take a reality price check. Upside price prospects may be increasingly limited.

Economic data from both sides of the Atlantic are broadly supportive of a moderate recovery in base metals price prospects throughout the remainder of this year. A sound reading of the April ISM survey, from the U.S. and a surprisingly strong rise in the eurozone’s Purchasing Managers’ Index figures have begun to restore momentum to the manufacturing-led recovery.

Although copper prices continue to respond to these positive developments, the recent decline to the support area of US$1,585 per tonne highlights the degree to which price movements reflect areas of weakness. With prices now trading at US$1,572 per tonne (near the 100-day moving average) and technical congestion at US$1,610 per tonne (the 10- and 30-day moving averages), the red metal appears to be caught between a rock and a hard place. This trend may continute for some time, as growth expectations, moderate upside risks and an extension of the recovery trend protect downside risks.

However, with the funds and small commodity trading advisors still in the driver’s seat of an otherwise thin market, technical indicators should be watched all the more closely. Having slipped below US$1,600 per tonne, copper prices are in an area of vulnerability. Not since early November 2001 have they traded materially below the 100-day moving average. With speculative funds still sitting on a sizable net long position on the Comex, a break from this area would be clearly bearish, raising the risk of liquidation. On the other hand, any downside moves should not be interpreted as the resumption of a downtrend. Although demand may be sluggish, it is still improving, and U.S. metals demand indicators are now stronger than they have been since mid-1997.

Low levels of activity and a steady flow of unsupportive data pushed aluminum prices into bearish territory. The move below the 200-day moving average at US$1,375 per tonne leaves prices in the lower part of the broad trading range, into which aluminum prices have been moving since the start of the year. The weakness over the report period highlights the gap that has opened up in aluminum between demand expectations and the start of any pickup in actual consumption. The underlying progress made in the U.S. manufacturing recovery has yet to deliver real demand, and with the seasonally quiet summer season only two months away, the short-to-medium-term outlook for aluminum does not look encouraging. On the supply side, news was mixed but, in terms of near-term price impact, biased to the downside. The next key support area is US$1,360 per tonne. Support here should be solid, and a drift below is unlikely — though not impossible (until prices can recover above US$1,385 per tonne, aluminum will be in weak technical territory).

Nickel has formed a clear upward price trend since the first part of the fourth quarter of 2001 through to the recent first quarter, but cracks are beginning to appear in its technical strength. Prices fell toward a test of support at US$6,800 per tonne during the report period, compared with a consolidated range of US$7,000-7,200 per tonne in the second half of April. On a positive note, the lack of headway made on the upside and the consequent drift below the support line of the 10-day moving average indicate that nickel may now be poised for a period of consolidation at a lower level.

In early April, the market learned that the Noril’sk Mining and Metallurgical Kombinat in Russia had used 60,000 tonnes of nickel as collateral for a loan. The news was initially interpreted as bullish by most in the market, as shown by the latest price hike, from the US$6,600-to-6,800-per-tonne range to US$7,000-7,200 per tonne. However, since price gains were made on the back of this news, it now seems reasonable to assume that nickel could drift lower to the US$6,600-per-tonne area. Unlike zinc, however, nickel is not lumbered with a large supply-demand surplus. On the contrary, the International Nickel Study Group is predicting a market surplus in the second quarter of just 21,300 tonnes, which would likely reinforce price supports.

The ability of zinc prices to defy the gravity of their own market’s depressed fundamentals does not, in our opinion, strengthen zinc’s position. Instead, zinc would appear to be storing up price weakness to be released at a later date. Heading into the summer months, we still expect zinc to experience a fresh test of support at US$800 per tonne as the lethargic metals complex adds to the downward pressure. As with the other metals, the stronger euro should provide buying opportunities for European consumers, but with supply factors weighing against the chances of a sustainable upturn, zinc will likely have to struggle in the current quarter. In the immediate term, the key price levels remain US$800 per tonne for support on the downside and US$820 per tonne for resistance on the upside.

The release of consumption and production forecasts for 2002 by the International Lead and Zinc Study Group (ILZSG) highlight the difficulties associated with any rise in the price of zinc. Over 2002, zinc consumption is expected to rise by 1.4% in comparison with last year. Although this marks an improvement from last year’s fall in demand of around 1.3%, year over year, the net improvement is negligible. In light of the ILZSG’s production growth forecast in 2002 of 3.6%, year over year, the scale of zinc’s current supply-demand imbalances is clear. Based on these assumptions, the zinc market this year is heading for a surplus of 500,000 tonnes. With fresh production cuts unforthcoming, price prospects for zinc remain limited, and downside risks outweigh those on the upside.

Gold prices have consolidated above US$307 per oz., but what is more surprising is the continued weakness of the U.S. dollar in relation to the euro and the yen. The strong close in gold prices at the end of the report period was born out of fresh U.S. dollar weakness. We continue to view the re-positioning of the greenback as a temporary matter; ergo, any gains gold prices make on the back of the weaker dollar are also expected to be temporary. While we retain our skepticism regarding gold’s ability to make consistent and sustainable gains over the medium term, in the s
hort term, excessive short exposure should also be avoided. The gold market remains technically strong, and the uptrend was well-maintained during the period under review. The absorption of large selling volumes above US$310 per oz. remains a hurdle which prices have yet to overcome, but given the continuation of the other factors that ushered gold prices higher, risks of a break of US$311-312 per oz. have increased.

With the gold industry, particularly in South Africa, still in a period of foreign-exchange-inflated profits, consolidation and strong gold equity values, the impact on bullion prices is expected to ease upside resistance areas as speculative buying increases. However, the problem with this rally (indeed with any rally) is that it can last only as long as the factors that engineered it. Given this, we still question the permanence of gold’s improved conditions, and we doubt that the degree of buying we have so far seen is sufficient to mark a clear change in gold’s fundamentals. Strong increases in share values of gold mining companies and high levels of speculative buying on Comex are more likely reasons for the rise in bullion prices; the downside risk associated with these, however, is clear.

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