Rosy forecast for base Metal Prices

Despite prevailing macro uncertainties we are expecting a substantial improvement in base metal prices this year.

The risk remains that economic growth will continue to disappoint and that a second recession will emerge. However, current fiscal and monetary stimuluses should help avoid that scenario in the U.S.

Europe and Japan appear more vulnerable, but in contrast to previous cycles, astonishing demand strength from China should offset this. Excluding China, leading indicators for base metal demand remain unimpressive but, on balance, constructive.

All eyes will be on the U.S. market, which is expected to lead other key Western World regions, while speculative buying will lead base metal prices higher. This first step in a recovery is already evident; Commodity Trading Advisor funds spurred prices 10% higher in the fourth quarter of 2002, while there are signs of macro funds getting increasingly active on the long side.

We think improving demand indicators will be the driving force of higher prices. The other determining factors, new supply and inventory levels, are starting to look increasingly constructive. Deficit conditions developing in several markets have already started to affect reported inventory levels, with drawdowns evident during the previous quarter. Supply discipline introduced in response to the October 2001 price trough, which was intensified during the previous quarter, has helped reduce downside price risk.

At a time of subdued demand growth in the Western World, we expect base metals with constrained supply sides and positive exposure to China (copper and nickel) to perform best. Aluminum should underperform the rest of the complex, though there is potential for positive surprises on the supply side, which could restrict downside risk. We expect lead and zinc prices to strengthen in line with a cyclical recovery and on short-term regional availability tightness.

To match this outlook, we upwardly revise our estimate for annual average cash copper prices by +5% to US$1,694 per tonne (76.8 per lb.) for 2003. We revise nickel prices by +8% to US$8,100 per tonne ($3.67 per lb).

The other main change is a downward revision to our estimated rise in zinc prices for the period 2003-04, as we believe the supply-side structure will hamper our previous optimistic forecast. On an aggregate basis, we expect a price rise of 10% this year, following a 0.3% drop in 2002.

The following provides further analysis on each metal, while a more extensive review will be published in The Northern Miner in early February.

r Aluminum — A rising price profile for a market with structural oversupply might seem optimistic. However, the potential for positive supply surprises (primarily related to the power situation in the Nordic region), coupled with a pick-up in demand and a general recovery in commodity prices, should support aluminum. As a result, we recommend a consumer-to-consider any-price dip (toward US$1,300 per tonne), especially if positioned in the euro area. The upside is restricted by the large supply surplus, and as a result, we think aluminum will underperform the rest of the complex.

r Copper — This is not the time to be short of copper. A modest recovery in Western World demand, in conjunction with strong Chinese demand (speculative and physical) and restricted growth in supply, induces us to recommend long exposure to this market. We expect development of a deficit to lead to inventory drawdowns, which will be further supportive for the market. A key risk would be that strong Chinese demand growth slows, since there is some evidence of rising manufactured inventories there. Chinese strategic stockpiling could play a central role, but there is no firm evidence of that occurring yet. We continue to expect strong Chinese import volumes this year, helped by restricted domestic supply growth.

r Lead — Last year’s losses will be recouped. We expect the lead market to benefit from restricted refined supply growth, owing to the tight concentrates market and regional physical tightness. Reduced export volumes from China on strong domestic demand and shortages in European availability have helped tighten the global market. However, a modest demand-growth profile keeps upside price potential limited in our view, and we expect lead prices to show the smallest increase in prices among the base metals this year, after aluminum.

r Nickel — Strong fundamentals and aggressive speculation allow for the possibility of a price spike. Concern over excess restocking in the stainless steel industry in a weak economic environment has been neglected by the speculative community. Instead, fear over extended supply tightness, owing to the lack of new capacity, has been the key driving force at this point in the cycle. Delay of the Goro project in New Caledonia and failed growth at the laterite operations leave highly likely projects at a small scale for the foreseeable future. As a result, reported stockpiles are at low levels, with a stock-to-consumption ratio below six weeks. The timing of the release of Norilsk’s stockpiled material (60,000 tonnes) is the big unknown, and could help decide the ceiling for prices.

r Tin — There will be price improvement from low levels. Looking at its relative performance on the London Metal Exchange (LME), tin would seem like a good bet. We expect tin to be among the strongest performers this year. However, this follows a year of the largest price drop on the LME, bar zinc. Production declines and the ban of Indonesian concentrates exports have enabled sharp reductions in inventory levels (with tin being the only metal registering a decline in LME stocks at the end of 2002, compared with a year earlier). The upside is restricted by a rise in Indonesian refined output and only a slow recovery in demand.

r Zinc — A downgrade to our price forecast does not mean we are negative toward zinc. Current prices represent good value for consumers, as fundamentals are improving and the market is moving toward deficit. We think prices will average a level 7% higher this year compared with last. Physical tightness due to output curtailments in Europe and material tied up in finance deals is already evident, pushing premia higher. The raw-material market remains tight, restricting refined supply growth. While output has gained momentum in China to support strong domestic demand, much lower export volumes are helpful.

— The opinions presented are the authors’ and do not necessarily represent those of the Barclays group. For access to all of Barclays’ economic, foreign-exchange and fixed-income research, go to the web site at barclayscapital.com. Queries may be submitted to the authors at kevin.norrish@barcap.com and ingrid.sternby @barcap.com