Analysts rethink growth expectations

The flagship commodities of the London Metals Exchange (LME) performed poorly Oct. 8-12, with copper and aluminum shedding 0.6% and 1.6%, respectively, of their average cash price value. Elsewhere, however, the performance was healthier, as demonstrated by lead (+5.3%) and nickel (+5.1%), but with tin (+2.3%) and zinc (+0.2%) also benefiting.

Unfortunately, the rallies in the less heavily traded metals probably do not herald a wider recovery; more likely, they’re a reflection of short-covering in what are even thinner markets than usual, and it is extremely unlikely that copper and aluminum will make similar gains any time soon. U.S. retail sales data for September showed the steepest drop since the series began in 1992. Even before then, however, macro-economists had been busy revising down their growth expectations for the remainder of this year and into 2002. There is now a consensus forming that the upturn in industrial and manufacturing activity that many had penciled in for the fourth quarter of 2000 will not emerge until sometime before late in the second quarter of next year (at the earliest). Even so, industrial production from member nations of the Organization for Economic Co-operation and Development (with which metals demand is strongly correlated) appears likely to grow in excess of 2% in 2002, well below earlier expectations of 3.5% or more. In addition, sharp increases in inventory over the past month suggest that most base metals markets are set to end the year with much higher levels of stocks than previously anticipated. Under these conditions, the need for producer cutbacks in copper, zinc and nickel is intensifying.

Copper prices enjoyed a mild rally on Oct. 12, but, for most of the week, prices had continued to trend down, dipping below US$1,400 per tonne for the first time in 28 months. In real terms, prices for the red metal are now at their lowest levels since the 1930s. The Oct. 12 rally was helped by a good performance in the U.S. equities markets, which were buoyed by the apparent success of air strikes against Afghanistan and prospects for economic stimulus as the finishing touches were added to what is said to be a multi-billion-dollar package. Nevertheless, copper price risk remains skewed to the downside, and if US$1,400 per tonne is convincingly broken, the next line of support will be US$1,380.

In the month since the terrorist attacks, copper prices have shed around US$40 per tonne, a relatively mild loss considering that LME stocks have risen 80,000 tonnes (+16%) during the same period. Total reported copper stocks (LME, Comex, producer, consumer and merchant) are now just below 1.6 million tonnes — their highest level since 1983 — and it looks increasingly likely that the 1999 price low of US$1,365 per tonne will be hit soon. This level provided good support in early 1999, partly because large production cuts (by Asarco, Phelps Dodge and Broken Hill Proprietary) were made at the time. However, because a large number of high-cost mines were closed back then, prices may need to fall much further before similar fundamental support is found this time around. Minera Michilla’s announcement that it is considering closing the 50,000-tonne-per-year Lince copper mine in Chile is a step in the right direction, but further steps are needed.

As with copper, aluminum prices trended steadily downward before bouncing off support at around US$1,300 per tonne on Oct. 12. Aluminum market volumes picked up markedly mid-week as a major producer was forced by the recent price drop to restructure its hedge book. The resultant high volumes of selling were absorbed by brokers and a major merchant covering its short position. However, consumer buying remains patchy, and until it picks up, aluminum is vulnerable to further price falls. Initial support is at US$1,300 per tonne and after that at US$1,280. Upside is likely to be capped at around US$1,320 per tonne.

Zinc prices rallied strongly toward the end of the week as short-covering in a thin market pushed the LME 3-month price up US$15 per tonne to a 2-week high of US$800 per tonne. It was the biggest upward price move since mid-August. There was some speculation that the price rally was related either to the scaling-back of base metals trading operations that took place at RMD Scotia Mocatta or the announcement that NM Rothschild & Sons is to shut its base metals trading. In the extremely thin market conditions that characterize zinc trading at present, the liquidation of even a small short position could push prices up quite rapidly. The initial move almost certainly sparked additional short-covering by funds that had been betting on prices breaking below US$780 per tonne before the end of the week.

With around 35% of zinc mines unable to cover cash costs of production at current prices, the market is eagerly awaiting mine production cuts. There is now some hope of cuts to come, following Asarco’s issuing of worker adjustment and retraining notification statements to employees at its three Tennessee zinc mines. The move was a reaction to low zinc prices worldwide. Cash costs at the mines are estimated at 48 per lb. — well below the current price, but even so, there is no guarantee the operations will close. Asarco is weighing three options, ranging from complete suspension of output to partial curtailment to no action at all. Last year, the three mines produced a total of 60,000 tonnes of zinc-in-concentrate.

Nickel was consistently the strongest performer in the LME complex, climbing on Oct. 12 to its highest close since late August. Registering five consecutively higher closes, nickel not only reversed all the losses made in September and early October but was able to move against the trend of the metals complex. The question now is: does this signal the start of the recovery in the nickel market and an end to the downtrend that has been in place since May last year?

Against a base metals complex that is still vulnerable to downward moves, it seems unlikely this is the case. We suspect nickel may still test fresh lows in the current price cycle. Given current fundamentals, the main difference between nickel and the other base metals lies in stocks levels. Stocks over the report period declined by 210 tonnes, during which time stocks in all the other metals (except lead) increased. Furthermore, in recent months, aggregate stock levels in nickel have remained stable and have increased only slowly, whereas stocks in other metals have increased to their highest levels in years.

Over the next few months, however, nickel — and indeed all base metals — is likely to be subjected to a period of slack demand and a faltering economic environment. While short-term short-covering and near-term supply concerns may be capable of producing a brief rally, we doubt that nickel will launch a sustainable recovery.

The mood in the gold market has changed rapidly. Bullish nervousness and a heightened sense that an opportunity had arrived for gold to prove its worth as a safe haven have been replaced by despondency. Three consecutive days of large losses left prices looking for support at US$280 per oz. on Oct. 12. With prices quickly learning to ignore the political situation, there seems little chance of a return to the US$290s. It is still difficult, in the current environment, to judge the impact unknown events may have on the yellow metal. If the bombing campaigns continue to operate smoothly, however, and financial markets give the benefit of the doubt to policy-makers, gold prices are unlikely to climb.

Other developments have cast doubt over gold’s credibility as a safe haven. The withdrawal of Credit Suisse First Boston from the precious metal business is not only a psychological blow to the bullion market; it also leads to the exit of one of the gold market’s daily fixing banks and will ultimately deprive the gold market of some of its liquidity, particularly in the field of exotic gold derivatives.

The London Bullion Market Association released some discouraging data: measured in terms of ounces transferred, the gold market shrank in September to 19.4 million oz., compared with the turnover of 19.9 million oz. in August.

Meanwhile, a tighter borrowing market has raised suspicions that producers, who had been absent from the market for much of the period after Sept. 11, have returned as hedgers to capture the high prices. This highlights the easing in tensions in gold and suggests prices will struggle to break resistance levels in the US$280s. Nervousness on Oct. 12, heading into the weekend, produced a stronger close and shows that support on the downside may be firm, but gold may now struggle to move out of the range of US$280-290 per oz.

— The opinions presented are solely the author’s 0and do not necessarily represent those of the Barclays group.