Another bummer for nickel, copper

Base metals suffered their third consecutive week of across-the-board declines during the report period June 11-15 as recent price support came under renewed attack. Nickel and copper were the hardest-hit, losing 4.1% and 2.9%, respectively, of their average weekly cash values, while aluminum and zinc were down a more modest 1.2% and 0.8%.

The market is growing pessimistic about future price levels, owing to a constant stream of poor economic data (the worse-than-expected U.S. industrial production figures released on June 15 are only the latest setback). However, there is reason to believe that, at least by historical standards, base metals are undervalued at current price levels. It is unusual for copper prices to be as low as they are at present, given the relatively low level of visible stocks. In aluminum, despite the weakness in the front end of the price curve, the market is in backwardation from the middle of next year onward, offering good value to consumers during the second half of 2002 and into 2003 and at price levels a long way below historical averages. Forward-buying volumes remain modest, however, because the strength of the U.S. dollar is keeping Europeans out of the market. The jury may still be out as far as the global macroeconomic outlook is concerned, but base metals market participants appear to have made up their minds that things are likely to get a lot worse before they get any better.

Following the previous week’s sharp fall, copper prices lurched lower again, establishing a new trading range of US$1,605-1,630 per tonne. The bottom end of the range represents the lowest 3-month price in two years. Interestingly, the fall in price has occurred at the same time when there has been a noticeable pick-up in buying interest, particularly from the Far East, and also far forward by some major U.S. consumers. But this was not enough to stem the flow of long liquidation and speculative shorts, adding to their positions. Data from the Commodity Futures Trading Commission show that the Comex fund net short position is again nudging recent highs at almost 20,000 lots, suggesting the potential exists for short-covering rallies, given the right sort of catalyst. However, with exchange stocks trending down only slowly (by just 3,400 tonnes during the period under review), shorts will not be too nervous just yet. Until recently, market participants were hoping for an announcement that more production would be cut in in the southwestern U.S. However, this became less likely when Grupo Mexico said it had no intention of reducing output at its operations. In the short term, we expect further probing of the downside for prices, with the likelihood of a test, early on, of support below US$1,600 per tonne.

European buying interest remains conspicuous by its absence, but this is hardly surprising. European growth prospects are deteriorating with each new release of data, while the euro remains weak. European copper prices expressed in local currencies are still above their early April lows, in stark contrast with U.S. dollar and the Japanese yen prices. With more euro weakness likely, the impact of weaker U.S. dollar copper prices may be cancelled out, and there is little prospect of any pick-up in European buying in the short term.

Notwithstanding poor demand, copper prices appear to be undervalued at current price levels. The current stock level of around 4.7 weeks has tended to be associated with significantly higher price levels than those prevailing currently. This suggests the market is anticipating a substantial surplus in the seasonally weaker second half of the year, together with a big increase in stocks.

Aluminum prices finally broke support at US$1,500 per tonne, as the London Metal Exchange (LME) 3-month figure moved below US$1,490 per tonne for the first time since mid-April. Despite further production cuts, the market retains its focus on the deteriorating macro-economic situation, favouring the view that, for the foreseeable future, demand weakness will more than offset cuts in production. This view is supported by anecdotal evidence from consumers of weak demand, and this is backed up by recent statistics. In the U.S., incoming orders for semi-fabricated products were down 24.4% in April, compared with the corresponding period of 2000. Rising exchange stocks also support the view that demand is weak. We continue to believe that a sizable portion of the stock rise reflects the transfer of already-existing inventory from off-warrant to on-warrant, though the steady increase is certainly harming market sentiment. The 62,000-tonne decline in International Aluminum Institute stocks since January supports this view, as do recent estimates from CRU International, suggesting that the market was roughly in balance during January-May. We still adhere to our view that there is potential for aluminum prices to spring back sharply late in the third quarter and early in the fourth quarter, but, for the time being, further probes to the downside appear probable, with a test of recent lows at US$1,465-1,470 per tonne likely in the short term.

Zinc perked up briefly, with the LME 3-month price closing above the 10-day moving average at US$925 per tonne for the first time since mid-May. However, the market proved unable to build on these gains, closing slightly down at US$924 per tonne on June 15.

The long-term downtrend, therefore, remains in place; indeed, it appears to have accelerated in recent weeks, and, at its current rate of descent, a test of US$900 per tonne for the LME 3-month price looks likely. A period below US$900 per tonne may be just what the market requires, since it is unlikely that significant production cuts will be enacted until this happens.

News from China briefly held out the prospect of some respite from the record levels of Chinese zinc exports finding their way to Western markets. The announcement pertained to the likelihood that the Huludao smelter would be cutting production and exports. Smelter representatives later denied the report and went on to say that production levels are planned to increase to 363,000 tonnes in 2001 from 330,000 tonnes in 2000.

The story in the nickel market remains largely unchanged from last week’s report. The slow downtrend in prices continues to erode the gains nickel made during April and May, with the LME 3-month price on June 15 at its lowest in five weeks. The interplay between the factors affecting nickel prices remains interesting: low volumes dominated by a small number of major participants mean that holders of short positions are cautious and tend to cover positions quickly if prices creep higher. On the downside, however, the weakness of fundamentals and the steady flow of dismal manufacturing data emerging from Japan, the U.S. and the eurozone are undermining sentiment.

Clearly, gold is benefitting from weak equities, though it is uncertain whether gold will be unable to overcome its own price weakness.

Despite hopes for a step-up in the trading range as prices moved toward, and then above, US$275 per oz., the yellow metal suffered another week of disappointment as long liquidation on June 15 pressured prices lower by US$5 per oz. Several factors — weak stock markets, fresh evidence of rising U.S. inflation, and a batch of U.S. economic data that showed further weakness in manufacturing and business sectors — failed to support a sustained improvement in gold prices. Against such a gloomy background, one can’t help but wonder, Does the average gold price improvement of 1.5% during the report period add enough strength to the safe-haven argument to encourage fresh fund buying? We remain doubtful, particularly since the fund long position in gold at more than 19,000 lots on the Comex is still large by historical standards.

The two areas of doubt that surround the recent strength in gold prices concern their longevity and justification. The U.S. equity sector is going through a period of poor sentiment, which is currently benefitting gold. How long this will last is a matter of d
ebate. It is still questionable whether there remains, in today’s economy, the view that gold is a safe haven, and whether the rationale for this is rigorous enough to support higher gold prices.

Despite the economics, the argument of “accepted wisdom” is a powerful one. If a sufficient portion of the investment community believes that gold prices will increase as economic concerns intensify, then, all things being equal, gold prices will increase. The view that the bullion markets are therefore areas of security becomes a self-fulfilling prophesy. As recent price movements illustrate, however, this belief has not yet fully taken root, leaving gold prices still liable to quick downward corrections.

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