Base metals after the fall

After a period of resilience, base metal prices are currently going through a phase of sharp corrections.

Aluminum has led the way south on March 27 (minus 6.7% from its recent peak at the end of February) driven by fund long liquidation and fresh selling; copper has seen a 7.6% correction over the same period, with the bulk of the losses having occurred only over one day in late March; nickel has maintained its status as the most volatile metal, having shredded 16.4% from its recent peak above US$9,000 per tonne; while zinc has lost 6% over the second half of March.

Are these price corrections providing a good buying opportunity, or is this the start of a new downturn?

Clearly, the economic outlook is becoming increasingly clouded. After a relatively strong start to the year, helped by restocking and currency movements, the month of February saw a marked slowdown in activity. This was evident in economic data releases, as well as in the cutback of outstanding positions on reduced risk exposure at times of heightened uncertainty.

While economic data might play a less significant role at present, when most attention is focused on military conflict, the latest sell-off in base metals occurred after poor economic data releases, again highlighting that demand factors are a key driving force for base metal prices.

U.S.-dollar depreciation and attraction to commodities as real assets at a time of extreme uncertainties might help restrict the downside, especially as the large net fund long now certainly has been reduced, or even eliminated. But it is insufficient, in our view, to push prices significantly higher.

Other factors also serve to restrict substantial downside risk, though these were absent in the price decline during 2001. Those are all related to the supply sides in regard to tight raw material and scrap supplies, as well as designed production curtailments in the copper market.

But considering demand as the key driving factor, there are a string of discouraging developments, which will likely keep metal demand and prices subdued for some time.

Case in point: the U.S. economy is possibly in much worse shape than had been counted for, and with extensive easing monetary and fiscal policies already in place, little ammunition is left to help stimulate growth.

Moreover, strong Chinese growth is likely to ease this year, reflecting the recent change in leadership, potential restructuring of the banking sector, and an expected slowdown in construction activity. So far, Chinese speculators remain good scale-down buyers, but without continuous strong purchasing power from the Far East, the downside is likely to be enhanced.

Economic growth numbers continue to be downwardly revised. Forecasters now expect U.S. industrial production to grow 1.8% this year, compared with a previous forecast of plus 2.2%. Consensus forecasts for German industrial production this year have likewise been downwardly revised, to 0.2% from 0.5%. Meanwhile, Japan is likely to perform a little better than previously expected (plus 1.2% versus the initial forecast of plus 1%).

So, our expectations of subdued growth remain in place, and we do not subscribe to the view of a potentially quick pick-up in economic growth after the war, rather believing that the economic malaise runs deeper.

Our first-quarter price forecasts look good. Our copper price forecast is 0.8% below the year-to-date cash price, whereas nickel and zinc have performed 5.1% and 0.6% better, respectively, so far than we had anticipated.

Aluminum, on the other hand, has performed much better than we (and the market) had estimated, with the year-to-date cash price at US$1,397 per tonne, compared with our first-quarter forecast of US$1,300 per tonne.

Looking ahead, we believe our price forecasts need few alterations. We expect small improvements in average cash prices on a quarterly basis. As prices are likely to remain highly volatile under current market conditions, this can provide interesting trading opportunities. In copper, for example, we do not rule out a correction to the US$1,550-per-tonne area but maintain our second-quarter cash forecast of US$1,675 per tonne.

The outlook for the base metals, as well as for the energy- and precious metals markets, will be analyzed further in this column in late April.

— The authors are minerals economists with Barclays Capital Research in London, U.K. 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.