The most recent U.S. industrial production data showed a solid gain in the fourth quarter of 2003, led by a 1% jump in manufacturing output. The gains were boad-based, spreading across almost all manufacturing output categories. The February strength, however, followed only modest gains in the prior two months and therefore does not suggest an acceleration on a trend basis. We expect manufacturing gains in the first quarter of this year to be similar to the 6% reading for the fourth quarter of 2003, and actual production continues to lag what would be expected on the basis of current manufacturing surveys. Given the metal-intensive nature of industrial production, the recovery in the U.S. is highly supportive of strength in the metals markets.
Copper
Having highlighted the potential for very sharp price gains in the first quarter, copper prices exceeded even our aggressive forecast, rising by another 32%, quarter over quarter, in the first three months of 2004, to a cash average of US$2,720 per tonne. Numerous factors have been extraordinarily supportive for copper prices: higher economic activity, strong Chinese demand, production disruptions, limited new capacity, U.S. dollar weakness, and investor allocation into metals. Moving into a seasonally strong quarter, we expect these factors to continue to spur prices higher.
While price prospects remain favourable, especially for spot prices, we have reason to believe the second quarter will generate peak levels for this year. We also reason future prices are likely to remain relatively high in a historical context, owing to structural shortages of supply and above-trend demand growth, and we have revised higher our price forecast.
January and February were especially strong months for copper prices, while in March, for the first time in about six months, prices showed some hesitation on the upside as they rose above US$3,000 per tonne for the first time in 8.5 years. Liquidity dried up and volatility increased as a result. While market-specific fundamentals remain strong, the lack of convincing follow-through buying activity has coincided with moderating leading-demand indicators and a reduction in downside pressure on the U.S. dollar. Based on its historical negative correlation with the trade-weighted U.S. dollar, copper is currently overvalued, for the first time since mid-2002. Investors have taken a more cautious stance, as is evident in data from the Commodity Futures Trading Commission.
Also in March, there have been signs that a tight Chinese market is loosening up a little. Examples include record-high imports of refined copper, the release of strategic stockpiles into the domestic market, and somewhat slower consumer order books. Consumers have also been reluctant to purchase copper in the prevailing high price environment. Physical premiums in Shanghai have eased as a result, from about US$150 per tonne to US$120 per tonne (which is nonetheless still high).
Looking forward, supply-side developments will play a key role for prices, and attention will especially be given to the return to full production at the world’s second-largest copper mine, Grasberg in Indonesia (760,000 tonnes per year), after the landslides in the fourth quarter. Also significant is the ramp-up to full capacity (1.2 million tonnes per year) at the Escondida mine in Chile after a period of lower production in response to weak demand. While the start-up of the only new copper mine this year (CVRD’s 160,000-tonne-per-year Sossego, in Brazil) is proceeding according to plan, most of the production growth will not occur until the fourth quarter. London Metal Exchange (LME) prices above US$3,000 per tonne are helping speed up new production projects, though none is so far matching the large-scale projects of the 1990s. Output in the African copper belt is advancing 10% to 382,000 tonnes in Zambia this year, on higher prices, while
Lead
Lead was the best-performing commodity out of a selection of 22 key commodities in 2003, gaining an approximate 85%. A low-price environment for lead and zinc over the past decade has taken its toll on exploration spending for those metals, and now that demand is improving, largely driven by China, the lead market deficit has deepened rapidly.
Shortages of lead are evident from sharp inventory drawdowns on the LME, especially at U.S. warehouse locations since the beginning of December 2003. This follows output disruptions in the region at times of seasonally higher demand. In line with the trend for physical spot premiums, the European market is also particularly tight following last year’s refined capacity closures. Data from Battery Council International shows that replacement battery shipments rose a significant 10.5%, year over year, in North America in December. Anecdotal evidence suggests the first two months of the year have also been strong, but replacement battery demand traditionally eases from March (unlike the seasonal demand pattern for other base metals).
The explosion at
In Europe, in light of the higher prices and premiums and ongoing contract negotiations for treatment charges (TCs), there is fresh speculation over an imminent restart of
Despite tightness of the lead raw material market, China managed to import 121,000 tonnes of lead-in-concentrate during the first two months of the year (+158%, year over year), and its exports of refined lead remain sizable (unlike trends in Chinese trade data for most other base metals). Still, we expect the upward trend in lead prices to persist through the second quarter in line with the rest of the complex, but we also expect relatively less upside pressure in lead as the seasonal peak period is now behind us and as the LME inventory drawdowns should slow down in line with much-reduced cancelled warrants.
Nickel
Compared 2003, nickel has had a less impressive price performance so far this year, and in contrast to their usual volatility, nickel prices have been trading largely sideways after a sharp correction at the beginning of the year. We see the broad range for 3-month nickel at US$12,500-15,000 per tonne over the medium term. A strong floor is positioned under the market, owing to prevailing deficit market conditions and the economic upswing. However, upside is also limited, given investor caution over the fact that prices remain around 14-year highs, and given firm evidence of Asian stainless steel mills de-stocking. Furthermore, strike action at some of the world’s largest nickel operations — in Sudbury, Ont. (
Taking advantage of high prices, nickel companies are pushing production to maximum operating levels.
Consequently, Chinese imports of nickel have fallen significantly in recent months, and, for several reasons, we think this is a trend that could continue in coming months. First, lower nickel content stainless steel production is gaining market share, from about 5% in 2000 to about 20% at present. Second, aggressive stockbuilding of nickel at domestic steel mills took place last year — material that is now being used. And third, steel is a sector in which the Chinese government has identified overcapacity and hence is subject to a controlled slowdown. There is anecdotal evidence of smaller stainless steel projects being cancelled or postponed as a result.
Zinc
Together with aluminum, zinc has been an underperformer in the current bull run of metal prices. Although zinc prices have followed the direction of the other base metals, they gained a more modest 12% in the first quarter of this year. However, we can identify compelling reasons to suggest that the upward trend in zinc prices will persist, and indeed zinc should register attractive gains in coming months. Worth pointing out, too, is that in previous cycles, zinc showed a tendency to lag peaks in other metal prices by about seven months.
Improving fundamentals, after major cost-driven capacity closures last year and higher demand more recently, are now finally starting to affect inventory levels. In contrast to most other base metals, which in some cases have seen their stocks fall to critically low levels (nickel and tin, with copper also moving in that direction), zinc stocks have been rising since 2001 and have reached their highest levels since 1995 on a total reported basis. Since mid-February, however, LME stocks have registered constant daily net outflows, apart from a few large inflows (partly to Dubai) that, we believe, reflect material moving from an off-warrant location and could be part of a warehouse financing deal.
The beginning of a declining inventory trend is constructive for prices, as we believe it reflects a pick-up in consumption of zinc. Anecdotal evidence suggests North American zinc producers have sold out of zinc, and producers of galvanized steel in the Western World are asking for more. High freight rates have enhanced the rise in physical premiums, with upside pressure on U.S. premiums in particular.
A pick-up in Western demand is key to higher zinc prices, but recent trends in the international trade of Chinese zinc are another crucial development. As expected, strong Chinese consumption, tight raw material supplies and lower export tax rebates are now having a marked impact on large-volume exports of zinc to the Western World. In addition, power shortages have affected zinc production severely in provinces of Guangxi and Hunan. Zhuzhou and Liuzhou Longcheng for example, which produced 285,000 and 100,000 tonnes of refined zinc, respectively, last year, have both had to cut output by at least a third. The country’s largest zinc producer, Huludao, on the other hand, is planning to restart and expand its idled 130,000-tonne-per-year smelter in July. Trade statistics show China reverted to being a net importer of refined zinc in February as a result — a trend that bodes well for the market balance and prices.
Again, like the other base metals, the supply side is likely to stay tight for some time, owing to underinvestment of new capacity in recent years. Teck Cominco (TEK-T) and Korea Zinc finally settled treatment charges, and a reduction from last year’s US$147 per tonne to US$140-141 per tonne (basis price: US$1,000 per tonne) confirms the shortage of concentrates. Higher output at some mining operations will fail to offset lost output at Teck Cominco’s temporarily closed 180,000-tonne-per-year Lennard Shelf mine in Australia and lower-than-planned output at Antamina this year (only half from last year at 180,000 tonnes). On the smelting side, Doe Run announced it is shutting 30,000 tonnes per year of its 80,000-tonne-per-year La Oroya smelter in Peru in 2005, while Glencore’s 185,000-tonne-per-year Porto Vesme smelter is unlikely to restart until the end of this year.
— 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.sterbny@barcap.com
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