Sept. 9-13 at a Glance
o Copper — The large net short could enable a rally on a sustainable basis if the economy improves.
o Aluminum — U.S. demand data are still weak but show possible early signs of demand bottoming.
o Nickel — Russian exports continue to rise.
o Zinc — Cost analysis reveals that less than half of the zinc smelting industry is profitable.
o Gold — Key factors supporting the precious metal remain in place.
Does the macroeconomic environment justify recent base metal rallies? Recent key economic data have been mixed, and the latest reading of the Composite Leading Indicator of the Organization for Economic Co-operation and Development was not particularly impressive, suggesting slow growth in industrial production. At the same time, base metal prices rallied by about 6%.
Assuming that economic growth will remain (at best) slow, with economic activity in the U.S. having slowed further since July (as highlighted by data released by the Federal Reserve), we believe the recent speculative rally in base metal prices was a premature attempt to leverage off an economic recovery. However, on Sept. 3, the speculative net short position in the Comex copper market reached its largest since November 2001, suggesting that a rally could be forceful once positive fundamental news occurs.
Following consistent gains in the Composite Leading Indicator since October last year (at a time when base metal prices have also trended moderately higher), the growth rate decelerated, according to the latest reading for July. The month-over-month change was negative for the second consecutive month (minus 0.3% versus minus 0.1%), while the year-over-year growth slowed from to 2.7% from 2.9%.
Together with the latest U.S. manufacturing data (which were flat), these indicators suggest that end-use demand is likely to remain slow in the near future, and that speculative activity of significant size (which we believe will be the initial main force to bring prices to higher levels on a more sustainable basis) is likely to remain absent before there is convincing evidence that the economy is recovering.
Upcoming economic data will be key for the outlook for base metal prices, with data on U.S. industrial production in August due on Sept. 17.
Copper prices have risen by about 6.5% from the previous week’s low (US$1,465 per tonne) to a high of US$1,559 per tonne for the report period.
Following a month of sideways movement, the rally occurred despite no specific market news. Instead, healthier equity markets and nervousness surrounding the Sept. 11 anniversary attracted speculative buying interest.
There has been a close relationship between copper prices and speculative trading activity. While the net short has certainly been reduced over the past week, we expect the next data from the Commodity Futures Trading Commission (due in mid-September) to show that it remains large. This will help limit downside price risk in the near term, and provide a good starting point for higher prices on a more sustainable basis once demand indicators show convincing signs of improving.
Speculators will certainly be among the first to try to leverage off an economic recovery, and given the length of the net short position, a rally could be forceful when positive fundamental news occurs.
The latest data from the U.S. Aluminum Association (USAA) on new aluminum mill product orders was mildly positive in our view.
Although remaining at low levels, the total net new order index improved by 6.6%, month over month, to 92.3, climbing back to levels registered in May this year. However, compared with the same month last year, the total index was still 5.5% lower. The index, excluding can stocks, showed a similar picture, rising by 4.9% over the month (to 86.36) while 7.8% lower from August last year. Significantly, however, the August 2001 figure was unusually high, resulting in exaggerated year-over-year falls.
The 3-month moving averages of both series are still pointing downwards, yet we believe the month-over-month improvements may be early positive signs of demand bottoming.
Looking more closely at the components of the total order index, month-over-month improvements were visible in most product types. The largest jump appeared in forgings and impacts (200%), while orders of insulated conductors and extruded shapes rose by about 25% each over the month.
However, these large fluctuations highlight the volatile nature of these data and have prompted us to look at moving averages instead. The 3-month moving averages of the total index and the one excluding the more seasonal can-stock data are still showing declining trends, and suggest that it is still too early to say that demand is definitely improving.
The latest data on Russian base metals, released by the State Customs Committee, showed that exports of aluminum and copper fell during the first half of this year, whereas nickel exports rose rapidly.
Although disrupted early in the summer by annual flooding at the Dudinka port (Noril’sk Nickel’s shipping gateway), exports amounted to 191,700 tonnes between January and July — almost double the amount in the corresponding period last year (plus 97.8%). If this rate of export growth continues, annual exports could exceed 300,000 tonnes, compared with 173,000 tonnes last year. Even if we believe exports of 300,000 tonnes for the full year are optimistic, recent statistics suggest a full-year figure will be significantly higher than last year’s.
Noril’sk, the world’s prime supplier of refined nickel, has a production capacity of about 250,000 tonnes per year, which is expected to increase by about 3% a year until 2004.
However, despite high Russian exports, robust demand growth (plus 6.5% from depressed levels last year), primarily driven by an improving stainless steel sector, should help this market to stay at least balanced.
There are renewed concerns about about the future of MIM Holding’s European
Cost analyses indicate the alarming state of the world zinc smelting industry, with fewer than half (48.6%) of all operations generating profits. In this analysis, we have assumed year-to-date exchange rates and inflation, average London Metal Exchange zinc prices for August (US$748 per tonne) and treatment charges (TCs) of US$167 per tonne and US45.4 per lb. A combination of negative factors, in light of current weak LME prices, low TCs and unfavourable exchange rate developments for non-U.S.-based production have put many smelters under pressure, with MIM’s smelting operations among the worst performers.
Although a partial restart of Outokumpu’s Tara mine in Ireland will give some respite to the tight concentrates situation, we think it’s reasonable to assume that some smelting capacity will be removed from the market if demand remains weak, which would put the zinc market in a better position (eventually) to enjoy higher prices.
The key factors supporting gold prices in recent weeks remain in place, and while tension continues to build over a possible war with Iraq, the downside is limited.
The market is seeing President Bush’s speech as a start to the countdown to war, but no deadlines have been set. Under these conditions of uncertainty, the unwinding of insurance purchases of gold after the Sept. 11 anniversary failed to have much impact, and gold rallied again on Sept. 12.
Although a little weaker on Sept. 13, spot ended in London well above key support provided by the 100-day moving average at $314.77 per oz.
Until the details of United Nations resolutions on Iraq have been settled, the market is likely to remain on edge, and few will want to be short. Secretary of State Colin Powell is set to meet other permanent members of the UN Security Council to form a resolution demanding the return of weapons inspectors to Iraq within weeks, as well as the country’s compliance with a range of other issues. The resolution is likely to contain a clear deadline and an implicit threat of military action if Iraq does not adhere to it. Once this news emerges, the market could be vulnerable to a selloff, though in the runup to any war with Iraq, prices are unlikely to fall far.
Just how vulnerable the market is to long liquidation depends partly on who the big buyers have been in recent weeks. The funds that have been the main participants on previous price spikes have been absent this time around. Speculative long interest on Comex at around 30,000 lots is less than half its May 2002 peak. The net position accounts for only 5% of total open interest.
The data suggest that trade participants, brokers, banks and producers have accounted for a much larger portion of gold market business in the past few weeks than has hitherto been the case.
Nevertheless, volume remains very low. Data from the London Bullion Marketing Association show turnover in August at a new low of just 17.1 million oz. transferred — a long way below last year’s 19.9 million oz. for August (that itself looks extremely modest compared with historical levels for the same month, which, during the late 1990s, were regularly in excess of 25 million oz.). These kind of data continue to chip away at gold’s reputation as a safe-haven investment in times of trouble, particularly given the escalation of global political tensions in recent months.
Still, with thin market volume and speculators remaining on the sidelines, upside potential cannot be ruled out for the short term. Having said that, we doubt prices will get above their recent highs in the US$324-to-$325-per-oz. region.
— The opinions presented are the author’s 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 author at kevin.norrish@barcap.com
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