The report period April 9-12 was encouraging for base metals markets, based on strong rallies in nickel, which saw its average cash price gain 5.2%, and aluminum, which gained 1.8%. Both markets were supported by supply-side factors, and their strength helped to stem recent losses in most other parts of the base metals sector, the chief exception being zinc, which continued its steady slide.
One notable recent feature of both base and precious metals markets has been the increase in speculative short-selling during recent weeks. The most recent data from the Commodity Futures Trading Commission show that the net short position in Comex copper (futures only) has reached a record 21,000 lots, while the gold short position, at more than 58,000 lots, now accounts for almost 45% of total open interest.
Recent rallies in nickel and aluminum demonstrate how quickly these fund positions can generate upward momentum, given the right kind of catalyst to stimulate short-covering, and both gold and copper market participants need to be wary of getting caught on the wrong side of a similar move. However, any price spikes are likely to be short-lived since there is little sign that the smaller technical trading funds or the more macro-oriented hedge funds are yet interested in building long positions. Imminent releases of economic data from the U.S. may help firm up the view that the economy is gradually stabilizing, though growing fears concerning Europe and Japan will likely prevent much speculation on the long side.
Copper prices briefly tested resistance at US$1,720 per tonne during the report period, their highest level since late March, but fell back quickly to end the week at US$1,698. The main factor pushing copper higher appears to have been a recovery in aluminum prices, which drew in some fund short-covering. However, with copper’s own fundamentals looking shaky, the upside could not be sustained, and a move back down to the US$1,650-per-tonne level still looks likely. One positive factor remains the large fund short position on the Comex — now at more than 21,000 lots. It is quite possible there will be a short-covering rally at some stage, though it is difficult to say from where the catalyst might come.
New data from the International Copper Study Group indicate just how weak the copper market is. The market was in surplus by 111,000 tonnes in January. Global copper demand is normally weak in the early part of the year, as the Northern Hemisphere winter leads to slower activity in key copper demand sectors, such as construction. However, the big increase in the surplus, compared with the level in January 2000 (+37,000 tonnes) suggests that the market was suffering from more than seasonal weakness. The 83,000-tonne increase in exchange stocks since then suggests that the market has remained in surplus, with recent large increases in London Metal Exchange stocks undermining sentiment even further.
Aluminum prices sparked sharply higher after the Bonneville Power Administration (BPA) appealed to aluminum smelters in the northwestern U.S. to remain closed for up to two years so that it can supply other users in the region. However, the market has still not shaken off its focus on consumption, regarding which bad news continues to emerge from Europe and the Far East. With the short-covering rally that took prices to a peak of US$1,537 per tonne for the LME 3-month price already subsiding, aluminum’s chances of making a concerted move higher depend on whether or not consumers step up their forward buying activity in response to the BPA appeal. We feel it may be some months before this starts to happen, and a price range of US$1,450-1,550 per tonne looks like a good bet for the short term.
The aluminum smelters supplied by the BPA have 60 days in which to respond to the appeal. The BPA warns that if they do decide to take up their power allocations from October onward, power tariffs will be at a level that makes aluminum production uneconomic, so there appears little room for manoeuvre, particularly since the BPA has also offered to provide employee compensation while the smelters are closed. Owing to the severity of the drought in the region and the problems associated with gas-powered generation (high gas prices and long lead times), it seems unlikely that the power situation will ease quickly enough for any smelter restarts to take place before 2003.
The short-covering rallies that boosted the price of several other base metals largely passed the zinc market by, and there appears little sign of an end to the steady downtrend in prices that has occurred since the early fourth quarter of 2000. The nearby spread tightness that flared briefly in the previous week dissipated quickly, but not before attracting almost 5,000 tonnes of metal into LME warehouses, indicating just how weak fundamentals are at present. The downward-trending 10-day moving average, currently at US$985 per tonne, has, since early March, formed a seemingly impenetrable barrier on the upside, and LME 3-month prices may now be heading for the low US$900-per-tonne levels last seen in January 1999.
The report period certainly offered little encouragement regarding fundamentals. A potentially troublesome strike at the 95,000-tonne-per-year Big River Zinc smelter, in Illinois, has done little to interrupt shipments, as stocks of metal were built up before the strike commenced and the plant is still operating with the help of salaried staff. Meanwhile, Korea Zinc reports that domestic demand fell further than expected in the first quarter, by around 7%, with only a limited recovery expected in the normally stronger second quarter, owing to a depressed local construction sector. Finally Cominco, the world’s largest producer of zinc concentrates, announced it has settled its supply contracts at levels similar to those achieved last year. Cominco concedes that treatment charges remained at historically high levels because the market is still in surplus.
The recent behaviour of the price of nickel proves two points we have been making since the start of the year: prices remain vulnerable to short-covering, and the upside is limited by a weak fundamental outlook. As in the price recoveries of mid-February and early March, US$6,400 per tonne provided, first, a target, but then insurmountable resistance. The previous week’s news of lower Russian exports acted as a belated catalyst to the market, and, despite the eventual failure on the upside, there are other factors which, despite weak demand, should prevent a sharp sell-off during the remainder of the first half of 2001.
The US$400-per-tonne rally in nickel displays more than a sensitivity toward exports of more material from Russia. The reduction still leaves a market that, according to our forecasts, will be in surplus for the next two years, at a time when nickel production is set to increase considerably (we estimate an increase of 6.3% this year against an increase of 2.7% in demand). The fundamentals do not suggest, therefore, that the possibility of a cut of 20,000 tonnes would trigger such an increase. We believe the recent increase provides evidence that significant short positions still exist in the nickel market, dating back to the steep falls of last October. As a result, prices are expected to remain vulnerable to short-term upside price moves while maintaining a downtrend by being capped at consecutively lower levels.
Gold prices re-established a support area above US$258 per oz. and, in the process, reaffirmed that US$260 per oz. provides an area of significant resistance. The result is a US$2-per-oz. trading channel, above or below which the market is placing an increased level of significance on price moves. A move above US$260 per oz. in the current environment is leading to greater excitement than would otherwise be the case, while a drop below the range is a highly bearish indicator, given the price’s current proximity to US$250 per oz.
The net fund short position on the Comex is now more than eight months old and has been increasing in magnitude since last August. Indications are that the net short position will remain in place for the remainder of the current quarter. This has two immediate consequences for price movements: the first is that moves higher stimulate short-covering by speculative funds, resulting in short-lived technical rallies that are not based on any change in fundamentals; the second is that moves to the downside are limited by the reluctance of funds to add to already-large short positions.
The overall consequence for day-to-day trading is that areas of resistance prove to be more fickle than areas of support, owing to the potential volume of short-covering. This also provides a reason behind recent volatility in the front-end gold-lending market, with one-month rates again increasing during the report period, though to a relatively modest 2-3%.
Further weakness in the euro, as the European Central Bank (ECB) left interest rates unchanged, contributed to an initial weakening of the gold price. As concerns grow over the economic prospects of the eurozone, and also over the abilities of the ECB to manage the economy, strength in the U.S. dollar may provide a further threat to gold prices. Our 6-month forecast for the greenback against the euro stands at 85, leaving room for further dollar strength this quarter.
— The opinions presented are solely the author’s and do not necessarily represent those of the Barclays group.
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