A mild uptrend brought improvements across most of the base metals complex during the report period Feb. 26-March 2, though aluminum, still recovering from the previous week’s sell-off, saw its average cash price decline slightly.
Zinc and nickel prices led the way — up 1.6% and 1.2%, respectively — with copper gaining just 0.1%. Another notable development was the tightening of nearby spreads in copper and zinc so that all the major London Metal Exchange (LME) metals are now either trading at flat or small backwardation for cash-to-3-months. The recent options declaration could prove interesting for copper, with significant open interest at US$1,825 per tonne and rumours of large over-the-counter positions as well, but elsewhere the outlook appears to be fairly neutral.
One reason for this is lack of consumer interest. Recent indications of consumer confidence in the Eurozone and the U.S. are disappointing, testifying to the uncertainty that is blighting the short-term economic outlook. This is the time of year when metals-consumers usually emerge from winter hibernation in Europe and the U.S.; indeed, the end of the first quarter is typically the busiest time of year for physical demand. However, consumer-related volume on the LME remains unusually light, and lack of Chinese buying interest is adding to the overall sense of inertia. Nearby, metal premiums in most regions remain modest, reflecting easy availability, despite low and falling LME stocks. In this environment, it is traders and small funds that are dominating volumes on the LME; hence the volatility in nearby spreads and the technical nature of recent trading patterns. Consequently, the short-term outlook appears to be one of sideways-trading within recent ranges until consumers regain their collective nerve.
Copper prices moved up sharply in the second half of the report period, supported by a tightening of nearby spreads and continued declines in exchange stocks of copper. Tightness in the spreads is focused on nearby dates, with cash-to-March moving into a US$4 backwardation. Several factors — the low level of stocks; significant fund short positions (including the largest fund net short position since November 2000, at almost 13,000 lots); and the existence of a major position holder in the LME’s warrant-holding report (50-80% of the total) — all point to the likelihood of further tightness to come. Significant options open interest in the US$1,800-1,825-per-tonne range means there could be some price volatility in the short term. Price risk is to the upside, with initial resistance at US$1,820 per tonne and support at US$1760-1,770 per tonne.
Japanese wire and cable data suggest a shaky outlook for demand for Japanese copper. Growth in wire and cable shipments slowed to just 2.5% (year over year) in January, following on from the previous week’s data release, showing slower growth in the brass mill sector as well (+5.4%). Last year, Japan’s copper demand grew 3.2%, helped by strong growth in both wire and cable (+4.1%) and the brass mill sector (+10%). This growth was underpinned by the strength of demand for electrical and electronic products for high-tech end-uses, which is likely to slow this year as a result of weaker demand for Japanese exports. In addition, the construction sector, the largest domestic market for copper, is expected to slow in the next fiscal year. A reduction in tax breaks for condominium construction from June 2001 will put housing starts into negative territory following recent strength.
Aluminum prices trended steadily upward during the report period, ending strongly on March 2 at US$1,572 per tonne for the LME 3-month price. Positive factors include the closure of Michigan Avenue Partners’ 204,000-tonne-per-year Longview smelter, in Washington state, and falls in both LME stocks (the first since Feb. 1) and Shanghai Exchange stocks. With the aluminum market back in a small contango and cancelled warrants high at 45,000 tonnes, we would not be surprised now to see a short period of net withdrawals from LME warehouses, though off-warrant stocks (especially in the U.S.) remain quite high. In the week ahead, aluminum prices are expected to challenge resistance at US$1,570-1,590 per tonne, with firm support expected at the US$1,520-1,540-per-tonne level.
Despite the overall improvement in price, the market reacted in fairly muted fashion to the Longview closure. Clearly, a significant cut at Longview was already factored into prices, though most market-watchers had expected a portion of the plant’s capacity to remain in operation to support its production of high-purity aluminum for the aerospace sector. However, the whole plant was shut down, and Michigan Avenue Partners now appears confident it can source high-purity metal from external sources. The closure leaves Alcoa as the only significant producer in the region, but there must now be some uncertainty regarding its output at the Ferndale and Wenatchee smelters, also in Washington state.
Demand remains a concern. The U.S. Aluminum Association reports a 14% year-over-year fall in December 2000 mill product shipments (excluding cansheet), as well as a 25% year-over-year fall in January 2001 orders. Data from Japan are also disappointing, with shipments of mill products growing by just 1.5% in January.
Nickel prices enjoyed a more encouraging performance during the report period, until mild long liquidation and profit-taking took effect on March 2. With volumes in the nickel market currently thin, there is no clear direction for prices to take. To an extent, the 10- and 30-day moving average lines provide the boundary to short-term price movements. Fundamentals are sufficiently firm to hold prices above support, and price action within the base metals complex is sufficiently subdued to limit attempts to the upside. As a result, range trading is likely to continue, though probably with a downward bias.
Zinc prices trended gently upward without ever doing enough to suggest that they are about to break out of their recent US$1,015-to-1,040-per-tonne range for the LME 3-month price. On March 2, prices fell back to close below the 30-day moving average at US$1,035 per tonne. Although zinc fundamentals are still poor, certain positive technical developments suggest there may be some potential upside in the short term. Nearby tightness strengthened, with the cash-to-3-month contango improving, thanks to a small backwardation in the cash-to-March spread. There is a large holder in the LME’s warrant-holding report in the 50%-to-80% band, so the potential for a squeeze is apparent. In addition, there has been some buying of upside zinc call options, adding to modestly high levels of open interest at the US$1,050-per-tonne and US$1,075-per-tonne March strikes. On balance, we doubt zinc will establish enough upward momentum to bring these positions into play, but the market will be watching warily.
A week can be a long time in the current gold market, as recent events proved. The report period was characterized by an early rapid rise in prices, the surge in lease rates, fears of tight nearby supply, and a growing sense of mild panic as prices grew strongly for four consecutive days. These factors all conspired to raise expectations of a repeat performance of previous rallies, when prices hit highs well above US$290 per oz.
The ingredients were certainly all there. To complete the picture, there were even rumours that the Washington Accord was going to be strengthened or extended. Data released by the Commodity Futures Trading Commission revealed that the net speculative short position on the Comex division of the New York Mercantile Exchange had reached its highest level since before the accord took effect, and suddenly the stage seemed set for an exciting price performance. In the end, of course, a US$10 increase to the high end of the US$260s was all that was achieved, leaving many in the market to wonder at gold’s chances of achieving a significant price rally again this year.
So why was the short-covering rally so short-lived? In a sense, the question is an incorrect one. The roots of the recent price action lay in higher lease rates for borrowing gold, which tightened the supply chain in the lending market. It is hard to say exactly how, why or where this tightness originated. Whatever the source, by the middle of the report period, the tight squeeze on prices had been relaxed and they had drifted back down to the lower end of the US$260s.
Bank lending clearly reached the market, leading to a reduction in lease rates and a corresponding reduction in prices. When lease rates and prices reached certain levels, some central banks were willing to increase their gold-lending into the market. It seems plausible to assume that the same central banks will be willing to increase lending levels again, should lease rates experience further spikes, thus limiting the extent to which lease rates can be squeezed higher in the future.
The lasting impact of the recent price rally, therefore, is to diminish the potential of future sustainable price increases. It has weakened the argument, used by many, that the large short position in the gold market left prices exposed to an inevitable short-covering rally. Moreover, central banks have proved themselves willing to increase lending levels when lease rates soar and threaten a squeeze on borrowed material.
Although short-covering undoubtedly took place, it did not provide the momentum needed to boost prices significantly. Despite the largest net speculative short position on the Comex in 18 months, the shorts did not rush to cover positions and, in not doing so, have diminished the potential of future short-covering rallies to cause price shocks.
— The opinions presented are solely the author’s and do not necessarily represent those of the Barclays group.
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