Base metals markets lick wounds

The report period March 20-24 was disappointing for base metals markets. Prices were becalmed, volumes were low, and March 24 saw a poor close, with copper, aluminum and zinc ending the final session at the low end of recent trading ranges. Despite further large falls in London Metal Exchange (LME) stocks, there are few signs that prices will be pushed higher, and investment funds remain sidelined for the time being. Recently, a return to work was negotiated at Pechiney’s aluminum smelter in Dunkerque, France, ending the strike that had prevented commercial production. This could result in some weakness in aluminum in the short term.

In what could be a potentially bullish development, the Organization of Petroleum Exporting Countries recently met to discuss raising oil production. High oil prices have been a key factor in persuading both metals consumers and hedge funds to be cautious regarding metal demand prospects this year, and an agreement to raise oil production significantly could help to allay uncertainty. Oil prices fell to US$28 per barrel recently from a peak of US$34 barrel several weeks ago, suggesting that a significant increase in output has already been priced-in by the market. The consensus appears to be for an increase of around 1.2 million to 1.4 million barrels per day.

It was another stagnant week for copper as prices failed to break out of the US$1,770-$1,810-per-tonne range, despite a further sizeable fall in LME stocks of 30,850 tonnes for the week. The surge in Chinese buying seems to be over for the time being, and the level of cancelled warrants has fallen to 52,800 tonnes from the previous report period’s peak of 74,200. Metal will continue to flow out of LME warehouses for some time, but this is now discounted by the market. Unless there is an indication of fresh physical demand or a rekindling of speculative interest, it looks as if the red metal will have to struggle to break out of its recent range on the upside.

Shanghai Futures Exchange stocks will be watched closely for the next few months to see if China’s recent buying will merely result in metal being switched from one exchange to another. However, trade data from that country suggest that at least a portion of the 50-100,000 tonnes brought in during the past few weeks will end up being consumed in China. Net imports of refined copper in January and February totalled 52,000 tonnes — unusually high for the time of year and more than 200% ahead of year-ago levels. Imports of copper scrap and concentrate also rose, suggesting that demand for copper and copper raw materials is strong in China.

Hopes that last year’s spate of merger activity in copper would result in further cutbacks to production appear to be fading. Grupo Mexico, which bought Asarco late in 1999 for US$2.25 billion, announced it will spend US$677 million in a range of projects in Mexico, the U.S. and Peru. This is sure to boost refined output over the next few years. In the U.S., Grupo Mexico has already set about raising output at Asarco’s former operations. Production at the Amarillo refinery is forecast to reach 340,000 tonnes per year by the end of 2000, up from 317,000 tonnes per year in 1999. GM aims to raise production at Amarillo to its full 440,000-tonne-per-year capacity over the next two years. Meanwhile, production at the Hayden smelter has been increased to its full 200,000-tonne-per-year capacity for anodes.

Aluminum suffered yet another disappointing week. Fund liquidation pushed prices down to a low of US$1,590 per tonne on March 22 — US$40 below the previous peak of March 17. Lending of the forward spreads by a major player was also evident, and the cash-to-3-months contango has now eased to US$27, compared with US$20 in the previous report period. Fears of a backwardation re-emerging may be receding, but a close eye will need to be kept on fundamentals (which, on the face of it, still seem to be good).

LME stocks fell a further 28,125 tonnes, and cancelled warrants, though down from the previous report period, remain high at 99,000 tonnes. The relatively quiet physical market in aluminum is at odds with reports of extremely healthy shipments of fabricated aluminum products.

Aluminum production continues to rise. IPAI data show that Western World output rose by 3.8% in February 2000 (after adjusting for the extra leap year day), slightly ahead of our 2.8% forecast for aluminum supply growth this year.

Following recent volatility, the nickel market was quiet, as 3-month prices traded in a narrow range of US$9,930-$10,240. Some had speculated that a sizeable drawdown in LME stocks was scheduled for March 24. The market was unimpressed by the 564-tonne fall actually registered, though it accounted for half of the 1,146-tonne weekly fall.

Although nickel prices appear to have stalled short of the 1995 high of US$10,500 per tonne, the downside appears still to be limited while the outcome of labour negotiations at Inco’s Sudbury, Ont., operations remains in doubt. Negotiations are due to begin in April, and any agreement will also set a precedent for Falconbridge’s Sudbury operations, where the labour contract expires Aug. 1. Local union officials are seeking an agreement better than that obtained at Inco’s Manitoba operation, where workers achieved an estimated 10% increase in wages and benefits over three years.

Inco is reported to have stock of around 24,000 tonnes, but this represents little more than ordinary working stock (around six weeks of production). Given the shortfall in production at Manitoba in the fourth quarter of last year and the desperately tight situation in physical nickel that has existed since then, it seems extremely unlikely that Inco would have been able to build up stocks in preparation for a possible strike.

After four consecutive quarters of strong growth in stainless steel production, output may be about to slow. On the other hand, the signs of such a slowdown are far from certain. Data reported by the International Nickel Study Group show that growth in nickel consumption slowed to just 2% in January 2000, yet this figure does not correspond to the anecdotal evidence concerning the strength of stainless steel production during the early part of the year, and we expect to see these preliminary figures eventually revised upwards.

There are also some signs that stainless steel mills are attempting to raise their use of stainless steel scrap and thus reduce their primary nickel ratio.

Sumitomo Mining has raised its forecast for nickel consumption growth this year in Japan to 187,000 tonnes from 185,000 tonnes. Stainless steel demand in Japan is still poor (orders for stainless flat products in January fell by 5.2%), but Japan consumes an unusually high proportion of its nickel in non-stainless steel uses (50%, compared with the global average of 30-40%), particularly in electrical components, and these sectors are projected to grow.

Zinc prices failed yet again to stage a recovery. Prices trended downwards for most of the report period before losing all the gains of recent weeks and closing at a 2-week low of US$1,125 per tonne. LME stocks remain at historically low levels and continue to fall. The last time they were so low was June 1992, when the month-end price stood at US$1,370 per tonne. There are rumours of hedge fund liquidation of a large long position at present, and this could be one factor preventing prices from rising.

One reason for the prolonged caution among physical buyers and speculators is the threat of large supply levels coming into the market from Asia — in particular, China. The uncertainty over how much material China is holding is dampening market activity considerably, even at a time when stocks are at 8-year lows. Korea Zinc, the world’s largest producer, is said to have made aggressive moves in Asian markets by lowering its premiums to capture a larger portion of the market share. The Chinese have reacted by restarting smelters at full capacity, and exports in January and February wer
e up over 100%, compared with year-ago levels.

Meanwhile, South Korea’s Young Poong Corp. says it intends to increase its annual refining capacity to 193,800 tonnes by October 2001 from the current 110,000 tonnes. The increase in significant considering that the company expects to export 44% of its production this year. On top of this, expansion of China’s Shaanxi Shangluo smelter is expected to be complete by May, according to a company source. Capacity will increase to 25,000 tonnes per year from the current 10,000 tonnes.

There was a rough spot in the gold market in the run-up to the fifth Bank of England auction, held March 21. There is no question that the sale has had an adverse effect on market sentiment. It was a disappointing auction in many respects for a market that needed some good news to lift it out of its current mood swings and provide some cheer. The allotment price came in at US$285.25 per oz. — almost a dollar below the morning’s fix and lower than the spot price just before the auction. The rate of subscription was also down on the previous auction; indeed, it was the second-lowest of all the auctions. The initial reaction to the result took US$2 off the spot price before short covering pushed prices up sharply to break through the US$290-per-oz. mark. It was clear to most observers that this spike would be short-lived as prices drifted toward their previous trading ranges.

Prices suffered a US$4 loss on March 23 as U.S. funds liquidated again, in response to a flat market that showed little interest in moving in any direction other than south. In a quiet market on March 24, prices settled in a US$284-to-$285-per-oz. trading range and took a break from the volatility that had characterized the early part of the week.

We still believe that the gold price will drift downwards and come to test lower levels of support at US$282 and US$280 per oz. The Bank of England sales are clearly having a less-strong impact on prices as the market learns to adapt to the new environment and take the 25-tonne auctions in stride. The healthy physical demand, particularly from Asia, that kicks in when prices edge toward the support level of US$282 per oz. has kept prices above US$280 since the start of the year. On the other hand, as hedge funds become increasingly acclimatized to the prevailing low-price culture associated with gold, the lower the price falls at which they will go short and effectively place a cap on price rises.

The result of all this is likely to be a fairly restricted trading range with little upside potential. On the down side, the Swiss sales, barring any constitutional objections, could begin as soon as early May. The method by which the Swiss intend to off-load 1,300 tonnes has yet to be announced, though it would seem likely that they would follow the Dutch method rather than the approach taken by the British. The Dutch, who still have 200 tonnes to sell, were able to take advantage of price spikes by announcing their sales retrospectively.

One thing silver market participants should keep abreast of is the latest development at Handy and Harman Refining Group (HHRG), one of the world’s largest custom refiners of silver: the group’s leaders have been indicted for fraud. The U.S. Justice Department is investigating a scheme to collect, by fraudulent means, export credits from the Argentine government for exporting precious metals out of Argentina. HHRG’s U.S. refinery is operating at or around 25 million oz. per year, and little spare custom refining capacity is available to the market. Golden West, the Australian refiner with a 50% stake in Handy and Harman, is re-evaluating all aspects of HHRG’s business, and any closure of HHRG’s silver refinery could lead to a short-term squeeze on availability of exchange-deliverable silver stocks.

— The opinions expressed are those of the author and do not necessarily represent those of the Barclays Group.