Base metals stand firm

Base metals markets enjoyed a second good week during the Aug. 20-24 period, with most managing to at least hang on to the gains made late the previous week.

Nickel was the strongest performer, as the weekly average cash price gained 4.1%. Copper and aluminum followed with +2.3% and +1.7%, respectively. Only lead, until recently the strongest performer on the London Metal Exchange (LME), registered a loss.

Significantly, the technical picture has improved significantly for all of the major traded metals, with 10- and 30-day moving averages all on the verge of crossing as the markets closed on Aug. 24, suggesting the possibility of fresh short-covering in the short term.

In addition to technical strength, recent data suggests signs of a troughing-out in global economic growth. Most notable is the improvement in the business sentiment indicator of Germany’s Institute for Economic Research (IFO). Against market expectations, the indicator rose for the first time in six months. In addition, the U.S. leading indicator was up for the fourth consecutive month, and we now believe conditions are falling into place for a recovery in global growth (albeit a slow one) in the fourth quarter. The global manufacturing sector will probably remain weak for some time, however, and metals demand is unlikely to bounce back strongly just yet. However, there is enough evidence to suggest that the steady downtrend in base metals may now be coming to an end.

Copper prices put in a resilient performance, clinging to the bulk of the gains made late in the previous week. With prices trading consistently above the 10-day moving average for the first time since late May, the market looks much healthier from a technical perspective. Consumers remain on the sidelines, so that most of the trading volume is dominated by fund and broker business trading the ranges. Consequently, the market is trading in a fairly narrow range, with resistance at US$1,520 per tonne and support at US$1,500 and then below that at US$1,480. There is still a large fund short position in the market, but large volume short-covering is unlikely to emerge unless the LME 3-month price breaks above US$1,550 per tonne.

The continued strength of the euro and the better-than-expected German IFO were supportive background factors. There was also positive fundamental news. Asarco announced it had cut around 20,000 tonnes of production at its Mission mine, laying off 110 of 625 workers. However, the cut is related to a change in the mining plan and is not a direct result of low copper prices. We should not expect any price-related production cuts before some time in September, when producers have gained a clearer view of the state of the market. China’s official imports of refined copper were healthy in July at 59,000 tonnes, below June’s 72,000 tonnes but above the monthly average for the year to date of 50,000 tonnes. Imports of copper in other forms continue to grow strongly, with concentrates and scrap up 27% and 29%, year over year, respectively.

The aluminum price recovery remains intact, with the LME 3-month price building on the previous week’s gains to reach a 4.5-week high of US$1,433 per tonne on Aug. 24. Influential trade buying from one source appears to have been a key factor in the improved performance of aluminum over recent weeks, but there has yet to be any substantial short-covering by funds, which, as in copper, are still running large shorts. The Aug. 24 close of US$1,432 per tonne has sent a strong technical signal to the market, though short-covering is unlikely to become a factor until prices have broken back above US$1,460-1,480 per tonne.

LME stocks reversed the previous week’s small decline, rising 4,425 tonnes, but, overall, they have not risen significantly since early August. Aluminum Association data show that there are signs of a bottoming-out in the decline in orders in the U.S., with its July orders index stabilizing, year-over-year, at 86.8, compared with 87.1 in 2000. However, there is still no sign of an upturn in orders, and weak data regarding U.S. durable goods suggest that de-stocking may not yet be complete.

Meanwhile, Alcoa has announced the restart of a 42,000-tonne-per-year potline at its 308,000-tonne-per-year Warrick Indiana smelter. At the same time, there is news (albeit unconfirmed) that the company will close 51 pots at its 400,000-tonne-per-year Baie Comeau smelter in Quebec. The Baie Comeau closure (resulting in lost annual output of 50,000 tonnes) will roughly balance out the Warrick restart.

The zinc market experienced its most volatile period in months as, early on in the report period, the LME 3-month price gave up almost all of the gains it had made in the previous week. However, it rebounded in the second half of the Aug. 20-24 period to finish at around US$860 per tonne. The upward move on Aug. 24 leaves zinc in a strong position technically, above both the 10- and 30-day moving averages. However, fundamentals are still weak, as is illustrated by the continued uptrend in LME stocks that are currently rising faster than for any other LME metal. In the short term, we think it highly unlikely that the LME 3-month price will have the strength to push through the previous high of US$880 per tonne.

China’s zinc exports in July fell to 17% below year-ago levels at just 39,133 tonnes, according to custom statistics. Exports for January-to-July 2001 are running at 11.4% below 2000 levels, which set a record at 550,000 tonnes. However, the record high level of zinc concentrates imports so far this year (up 1,200% from January to July, to 381,745 tonnes) suggests that production in China is still growing strongly, as do official production data, which show a 15% rise in output from January to July, year over year, to 1.2 million tonnes. In addition, as much as 75,000 tonnes of zinc have reportedly accumulated in China; low international prices are preventing it from being exported. We would therefore not be surprised to see Chinese zinc exports rebound later this year, particularly if prices recover.

Against a noticeably more buoyant base metals complex, nickel price movements were subdued. Big moves lower at the start of the week and a subsequent recovery highlight the support we expect prices to receive throughout the remainder of this quarter and into the next. Although support on the downside may protect against possible future price falls, the lack of response to moves higher in copper and aluminum suggests that the nickel market may struggle to benefit from the long-awaited economic recovery as strongly as copper and aluminum. Given that the nickel market is in the midst of the summer trading period, it is not surprising that the period under review was quiet; moving in a narrow range of US$5,650-5,800 per tonne, prices were stable, and small LME stock changes resulted in a net decrease on the week of 78 tonnes. This, in turn, left inventory levels little-changed, while the cash-to-3-month contango remained steady at around US$40 per tonne.

There was a conspicuous lack of reaction to the price moves in copper and aluminum, particularly the latter, which gained one of its strongest technical positions in several weeks. As we expected, the drift in nickel toward US$5,600 per tonne was gradual, but the fact that prices still drifted lower as copper and aluminum drifted higher indicates continued easing in market conditions and a consequent reduction in upward price potential.

Price behaviour in the gold market has reinforced our bearish view, leading us to believe that prices are set to undergo some significant downward pressure in the short term. Prices may be unable to react favourably to the weakest U.S. dollar since the first quarter of 2001, mounting concerns that the greenback is poised to enter a period of price re-adjustment and market disappointment (reflected not only in the dollar but also in equities). The question then becomes, When will prices move higher? The focus has turned to the actions of speculative funds, though we believe such reasoning may b
e flawed.

The problem with the current market, which, from a speculative perspective, is net long, is twofold. First, it is evident that recent fund buying has not resulted in a significantly higher price; second, we believe that the reason for the fund buying — weak U.S. dollar concerns — is misplaced. As the greenback strengthens (which we believe will happen), the initial motivation for fresh fund buying will disappear.

The situation becomes less clear when the extent of current fund interest is considered. We estimate that, as a proportion of total open interest, fund activity in the report period accounted for 35%, the highest level since 1993. This exposes prices to significant downside risks. The last time fund positions accounted for such a high proportion of open interest, gold prices fell by US$50 per oz. as long liquidation resulted in acute downside pressures. If the euro is unable to retain its recent gains against the U.S. dollar, a sharp increase in the dollar could act as a catalyst for holders of long positions in gold. We saw the beginnings of a weaker price on Aug. 24 as gold fell to the low US$270s, even though the dollar/ euro exchange rate remained stable. If the dollar weakens in the days ahead, we expect to see corresponding falls in gold prices.

— The opinions presented are solely the author’s and do not necessarily represent those of the Barclays group.