Base metals tumble, gold stagnant

As expected, base metals fell sharply during the period Dec. 3-7. Moreover, after breaking through key technical levels and closing poorly at the end of the week, further declines look probable in the days ahead. Lead was the biggest loser on the London Metal Exchange (LME), the average cash price having shed 2.8%; it was followed by aluminum, which lost 1.3%, zinc, which fell 1.1%, and copper, which shed 0.3%. Nickel was the only gainer, improving 0.3%.

The sharp deterioration in metals prices owed something to a combination of several factors, including an easing of Enron-related nervousness, big increases in LME stocks and some poor U.S. employment data that put the skids under the emerging recovery story. Despite the worrisome data (usually regarded as a lagging indicator by economists), the signs of stabilization in the U.S. economy continue to appear. The jump in the new orders index of the National Association of Purchasing Management (the largest-ever 1-month increase) looks particularly impressive alongside the continued decline in manufacturing inventories. Of great concern at this juncture, however, is the much-worse-than-expected data coming out of Europe and the continued reluctance of the European Central Bank to cut rates in response. German industrial production, the main driver of metals demand, weakened much more than feared during the report period, and the likelihood is growing that European base metals demand will remain weak until well into next year.

Copper prices fell sharply, shedding US$95 per tonne from the Dec. 7 high of US$1,586 per tonne to close at US$1,490 per tonne. After the previous week’s panic buying, the drop is hardly surprising, given that the announced cutbacks proved less than headlines had at first suggested. Poor demand also returned to the agenda late in the week, owing to three factors: poor European industrial production data from Germany; the official announcement that Japan had entered a recession; and worrisome U.S. unemployment data. With the Commodity Trading Advisors’ fund short position massively reduced and LME stocks continuing to climb following the demise of Enron (up another 25,000 tonnes), the stage is set for further falls in LME 3-month prices. Our initial downside target is US$1,460 per tonne (30-day moving average).

Negotiations for next year’s annual concentrate treatment and refining charges will soon resume in Hawaii, between Japanese smelters and Latin American miners. In 2000, terms were settled at US$75 per tonne for treatment and 7.5 per lb. for refining. The Japanese smelters have been looking for a roll-over of last year’s terms, but miners are hoping for something below US$65 and 6.5 per lb. The gulf between the two sides is wider than usual, reflecting the high degree of uncertainty that exists over copper market prospects in 2002. Nevertheless, falling spot treatment and refining charges are evidence that the concentrates market is tightening. The large cutbacks at mines (compared with far fewer at smelters) should also work in the miners’ favour.

The price of aluminum fell even more sharply than copper, ending at US$1,358 per tonne, or US$114 below its recent peak. In addition to the fund liquidation that has hit other metals, small amounts of mainly European forward selling and consumer liquidation of long positions have added to the downward momentum. Market nerves were jarred mid-week by news of power problems at Alcoa’s 300,000-tonne-per-year Warrick smelter, where two-thirds of the plant’s production has been taken offline. Alcoa said it was too early to quantify the likely production loss, but the market seems to be comfortable with estimates of around 50,000 tonnes, equivalent to a 3-month shutdown. In the week ahead, the US$1,350-per-tonne level (50% retracement of the recent rally) will be crucial. If it gives way, a fast move lower to US$1,300 per tonne may be in the cards.

Zinc prices struggled to keep above crucial technical levels, twice just managing to hold above the 30-day moving average on the close. However, after failing to achieve this target on Dec. 6, the LME 3-month figure then plummeted to a one-month low of US$771 per tonne. Following a brief interruption, zinc prices now appear to have re-established the downtrend in place since the beginning of the year, and an eventual move back to the recent low of US$754 per tonne looks likely in the absence of further production cuts or a dramatic improvement in demand prospects.

Unlike copper and aluminum, zinc has not yet seen the big increase in LME stocks that might have been expected following Enron’s collapse. LME stocks have barely changed over the past few weeks, though we estimate that the build in off-warrant stocks of zinc in recent years has been much greater than in other metals.

With nickel prices largely able to maintain the US$200 trading range between US$5,200 and US$5,400 per tonne in recent weeks (amid far wider ranges in the metals complex), it was unsurprising that, by Dec. 7, pressure on the downside was increasing. The closing price below US$5,200 per tonne weakens nickel’s technical stability on both the daily and the weekly price charts. With small speculative funds still in the driver’s seat for nickel prices, we are are being especially careful in assessing near-term price possibilities for nickel on the basis of technical indicators.

Aside from technical indicators, evidence is growing that a major market participant may be positioning itself to squeeze the market. Although technicals have weakened, more fundamental events in recent weeks lead us to suspect that an attempt to push prices higher may be about to take place.

For the second time in a month, we saw another bogus new report related to Noril’sk in Russia. Earlier reports that production would be cut in 2002 were unconfirmed, and toward the end of the week, officials were backing away from the story. This is especially suspicious given that a similar story surfaced in the previous week. Another small week-over-week fall in stocks (minus 48 tonnes) also occurred, but, as in the previous week, the main source of support may emerge from cancelled warrant growth. These grew by 34% during the report period to the highest level since June 2000. Ingredients for a short, year-end spike are in place.

Hemmed in by lethargy, only limited weakness by the U.S. dollar and a strong performance by the Dow, gold prices moved in a narrow range and in uninspiring fashion. Initial strength, on the back of political deterioration in the Middle East, was brief, and consolidation at a higher level, on the back of renewed weakness in the greenback, failed to materialize. We expect similar trading conditions to continue for the remainder of the year and would be surprised to see a serious test of support at US$272 or US$270 per oz.

This stability, however, is moving the other precious metals markets into the limelight. Silver ended the week at its highest level since late October, whereas platinum reached mid-October highs and palladium climbed steadily to the highest closing price (on Dec. 7) since September. The move higher in the platinum group metals markets is fully in line with our view that, over recent weeks, both platinum and palladium have been underpriced. With recent data in the U.S. confirming our views that recovery will begin by the first quarter of 2002, industrial users of platinum group metals are now faced with the prospect of stronger consumption levels and depleted inventory levels as the destocking process continues.

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