The base metals market deteriorated further during the report period June 4-8. Only the performance of tin, the average cash price of which gained 3% on aggressive fund buying, saved it from an across-the-board decline for the second consecutive week. New lows were recorded for the current cycle in copper (US$1,632 per tonne on June 8, the lowest since July 1999) and zinc (US$913 per tonne, the lowest in seven and a half years). Aluminum prices dipped briefly below key support at US$1,500 per tonne, while nickel fell below US$6,900 per tonne for the first time since early May.
This poor performance can be pinned firmly on continued fears that there is more bad economic news to come. Particularly unwelcome is the worse-than-expected 0.9% decline (month-over-month) in Germany’s April industrial output; the market had expected a 0.7% increase. However, the market has become preoccupied with the macro-economic picture at the expense of supply developments and low stock levels and may be ignoring signs of a bottoming-out in the third and fourth quarters. If base metals do begin a recovery soon, they will be led by the aluminum sector, where supply cuts over the 18 months amount to almost 1.8 million tonnes per year. It’s interesting to note that early in 1994, the memorandum of understanding resulted in the closure of 1.25 million tonnes per year of capacity. By November of that year, prices on the London Metal Exchange (LME) hit more than US$2,000 per tonne.
Strikes and production cuts did little to help copper prices overcome resistance at US$1,690 per tonne early in the report period, and by the end of the week, disappointed long liquidation had forced prices down below previous support at US$1,655 per tonne. At one stage, on June 8, the LME 3-month price fell to US$1,632 per tonne, its lowest since July 1999. More evidence of rapidly slowing growth in European economies, little sign of a growth recovery in the U.S. and only modest declines in LME stocks are all serving to keep sentiment depressed. In the short term, copper looks likely to go on to establish fresh lows, mainly under the influence of short selling by the technical trading funds that continue to dominate market volume. If US$1,630 per tonne is broken, the next line of support will be US$1,615 (the July 1999 low) and, after that, US$1,600.
Despite fresh signs of price weakness, there are a few signs that better things are to come. During the past few weeks, we have seen consistently good levels of scale-down buying, notably from the Far East. Also, there recently has been good demand for July-September upside call options.
Could we be approaching a bottoming-out in copper prices? It’s fair to say the risk-to-reward ratio of selling copper short in the low US$1,600s is much less favourable than selling it at US$1,750 per tonne. This fact, plus the already-sizable net short position that speculators are holding on Comex (15,000 lots as of June 5), suggests that the potential for further fund sales at this level is limited.
Aluminum finally pierced the US$1,500-per-tonne support level on June 8, with the LME 3-month price falling to a 3.5-week low of US$1,492 per tonne before rebounding quickly to finish at US$1,507. The briefness of this test of the downside, when much of the rest of the base metals complex was registering new lows, illustrates that the aluminum market is currently well-supported by supply-side concerns. LME aluminum stocks continued to climb, almost to 12,000 tonnes — more than likely a response to the residual tightness in nearby spreads. The 145,000-tonne increase in LME stocks since early May almost certainly reflects the movement of metal from off-warrant stocks. Indeed, we believe the aluminum market has been in deficit for most of this period, implying a steady drawdown in total stocks of metal. With downside support holding firm, a test of resistance at US$1,520 per tonne looks likely in the short term.
Power shortages continue to keep the aluminum market on edge. Alcan announced a 50% production cut at its 275,000-tonne-per-year Kitimat smelter in British Columbia, effective June 18 and lasting at least until next spring. There were no fresh cutback announcements in Brazil, at least none in addition to the 100,000 tonnes per year already announced, but reports suggest that rationing will soon spread to the north of the country, and we expect production cuts at Brazil’s two largest smelters, at Sorocaba and Belem, to be announced soon. A 25% cut at both these smelters equates to lost output of around 180,000 tonnes per year.
Zinc prices hit a 7.5-year year low on June 8, with the LME 3-month figure breaking below the January 1999 low of US$1,914 per tonne with barely a pause, before continuing its descent to the US$911-per-tonne level, not seen since early 1994. The decline, which has been under way since late January, accelerated during the report period, though, with the downside looking a little over-extended as a result, there may be a brief period of consolidation before the downtrend resumes. Zinc’s prospects will improve only when mine cutbacks are enacted. A weaker U.S. dollar would help this process insofar as it would raise the pressure for cuts at mines outside of the U.S. For the time being, however, there appears little sign of any weakness in the greenback.
Energy shortages in Brazil have prompted that country’s second-largest zinc producer to consider further production curtailments. Paraibuna de Metais has already slashed annual output to 81,000 from 93,000 tonnes and says it may announce a further cut to 71,000 tonnes in order to sell some power back to the market. Paraibuna originally considered shutting down all its capacity, but despite local power prices rising to 684 from 459 Reais (fixed by the government), prices are not yet high enough to offset the costs of closure.
Nickel seem finally to be succumbing to weak fundamentals, as prices fail to respond significantly to a brief short-covering rally. Prices at mid-week threatened a re-test of the US$7,200-per-tonne resistance level after Russian-led buying exposed a series of short positions. These gains lasted for barely a day, however, as a consequent price fall through several key areas forced prices to their lowest close since mid-May.
For the time being, the surprising strength in nickel, which has seen prices rise from lows of US$5,800 per tonne at the start of April to test US$7,400 per tonne last month, appears to be over. And while it is true that the presence of short positions is preventing a sharp collapse in prices, the trend now is almost certainly downwards. Low volumes, which have exposed the nickel market to domination by a small number of participants, will lead holders of short positions to exercise caution. As recent events illustrate, in the currently thin market, it takes little buying (in this case, from Russia) to shift prices higher. It is this caution that has prevented a sudden slip in prices, despite the recent presence of a large, US$400-per-tonne chart gap down to US$6,800 per tonne.
Until late on June 8, gold prices were locked into the narrowest trading ranges of the year. Not surpringsly, then, current discussions are focused on price direction. Post-mortem questions centre on the reasons for gold’s sharp fall, though few, if any, satisfactory answers are being offered. The fundamentals and investment principles that underpin prices remain in place, and they still don’t point to improving prices in the medium term.
Developments in the gold equities and investment arena have come to the fore, as macroeconomic concerns give rise to classical views of the yellow metal acting as a store of value. For example, gold equities indices are rising in the face of growing investor uncertainty, with the gold price following closely behind. The first point to make is that gold equities started rising in the fourth quarter, when U.S. concerns were heading toward panic proportions and equity values on both sides of the Atlantic suffered historic falls. We predict a recovery in
the second half of 2001 and growth in the first half of 2002, which points to a reduction in the life span of the relationship between general equity weakness and gold index strength.
The timing of the start of the gold index’s upturn coincided with two sharp falls in U.S. equities on the back of major profit warnings. However, the ability of the U.S. to avoid recession will, we believe, restore investor confidence and diminish the need for safe-haven investments in gold equities. Once this happens, the gold index could resume its usual relationship with the Dow Jones industrial average and, soon thereafter, submit to the downward pressure of the weaker euro and the stronger U.S. dollar.
— The opinions presented are solely the author’s and do not necessarily represent those of the Barclays group.
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