During the report period May 28-June 1, base metals moved back to test the bottom end of their recent price ranges and, as a result, posted some large declines. Copper, aluminum and nickel all registered falls of more than 2% in cash prices, with zinc only just behind at minus 1.9%.
Economic data have, almost without exception, been worse than expected, and so further deterioration in metals demand must be expected in the short term. The week started poorly, with a large fall in Japanese industrial production, and ended badly with reports of a sharp slowdown in European growth in the second quarter, plus another lurch lower in the U.S.-based National Association of Purchasing Management. Against this backdrop, the mounting list of production cuts, strikes and other supply-side worries affecting base metals output is taking its toll on prices. The mood of the base metals industry is growing more pessimistic as hopes for a strong recovery in the second half of this year begin to fade.
Copper prices fell back sharply during the period under review, with the London Metal Exchange (LME) 3-month price shedding $87 from its high on the previous Friday (May 25) to end the week at US$1,669 per tonne. Despite a backdrop of supply concerns, the market remains focused on a deteriorating demand picture, and a more bearish mood is taking hold throughout the industry as hopes of a pick-up in the second half of the year are beginning to fade. Stock movements continue to disappoint for this time of year. A rise of 1,400 tonnes in global stocks has halted the modest downtrend that was in place over the past month, suggesting there will be some big increases once the seasonal peak for demand has passed as we head into July-August. Volumes remain thin, and it is still the day-trading technical funds that hold most sway over price direction. The Commodity Futures Trading Commission reports there has been little change in the fund net short position at 7,400 lots (well down from the recent peak). Before prices pick up again, another move downward looks likely, with a test early this week of the recent low at US$1,654 per tonne quite possible. July copper remains tight, but the narrow cash-to-3-month contango is steady at US$15 per tonne.
Supply news, though positive, has been ignored by the market. Mine production cuts were announced by Phelps Dodge and Kennecott Copper, though neither will have much impact on refined copper production in the short term. Strikes are under way at the 90,000 tonne-per-year Palabora mine in South Africa and the 190,000-tonne-per-year Radomiro Tomic operation in Chile, and labour talks are taking place at Noranda’s 360,000-tonne-per-year refinery in Montreal. In addition, the market is anticipating the expiry of labour contracts at the end of June at Asarco’s high-cost copper operations in the southwestern U.S.
The lack of reaction to all of the above underscores the market’s current focus on demand, where conditions appear to be rapidly deteriorating. Poor economic indicators suggest further weakness to come in the U.S., and conditions are still worsening in Europe and Asia. In both these regions, demand indicators are pointing firmly downward. Japanese data show falling industrial production, rising unemployment, falling household spending and lower auto exports, all of which suggest that any recovery is a long way off. Meanwhile, Europe is sporting rapidly declining levels of business and consumer confidence, a weak currency and growing inflationary pressure.
After the previous week’s failure to get above key US$1,550-per-tonne resistance, LME 3-month aluminum fell back to test the bottom of its recent range, uncovering good support toward US$1,500 per tonne. Persistent supply-side fears are providing the support, but deteriorating consumption prospects suggest aluminum prices will have to struggle to get much above the US$1,550-per-tonne resistance level for the foreseeable future. The cash-to-3-month spread has moved back into contango, at US$15 per tonne. With spread tightness still a factor, it is perhaps not surprising that LME stocks climbed up another 16,325 tonnes during the report period, bringing the increase since the start of May to 123,250 tonnes. LME stocks now total 585,000 tonnes, back to the level they were at exactly one year ago.
Zinc prices show no sign of reversing their long downward trend, having hit a low of US$930 per tonne on June 1, within touching distance of the January 1999 low of US$914 per tonne. There seems a strong likelihood that this level will not prove the bottom for zinc prices, since the mine production cuts that are required to balance the market are unlikely to be forthcoming unless prices fall significantly below US$900 per tonne and give producers the impression that they will remain there for some time.
The inability of smelter production cuts to excite the market has been illustrated several times in recent weeks — first, when Cominco announced it would likely make further production cuts at its Trail smelter (currently operating at only 60% of its 290,000-tonne-per-year capacity) and that these would probably remain in place through most of 2002, and more recently, when Brazilian zinc producer Paraibuna Metais announced it was considering halting production at its 94,000-tonne-per-year smelter in Minas Gerais state. Paraibuna intends to sell power from its captive plant if power prices rise high enough.
The problem with production cuts at smelters is that there is ample spare capacity elsewhere, notably in China, and good availability of concentrates, ensuring that growth in metal production continues to outstrip demand. Not until mine production cuts move on to the agenda can an improvement in the zinc supply-demand balance be expected.
Given the sharp falls experienced last week by copper and aluminum, it’s not surprising that nickel, too, suffered its share of downward price movement. The lack of fundamental support for prices at these levels makes nickel’s position precarious, especially as it is getting little support from the rest of the base metals complex. The technical factors that pushed nickel prices higher last month to just over US$7,400 per tonne are fading, and the lack of market interest that helped prices on the way up, may work against them on the way down. Buying remains absent from the market, leaving prices vulnerable to sharper downward moves as sell-stops are triggered.
So far, despite a large chart gap of between US$7,200 and US$6,600 per tonne, nickel prices have been able to avoid a sharp fall. Until the end of the report period, however, prices had been able to remain above US$7,000 per tonne — a high price, given the state of the current market. With prices registering two successive closes below this level on May 31 and June 1, the downside risk to nickel prices has increased significantly, and, at current levels, short selling and long liquidation will maintain the bias on the downside until prices return to at least the US$6,600-to-6,800-per-tonne trading range.
It was another week of sharp price movements in the gold market, as expected support levels of around US$270 per oz. proved ineffective at maintaining higher prices. The large net speculative long position that had developed during the previous week created instability and gave rise to nervousness, which caused a wave of selling as speculative long positions were liquidated. As a result, prices were pushed back to pre-rally levels and left looking for support at US$265 per oz.
The technical picture creates a mixed message for price direction this week. While the Relative Strength Indicator suggests that prices at these levels are oversold, of the four main moving average lines, only one, the 100-day moving average, is now providing support for prices at US$265 per oz. The US$10-per-oz. price fall during the report period left the 10-day moving average in a virtual vertical free-fall by the afternoon of June 1 and pushed prices below the previous rigid line of resistance, namely, the 200-day moving avera
ge. It was the move above the 200-day moving average that initially encouraged the sharp rise in prices. Any attempt to return to US$270 per oz. now faces an additional hurdle in the form of this area of technical resistance.
Although lease rates have remained stable, the persistence of borrowing has raised concerns of the return of producer selling. Given that much of the borrowing has been originating in Australia, where gold prices remain attractive to potential hedgers, this has only heightened concerns. Recent weakness in the value of the Australian dollar against the U.S. dollar supports the view that Australian-based hedging may be taking place. Even if the suspicions are ill-founded, they are worth noting as a potentially damaging influence on current price movements.
— The opinions presented are solely the author’s and do not necessarily represent those of the Barclays group.
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