Demand strong for most base metals

Rallies in aluminum, nickel, zinc and copper took base metal prices back to the top of their recent trading ranges during the report period May 15-19.

Although prices fell back during the latter part of the week, demand remained strong. London Metal Exchange (LME) stock withdrawals continue at a rapid pace, and nearby spreads in copper and nickel have tightened up again — all of which points to the likelihood of further price increases.

The recent interest rate hike by the Federal Reserve Board in Washington was accompanied by comments suggesting that further rises may be in store. The subsequent weakness in equity markets on May 18 and 19 probably contributed to the failure of metals to build on their gains from earlier in the week. More than likely, metals markets will continue to be heavily influenced by the Fed’s stance on interest rates over the next few months. Data released by the U.S., particularly the May employment and CPI reports, should be watched closely for any clues regarding further liquidity tightening.

Copper‘s 4-week price rise met resistance at US$1,850 per tonne, a key chart point, corresponding to the 200-week moving average. If it can break through this level convincingly, further increases may be in store.

The U.S. copper market is becoming increasingly tight. Following closures of U.S. refining capacity in 1999 and the imminent closure of the Carrolton secondary refinery, refined output in the recent second quarter was almost 300,000 tonnes lower (on an annualized basis) than in the corresponding period last year. With demand at high levels, a number of merchants are short of copper, causing local prices to rise. The LME-Comex arbitrage is currently at US$33 per lb., though it recently has been as high as US$55, compared with an average for the past year of around US$10-20. European producers are also short at present, both on the LME and in physical. The Far East, however, is a little quieter, particularly in Japan, where consumers report a lack of recent order bookings.

Physical tightness in Europe and the U.S. is feeding through into the structure of LME prices, which explains the tightening in nearby spreads during recent weeks. Further tightness in nearby spreads is likely, given that physical copper demand is at a seasonal peak and LME stocks are at their lowest level in many months.

On the other hand, there will likely be downward pressure on quotes, and there is a strong possibility that the copper forward curve will move into backwardation along its entire length, mirroring the developments seen in the other major LME-traded metals.

Recent weeks have been marked by small amounts of producer hedging, mainly in options, and this partly explains the recent flattening of the forward curve. However, most of this movement is a reflection of two factors: dealers anticipate forward selling, and forward prices are being marked down accordingly. If nearby prices continue to rise, the forward curve could continue to move into backwardation.

Aluminum prices have at last began to follow other metals prices higher. The LME 3-month price broke out of its recent range and climbed to a peak of US$1,544 per tonne. Although stocks have continued to fall rapidly, providing some fundamental underpinning for the price rise, the market may have to struggle to make further headway. The reason is that high stocks in Asia are beginning to exert downward pressure on premiums.

Japanese port stocks climbed a surprisingly large 28,000 tonnes at the end of April to reach 271,000 tonnes. Japanese port stocks are now at their highest level since February 1999. The worry is that this may be the start of an upward trend. Local merchants suggest that material originally destined for other parts of Asia has been delivered to Japan because of a lack of recent buying interest. We note also that stocks of metal at Korean ports are at high levels of around 70,000 tonnes — a little lower than at the end of March, but still almost double “normal” levels of 40,000 tonnes.

The LME 3-month price for nickel moved decisively out of its recent US$9,450-9,960-per-tonne trading range, hitting a peak of US$10,378 — less than US$100 below the early March peak of US$10,460 per tonne. The catalyst for the increase was a combination of fresh fund-buying and some dealer short-covering. Sentiment may have been firmed up by the 98% strike mandate issued by Inco unions, and by the statement from union representatives that they will not accept an offer later than May 27 (the labour contract expires on May 31).

Nickel spreads also tightened sharply. Cash-to-threes moved out US$340-380, with June-July at US$230. Some large shorts have not rolled forward their positions, and nearby tightness could get even worse. Interestingly, the bulk of the nearby tightness is centred on the period when Inco (thought to have around one month’s stock of specialty plating and powder nickel grades) could start to run seriously short of material if a strike does take place. The October-to-December spread and the first half of 2001, already in steep backwardation, also tightened.

Zinc fell victim to another bout of fund liquidation, knocking prices back from a 17-week peak of US$1,205 per tonne early in the report period to a low of US$1,170 on May 19. Zinc stocks continue to trend downward and are approaching the region where a sharp spike in prices is conceivable. However, with Chinese exports still at high levels, this is looking less and less likely.

Zinc stocks are close to the kind of level that, in the past, has been associated with sharp upward moves in prices. On the other hand, the situation regarding the Tiger funds long position remains unclear, which could dissuade investors for the foreseeable future.

Chinese exports are likely to remain at high levels of more than 500,000 tonnes per year, despite strong growth in local demand triggered by several expansion projects that are about to come on-stream.

Meanwhile, gold prices slid to US$271.70 per oz.–their lowest level in eight months. The chief culprit would appear to be pressure from Australian producer sales. Late in the report period, prices moved away from their lows as Australian selling eased. However, more selling is likely if the Australian dollar continues to weaken.

Gold is not being helped by the reluctance of buyers to enter the market ahead of the next U.K. gold auction, scheduled for May 23. Perhaps this is not surprising. In three of the five auctions held so far, the gold price fell in the week following the auction. Only in September did the price rise after the auction; the only other time it did not fall was after January’s sale, when it remained level. The September sale was characterized by the highest cover ratio so far: eight times oversubscribed. Given the poor level of physical demand at present, we think a high cover ratio extremely unlikely on May 23. Therefore, if previous patterns hold, gold is headed lower, and a test of support at US$270-271 per oz. could be in the cards.

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