Economic growth fuels inflation fears

Against a background of ever more positive economic data, base metal prices continue to disappoint. During the report period Feb. 21-25, aluminum and copper continued to trend downward; lead and zinc remained stuck in their recent low trading ranges; and even nickel, the star performer of the year so far, began losing its upward momentum, stalling at a London Metal Exchange (LME) 3-month price of around US$10,000 per tonne.

Meanwhile, underlying demand conditions across almost all regions could scarcely be better. In the fourth quarter of 1999, the U.S. gross domestic product rose to 6.9%, compared with market forecasts of 6.2%. Also, euro-zone industrial output grew by 4.4% in December 1999; industrial output in Singapore climbed 26.8% in January 2000; and Malaysia reported economic growth of 5.4% in 1999. Even in Japan, where consumer confidence is still poor, industrial production is expected to have climbed 3% in January.

However, strong growth data for Europe and the U.S. is causing the financial sector to be increasingly concerned about inflation; hence the 2.3% fall in the Dow-Jones industrial average on Feb. 25 (to below the psychologically important 10,000 level). The continued strength in oil prices is doing little to dispel these concerns. Nonetheless, long-term hedge fund investment in metals is unlikely, and, in the meantime, consumers of the major traded metals appear content to stick with a hand-to-mouth approach, as illustrated by the muted reaction to the recent declaration of force majeure at Pechiney’s Dunkerque aluminum smelter in France (Europe’s largest). The declaration was caused by a strike.

Copper prices made a half-hearted attempt to push higher, but the Feb. 24 high of US$1,877 for the LME 3-month price was not enough to trigger covering against options positions at US$1,900 and US$1,950 per tonne. The Feb. 25 close at US$1,820 per tonne suggests that the market may stop below US$1,800 per tonne; a test of the downside is now probable, though the market should find support at US$1,780 per tonne.

The increase of 24,850 tonnes in LME warehouse stocks on Feb. 25 was not totally unexpected. Deliveries of 10,775 and 16,000 tonnes, respectively, were made to the New Orleans and Hamburg warehouses as part of a warehousing deal between a producer and trader; under the deal, deliveries of a similar magnitude are expected every month this year.

The sharp fall in Japanese wire and cable shipments (4% fewer in 1999 than in 1998) and orders (8.8% fewer) proved worse than expected. Nonetheless, the brass mill sector, accounting for 30% of demand for refined copper demand, has recovered strongly in recent months, reflecting a healthy electronics sector. In contrast, end-use sectors for wire and cable, accounting for 70% of demand, remain depressed.

Globally, demand for copper appears likely to grow. CRU International estimates an increase in demand of 4.2% the first quarter of 2000, owing to growth in China, North America and Europe.

Chinese demand for copper is expected to grow, and a recent upturn in the LME-Shanghai arbitrage suggests that Chinese buying may be about to take off. A 10,000-tonne shipment is believed to be en route. However, some of China’s requirements will be met by domestic production. Local officials are forecasting that higher copper prices and better availability of raw materials could raise domestic output by around 5%, or 60,000 tonnes. Chinese copper production in January 2000 rose 13%, compared with year-ago figures.

The aluminum market’s muted reaction to the announcement of force majeure at the 230,000-tonne-per-year Dunkerque smelter illustrates considerable deterioration in market sentiment. The LME 3-month high for the report period was just US$1,666 per tonne, and aluminum closed on Feb. 25 at US$1,650 per tonne.

The general perception is that there is enough aluminum in Europe, both in LME warehouses and off-warrant, to supply demand. Dunkerque produces high-purity metal, so premiums for this type of aluminum could rise. However, we understand that despite large deliveries into LME warehouses in February, there is still a substantial amount of duty-paid material being held off-warrant in Europe and hence little likelihood of a shortage of physical metal unless the strike is prolonged.

Wrangles over Russian aluminum continue. The owners of the Krasnoyarsk smelter claim that a group of the plant’s shareholders has sold a controlling interest to entities linked to Sibneft, the Russian oil company. Sibneft itself has attempted to distance itself from the situation, reporting that any of its shareholders that may be involved were acting independently. However, none of this appears to be affecting Russian production: recent data show that output between January 1998 and January 1999 climbed 3.4%, while alumina production in the Commonwealth of Independent States rose 9.2%. Russian exports climbed 11.5% in 1999 (compared with 1998). On the other hand, we hear unconfirmed rumours that nervousness over the ownership situation has led to the stockpiling of around 100,000 tonnes of Russian metal in St. Petersburg against contracted future deliveries by merchants.

There are also reports that high alumina prices have induced some Chinese smelters to cut back on production, resulting in lost output of 50,000 tonnes so far this year. This would equate to a drop in Chinese annual output of more than 300,000 tonnes this year, or around 10% of total output. We are aware of only one small Chinese plant that has confirmed a production cut, namely the 12,000-tonne-per-year Pinxian plant, currently operating at 60% of capacity. Although Chinese alumina imports fell sharply in January 2000, local producers are raising output levels and local analysts are forecasting an increase in alumina output of around 200,000 tonnes this year to 4 million tonnes. If China produces around 2.7 million tonnes of aluminum in 2000, it will require only around 1.3 million tonnes of imports — less than last year’s level of 1.6 million tonnes.

Whilst the alumina market undoubtedly remains tight (a recent spot deal was reported at more than US$550 per tonne), there is evidence that shortages are not quite as severe as some parties have tried to make out. CRU International estimates that the alumina market was in surplus by around 170,000 tonnes in the fourth quarter of 1999 and is likely to be in only a small deficit of around 15,000 tonnes in the first quarter of 2000. We continue to believe that alumina availability will not be a constraining factor in primary aluminum production growth this year.

LME 3-month nickel continues to trade nervously in a narrow range on either side of the US$10,000-tonne level. During the report period, LME stocks fell 1,860 tonnes, and they are averaging a decline of around 2,000 tonnes per week. At this rate of withdrawal, LME stocks will have dwindled to almost nothing by May 31, the date that the labour contract at Sudbury, Ont., is due to expire. Total nickel stocks currently represent about 10 weeks of supply — a level rarely reached at any time in the recent history of the nickel market.

The lifting of a blockade at Eramet’s SLN nickel subsidiary in New Caledonia should allow the smelter to continue operating at 70% of capacity. Talks were scheduled to resume Feb. 29, but, even if a settlement is reached, nickel prices are unlikely to fall back from current levels. There are two reasons for this: the threat of strike disruption in Canada and the scarce supply of physical units.

Despite a reasonably good 5-day period, zinc prices failed to break out of their recent trading range. A high of US$1,131 per tonne was reached on Feb. 24, but prices on the following day closed slightly down at US$1,113 per tonne. Although LME stocks rose by more than 2,500 tonnes on Feb. 25, fundamentals remain firm and zinc prices are significantly below the level that one might expect them to be, given the low level of stocks. From both a technical and fundamental perspective, a break
out of the recent trading range seems overdue for zinc, and chart patterns suggest the recent price decline is bottoming out.

What may be keeping potential buyers out of the market is the current high level of Chinese exports and production. Chinese zinc production climbed 7.2% in January 2000, after rising by almost 15% in 1999. Exports of zinc from China are traditionally low in the early part of the year, but January 1999 saw an increase of 95.5% (compared with a year ago), reaching 35,949 tonnes. There are also reports that up to 100,000 tonnes of Kazakhstani slab zinc in the U.S. were recently been custom-cleared.

Gold fell decisively below the US$300-per-oz. mark during the report period, as nervousness over producer hedge buy-backs faded with the announcement that Ashanti had reached a settlement with its bankers. Gold prices seriously weakened and moved back to the US$290-to-$292-per-oz. range. The Feb. 21 morning fix was set at US$305.75, but, by the morning of Feb. 25, this had slipped to US$297.15, and prices continued to weaken as the day wore on. The market finally closed in London at US$292.40 per oz. Weakness in platinum group metals markets also contributed to the lower gold price, as palladium and platinum prices fell sharply from their recent highs. Earlier in the report period, covering in Asia had helped lift prices, but this failed to inject any signs of a convincing recovery or strengthening in prices.

The Dutch have now sold 95 tonnes of the yellow metal since December 1999, and the fact that the market has been able to absorb this amount in a relatively short space of time suggests that physical demand is reasonably good. However, there will be little respite from central bank sales over the next few months, with the Bank of England’s final 25-tonne auction scheduled for March 21 and Swiss gold sales also likely to begin soon.

In South Africa, the Chamber of Mines released figures showing that mine output in the country has fallen to its lowest level since 1954. In 1999, 449.5 tonnes were produced — down from 464.4 tonnes in the previous year and 492 tonnes in 1997. Following its peak of 1,000 tonnes, 30 years ago, South African production has declined steadily, but recent restructuring in the face of low prices has helped push production lower still.