Firm prices, fundamentals add value to nickel and tin markets

The following is the fourth in a series devoted to metals markets and was culled from Barclays Capital’s monthly report The Commodity Refiner. This week’s instalment looks at developments in nickel, tin and zinc.

Nickel

Firm prices are justified by strong longer-term market fundamentals. We recently raised our nickel price forecast, reflecting this market’s relatively favourable stance in the London Metal Exchange (LME) complex over the coming years.

The market is weary of strike action at Norilsk Nickel in Russia, which shows it is responsive to any potential supply disruptions in tight market conditions. New price spikes cannot be ruled out, though already the fund community is estimated to hold a large net long position.

As for most other commodities, China represents a key positive, with nickel imports rising strongly to support the buildup of stainless steel capacity in response to strong domestic demand.

Another key positive is the low level of Exchange inventories, leaving the stock-to-consumption ratio low in a historical context and relative to the other base metals. Also advantageous is that few new projects are expected to come on-stream over the next few years. The recent announcement by Inco that it is reviewing its Goro project, in New Caledonia, which will delay startup by at least six months (2006 at the earliest), is indicative of this trend. However, the company’s plans for its massive Voisey’s Bay project, in Labrador, will not be affected, and that will bolster output, starting in 2006.

However, near-term price risks exist, especially after the recent sharp and rapid fund-driven rally. Risks are primarily related to demand for stainless steel in a troubled U.S. auto sector and an overall environment of subdued industrial production.

In addition, nickel demand outside the stainless steel sector remains weak, while demand from the aerospace and land-based turbines continues to deteriorate. Other causes for concern are Russian stockpiles and the potential rise of scrap availability in an environment of higher prices.

While the timing of the release of the Russian collateral loan of 60,000 tonnes represents a key unknown in this market, Russian export volumes were unusually low at the end of 2002. October exports were the lowest on record for that month, which could be an indication of further Russian stockpiling. In addition, recent large inflows of metal into LME warehouses in Europe could be of Russian origin.

No less worrisome is the increased availability of secondary supply in a strong price environment coupled with improved scrap collection in Asia. However, in the near-term, we expect the primary ratio in stainless steel production to remain high. The other negative effect from high primary prices is that small or more expensive projects could boost efforts in securing financing.

While there were signs of weakness in U.S. stainless steel prices during the fourth quarter, they’ve been relatively firm in early 2003. European and Asian steel prices also remain in their upward trend. Open interest and prices for nickel futures continue to move in a similar pattern, which suggests that higher LME nickel prices during the fourth quarter and the early part of this year have been supported by the establishment of fresh speculative long positions. As a result, this market has not been made a victim of aggressive short selling, whereas most other LME metals have been. This is also indicative of relatively superior fundamentals.

In December 2002, total nickel futures open interest amounted to 36,000 lots, compared with 41,000 in the previous month and 49,000 lots at the previous peak, in August.

Trading volumes of LME nickel futures were relatively modest during 2001-02, compared with rising trading volumes when prices moved above US$10,000 per tonne. However, trading volumes picked up a little in December, at 237,000 lots, which was 8% higher than in the previous month and largely flat compared with the year-earlier period.

Still, nickel trading volumes represented the lowest share of the LME traded metals after tin in December.

An indication of future metal tightness is that the whole nickel forward curve beyond three months is trading in backwardation. In addition, all future prices have risen sharply, compared with the past couple of months.

In contrast to early in the fourth quarter of 2002 and future prices beyond three months, the nearby spread (cash to three months) is trading in contango, at around US$20 per tonne.

Fear of tight supplies has not been evident in spot premiums to the same extent as in primary LME prices. Movements in physical premiums have varied across regions, and gains have generally been modest.

Strong Japanese stainless steel output has given support to Asian premiums, while Russian full-plate cathode premiums have also edged a little higher in Europe. U.S. premiums are also supported by good demand from the stainless steel sector.

LME nickel inventories have continued to decline and are at low historical levels. Total LME stocks stood at 22,000 tonnes at the end of 2002. Although this was similar to year-earlier levels, inventories were well down from their 2002 peak of 28,000 tonnes at the end of June.

Drawdowns have been evident at most key locations, signalling strong demand for primary nickel from the stainless steel industry. Hull, England, is now the third-largest location (replacing Baltimore, Md.), following the large delivery in mid-December.

Cancelled LME nickel warrants currently account for about 5% (or 1,100 tonnes) of the total remaining LME nickel stockpile, which suggests there is a significant amount of metal still awaiting outward delivery. Therefore, LME inventories can be expected to remain low for the foreseeable future.

We estimate that total reported nickel inventories stood at 137,000 tonnes at the end of 2002. We have revised our data for inventories held at consumers at the end of the year to 22,100 tonnes, based on data from London-based CRU International.

We expect inventories will maintain the overall declining trend in an environment of robust stainless steel production and improving economic growth.

The current total reported stockpile represents about 6.7 weeks of consumption, which is near historical lows. We think this ratio will remain subdued and have an overall supportive effect on prices.

Monthly Chinese nickel import volumes rose during the last quarter of 2002. As a result, net imports amounted to 76,500 tonnes in 2002, which was almost 50% (or 25,000 tonnes) higher than in 2001. Rising domestic stainless steel capacity is the main reason behind the rise in imports, while imports of stainless steel have also risen sharply.

According to statistics from the International Nickel Study Group, the global nickel market was in a 3,100-tonne surplus in November, compared with 2,900 tonnes in October and 3,300 tonnes in November 2001. The surplus was the result of a 4.6% rise, year over year, in refined output to 100,000 tonnes, whereas demand rose 5%, year over year, to 97,000 tonnes. Both supply and demand fell from the previous month, by 0.8% and 1%, respectively. Mine output totalled 103,100 tonnes in November.

The Western World deficit expanded to 12,800 tonnes in November, with demand rising by 4.5%, year over year.

Tin

The upward trend in tin prices since August 2002 remains firmly in place. Renewed drawdowns of LME inventories in response to production losses during 2002 have continued to provide support. However, rising refined output in Indonesia is offsetting declines elsewhere, though there are also signs that demand conditions are improving.

Following the ban of exports of Indonesian concentrates (which began six months ago), domestic refined production at PT Timah and PT Koba has risen sharply. In fact, PT Timah reported record figures of both concentrates and refined production during the third quarter, as well as strong levels during October. Its refined output was 46% higher, year over year, in the third quarter, at 13,900 tonnes.

Declines in output have occur
red in Malaysia, where the Malaysian Smelting Corporation closed two furnaces, reduced its smelting capacity to 15,000 tonnes per year. Output reductions are also evident in China; as a result, that country’s exports of refined tin fell by about 30% last year to an estimated 30,000 tonnes. The Chinese government set its export quota for 2003 at 65,000 tonnes, which it is unlikely to reach.

However, a few Chinese tin operations are expected to restart this year:

Chief among these is the Longquan smelter, where production of 12,000 tonnes per year will soon resume. Nonetheless, it is expected to produce only 2,000-3,000 tonnes in 2003, owing to a flooding disaster in 2001.

Meanwhile, the Gaofeng Mining Company has now received government approval to restart its mine at a reduced rate after it was closed for safety reasons at the beginning of last year. Minsur’s refined tin output reached 32,700 tonnes during the first nine months of last year, which was 40% higher than a year earlier.

On the demand side, U.S. tinplate production has risen since import tariffs were introduced, and shipments in the third quarter were up almost 10%, year over year. Also encouraging is that Japanese electronics manufacturers will reduce the use of conventional tin-lead solders over the coming years, which should help boost demand for tin. Already, robustness in the Asian electronics sector is boosting tin demand in the region. We estimate that Chinese demand growth during the first 10 months of last year was 7%, year over year. In conjunction with overall tight supplies, this will likely help keep the global tin market in deficit for the foreseeable future.

Western Europe remains the key consumer of tin, for it is a major producer of tinplate (which is one of the key end-uses of tin, apart from solders and chemicals). We estimate European consumption will reach 61,000 tonnes by 2003, while Chinese consumption is rising at a fast rate (to an estimated 57,000 tonnes by 2003).

Open interest for tin futures has recently declined, at a time when prices have trended higher. This suggests that prices have been driven higher by short-covering. In December, total tin futures open interest amounted to 22,000 lots, slightly lower that the recent peak, in October.

Open interest and prices for tin have been moving in irregular patterns, making it difficult to read trading activity, compared with other LME metals. What seems clear, however, is that the sharp price fall during 2001 was driven by aggressive short-selling, with open interest moving in the opposite direction of prices.

Tin futures trading volumes picked up a little in December, at 119,000 lots. This was 6% higher than in the previous month and 13% higher than a year earlier. Tin was the least-traded metal on the LME in December.

The whole tin forward curve remains in a full contango, with the shape of the curve unchanged compared with recent months; meanwhile, prices for all future dates have risen by an equal amount. All of this implies market perception of good metal availability over the coming 15 months.

The cash-to-3-month spread remains steady at around US$25-30 per tonne, suggesting good availability also of material for prompt delivery.

While European premiums have firmed somewhat, business generally remains quiet, and most consumers are believed to have covered their requirements for the first quarter of 2003.

Although tinplate demand in the U.S. is strong overall, there were signs of consumer de-stocking at the end of the year. This may prevent a further immediate rise in spot premiums. Tightness in the Chinese market, meanwhile, keeps Asian premiums strong.

LME tin inventories have continued to decline in most major warehouse locations in recent months. Inventories in Europe have been depleted at an accelerated pace as producer shipments were reduced or diverted elsewhere.

The total LME tin stockpile fell to 25,600 tonnes at the end of 2002, which was 5,000 tonnes lower (minus 16%) than a year earlier and as much as 13,400 tonnes below the peak of 39,000 tonnes in July 2002. We believe the sharp decline is related to reduced metal production and a pick-up in demand.

Cancelled LME tin warrants remain at relatively robust levels (8% of the remaining total, or about 2,000 tonnes), signalling the possibility of further net drawdowns.

On a total reported basis, we estimated tin inventories were at 53,100 tonnes at the end of 2002, little-changed from a year earlier. While exchange stocks represent the largest share and have been declining sharply, producer and consumer inventories registered modest gains during the fourth quarter, to 11,500 tonnes and 16,000 tonnes, respectively.

Despite a decline in inventories and a pick-up in demand, the tin stock-to-consumption ratio is still the second-highest among the base metals, after copper.

We estimate that total stocks represent 9.5 weeks of current consumption, compared with the recent peak of 12.4 weeks between the second quarter of 2002 and the third quarter of 2002, and compared with the low of 6.2 weeks at the end of 1999.

Zinc

The global zinc market has been the subject of some well-needed restructuring in recent months. Smelting overcapacity is still the main problem, which is why we recently reduced our estimated rise of the zinc price.

An indication of this, perhaps, is the lack of positive price reaction on the day Metaleurop reported it might have to close its Noyelles Godault plant in northern France. However, on the same day a disappointing U.S. industrial production number was released, signalling again that demand indicators perhaps represent the key driving force.

Still, we think zinc represents good value below US$800 per tonne, especially because positive developments are evolving on the supply side, and investment funds are estimated to hold a large net short position. This, combined with prospect of growing demand in the Western World and the likelihood of reduced exports of refined zinc from China, is limiting downside risk, and we estimate cash prices will average US$834 per tonne this year, and rise further to US$975 per tonne in 2004.

MIM Holdings has completed the sale of its Duisberg zinc smelter in Germany. It is also moving out of the zinc business by selling its Avonmouth smelter in the U.K. A similar strategy is being followed by Noranda, the world’s third-largest zinc miner, which says it will invest little new capital in zinc capacity and focus instead on copper and nickel. According to estimates by CRU International, the average return on capital in the lead-zinc industry is in negative territory, compared with the average for all base metal producers, at +8%. However, the fact that major producers are moving out is a positive sign for longer-term prospects.

These developments, together with power-related output curtailments at Glencore International’s Porto Vesme operation in Sardinia, Italy, have created tightness in Europe. As a result, stockpiles have started to level off and premiums are firm, which are further reasons to believe that prices will remain supported and trend modestly higher.

We believe the sharp rise in galvanized steel prices during 2002 was supported by re-stocking, but also boosted by higher steel prices.

Given the historical positive correlation and in light of continuous weak demand conditions, we think galvanized steel prices are likely to ease, rather than zinc prices rise substantially.

The relationship between futures open interest and prices for zinc suggests speculators have been short-selling this market aggressively since early 2001. More recently, however, futures open interest started to fall at the same time as prices picked up, indicating that some of those short positions were covered. According to the latest monthly LME data, total zinc futures open interest has fallen to 124,000 lots, the lowest level since February 2002.

Monthly trading volumes of LME zinc futures have averaged about 575,000 lots since 1998. In December, volumes amounted to 699,000 lots, which was as much as 42% higher than during the corresponding period in 2001.
However, compared with the previous month, volumes were reduced by 8%.

Zinc is the heaviest-traded LME metal after aluminum and copper.

The zinc forward curve remains in a full contango, with the shape and price levels little changed from a month ago. The contango reflects good metal availability over the coming 26 months.

Zinc spot treatment charges have continued to fall and are around the same low levels that were registered in mid-1994, at US$140 per tonne, reflecting a tight market for raw material.

Spot treatment charges (TCs) look to remain under pressure, mainly because of the possibility that the Avonmouth smelter will close. The future of Porto Vesme adds to the uncertainty. As a result, annual TC negotiations between European and Asian smelters and their suppliers are unlikely to be concluded before February.

Supply curtailments in Europe, strength in sheet galvanizing and inventory drawdowns have all helped push European physical spot premiums higher, by about US$10-15 per tonne (or about 15%) recently.

Inventory flows continue to diverge distinctly between regions. European stockpiles are down, while Asian and U.S. LME zinc inventories are sharply higher. We believe this partly reflects Far Eastern shipments redirected from Europe to the U.S.

Inventories at Trieste, Italy (the key European location), are half of what they were a year ago; they now contain only 43,600 tonnes, or 6.5% of the total. We believe this is partly due to a combination of recent re-stocking by galvanizers, but also because of the prevailing production curtailment at Porto Vesme.

The LME warehouse in New Orleans remains the major location, accounting for about 35% of the total, or 236,500 tonnes, while the stockpile held in Singapore has risen close to that level, at 226,400 tonnes.

As a result, the rising trend in total LME zinc stocks has levelled out, with inventories rising a modest 0.2% during December to 651,200 tonnes. However, compared with the same time last year, stocks are still sharply higher (plus 50.3%).

Cancelled LME zinc warrants have come down sharply since their peak in September and now account for only 2.6% of the remaining total, which suggests that 17,500 tonnes still await outward delivery.

Total reported zinc stocks exceeded 1 million tonnes by the end of 2002, which is relatively high historically. Nonetheless, the latest data from the International Zinc & Study Group suggest both producer and consumer inventories declined in October, to 274,000 tonnes and 115,000 tonnes, respectively.

High levels of inventories and subdued demand conditions have left the stock-to-consumption ratio at its highest since 1988, at an estimated 7.8 weeks at the end of 2002. However, with a pick-up in demand and with the large supply overhang being reduced, we expect the stock-consumption ratio to fall, providing support to the price.

A reduction in Chinese export volumes of refined zinc was helpful to the Western World zinc market in 2002. Over the year, net refined exports amounted to 404,000 tonnes, which was 29%, or 117,000 tonnes, lower than in 2001.

However, in December, net exports picked up somewhat, to 35,000 tonnes, compared with 19,000 tonnes in November. Nonetheless, they were still 5,000 tonnes lower than in December 2001. We believe the tight raw material market and low LME prices helped restrict Chinese metal exports.

According to the latest statistics from the International Lead & Zinc Study Group, the global zinc surplus was reduced to 32,700 tonnes in November from 44,600 tonnes in the previous month and from 86,200 tonnes in November 2001.

Refined consumption rose to 748,700 tonnes (4.3% higher, year over year, but 0.1% lower, month over month), while refined output was reduced to 781,400 tonnes (2.8% lower, year over year, and 1.5% lower, month over month). This reflects a tight concentrates market, with mine output at 733,000 tonnes in November (5.4% lower, year over year, and 0.4% higher, month over month).

— The opinions presented are the author’s and do not necessarily represent those of the Barclays group. For access to all of Barclays’ economic, foreign-exchange and fixed-income research, go to the web site at barclayscapital.com. Queries may be submitted to Kevin Norrish, head of commodities research and energy, at kevin.norrish@barcap.com