Hope for depressed prices

A strong afternoon’s trading on Friday saw prices for aluminum, copper, zinc and lead all finish the week of Nov. 20 with encouraging gains. Indeed, some analysts are of the opinion that the period of depressed prices seen across the London Metal Exchange’s (LME’s) base metals markets since mid-September may be coming to an end. On the other hand, Thanksgiving holidays in the U.S. meant that volumes late in the report period were low.

Although metals markets are looking stronger technically, there are still doubts concerning market fundamentals. Current demand levels in Europe and the U.S. are weaker than they were earlier in the year, but many of the consumers with whom we spoke do not anticipate a sharp contraction; indeed, many are hopeful that next year will prove reasonable for volumes. However, U.S. leading indicators for metals demand still point to a sharp fall in consumption, and there are increasing concerns about European growth, particularly with the now-high cost of oil in local currencies. In the Far East, the storm clouds appear to be gathering over Korea and Taiwan. We remain bullish on the prices of major LME traded metals, particularly copper and aluminum, but we’ll be watching macro-economic data closely for any signs of deterioration.

After sinking to a fresh, 13-week low of US$1,780 per tonne on Nov. 22, copper prices ended the week encouragingly, closing above the 10-day moving average for the first time since early November. Fundamentals still appear firm, and we think copper is undervalued by around US$100-120 per tonne. Forward-selling pressure from producers has eased in the past few weeks (reflected by an improvement in the back end of the price curve), and if fund short-selling is also at an end, there is potential for a modest recovery in prices over the next few weeks or so.

There has been plenty of positive fundamental news of late. The International Copper Study Group (ICSG) revised its forecasts of the copper market deficit this year to take account of higher-than- predicted consumption levels. From a forecast of less than 100,000 tonnes, the ICSG has increased its copper deficit forecast for this year to 340,000 tonnes, and to 250,000 tonnes in 2001. Consumption for the year is forecast to rise 6.5%, with production rising by 2.1%. Our forecast deficit for 2000 is lower, at 267,000 tonnes, with world consumption rising 4.5%. Another deficit — 150,000 tonnes — is forecast for 2001, based on consumption growth of 2.1%.

Meanwhile, China’s latest export statistics show that its insatiable demand for copper continues. Net refined copper cathode imports up to October were 72% higher than the year-ago level, while total copper imports, in all forms, were 43% ahead. Although we’ve been expecting Chinese imports to slow down, there appears little sign that this will be happening any time soon. Indeed, a recent widening in the Shanghai/LME arbitrage to more than US$400 per tonne, from US$320 per tonne in September, suggests a renewed appetite for the red metal. We note also that Chinese smelters are seeking concentrate in the spot market at present and that KGHM has announced an increase — to 50,000 from 30,000 tonnes — in its contracted supply of copper to China.

Aluminum prices picked up, as news of a production cut by Kaiser Aluminum enabled the LME 3-month price to hurdle resistance at US$1,500 per tonne, ending on Nov. 24 at its highest level in a month. However, in a thin market and with the U.S. absent, it is difficult to judge just how meaningful the late surge in prices was. Earlier in the week, the price response to Kaiser’s production cut was sluggish, illustrating the market’s continued preoccupation with demand issues. If demand fears re-emerge, aluminum could quickly fall back below US$1,500 per tonne, especially since technical indicators are overbought. Although we are positive on aluminum prices from a fundamental perspective, upside potential looks limited in the short term.

Our medium-term optimism regarding aluminum prices stems from our view that supply growth will be constrained over the next 18 months by cutbacks, owing to a lack of affordable power in the American Northwest. We were a little surprised at how quickly Kaiser has decided to cut its production in the region, since new power contracts do not come into effect until October of next year. The size of Kaiser’s production cut was also a little bigger than expected, at 48,000 tonnes.

In low-volume trading, nickel prices moved in a fairly narrow range during the report period, with the LME 3-month price trading between US$6,670 and $6,940 per tonne. The 10-day and 30-day moving averages are separated by little at the moment, and as both trend downward, they are providing stiff resistance to any moves above the US$6,950-to-7,000-per-tonne level. Looking ahead, we still favour the downside for nickel, but US$6,600 per tonne should provide some support in the short term.

Positive market news is in short supply for nickel, though Noril’sk reports that its shipments for 2000 will be considerably below last year’s levels. In the first three quarters of 2000, Russian exports of nickel reached just 132,200 tonnes, or 16% below the year-ago level.

The decline in Russian shipments goes some way toward explaining why nickel stocks are not rising rapidly on the LME. Despite a widening in the backwardation, LME stocks fell by 612 tonnes in the period under review — the largest decline in 13 weeks.

As for the backwardation, it looks set to remain in place as long as LME stocks stay low and fears over nearby supplies persist. Settlement of the long-running strike at Falconbridge would help ease the situation, but, after appearing ready to break the deadlock, the two sides now seem to have hit yet another stumbling block. The company has said talks will not re-start unless the union agrees to reduce the number of company-paid union positions and the amount of time spent on union business in the workplace. It’s unlikely the union will accept such conditions, so the stalemate looks set to continue.

On the demand side, Sumitomo of Japan says it will halve its stainless steel export volumes because of low prices in Asia.

Despite a bout of short-covering on the afternoon of Nov. 24, which took prices to a high for the week, zinc continued to trade unenthusiastically and lacked momentum in either direction. Given the current inertia in most markets, particularly in the base metals complex, it is not surprising that zinc is suffering from narrow trading ranges and thin volumes. At the LME level, zinc-trading volumes are usually lower, as more fund activity is absorbed by copper and aluminum. In periods of quiet trading, zinc therefore suffers more from the subdued volumes and generally adopts a passive role.

Short covering on Nov. 24 took prices up to a high for the week of US$1,079 per tonne and reversed the losses incurred earlier on, when the LME 3-month price dipped to a low of US$1,049 per tonne — the second-lowest fall since July 1999. Given the low volumes and thin market conditions just before the U.S. Thanksgiving holidays, the mini rally may not be terribly meaningful. If prices do shift lower in the days ahead, the first line of support will be in the US$1,060-1,065-per-tonne region.

Zinc’s move higher coincided with the release of bearish Chinese customs data showing a large increase in zinc exports in October. Exports of refined zinc reached 49,754 tonnes — a 49% increase over October 1999. The increase brings total refined zinc exports for the January-October period to 478,253 tonnes, a year-over-year increase of 23.6%. China’s full-year zinc exports are on-target to reach a record high in 2000.

The 1-week-old strike at the Outokumpu’s Tara zinc mine, in Ireland, continues, and there is little indication of any progress. The mine is Europe’s largest producer, at 160,000 tonnes per year, and the fact that prices are showing little sign of reacting to the dispute is perhaps an indication of zinc’s weakening fundamentals.

The growing level of Chinese exports will depress sentiment further and hinder moves to the upside. A supply surplus, fuelled in part by greater Chinese exports, is already being factored into prices and should therefore not itself break support. We therefore expect prices to continue treading water, at least until the base metals complex can shake off its current malaise.

Gold prices remained in a trading range of US$265.5-267 per oz. Although prices continue to edge slowly away from the US$264-to-265-per-oz. lows that were reached in late October, when support at US$270 gave way, they continue to lack any sense of direction. In the short-term the downside for prices appears limited. If current support levels do give way, however, the charts suggest that the next southbound shift in gold will take prices back to the 20-year lows experienced in 1999. In the short term, however, prices don’t appear to be ready to break downside support yet.

A report from the Commodity Futures Trading Commission showed that the fund net short position on the Commodity Exchange of New York (Comex) was recently its highest level in more than a year: minus-44,976 lots. Not since September 1999 (immediately prior to the announcement of the Washington Accord) has the fund short position on Comex been so large. However, with prices having found a support level in the mid-60s, the scope for a short-covering rally appears greater than does a return to levels below US$260 per oz. — particularly when gold is viewed in the context of the current economic climate.

A greater sense of pessimism concerning the prospects for the U.S. economy is casting some doubt on the continued stability of the U.S. dollar. Despite the euro’s tendency to drift lower against the dollar, it is clear that the European Central Bank has earned some credibility from the market in its attempts to support the euro and prevent slides to fresh lows. The poor performance of the U.S. stock markets around the time of the U.S. Thanksgiving (the Nasdaq lost almost 5% on Nov. 22) has highlighted the vulnerability of the U.S. dollar.

Meanwhile, if economic uncertainty grows, support in the US$265-per-oz. area could be strengthened and the risk could turn to the upside as rallies driven by a heavily short market cause players to think twice before venturing further into short territory.

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