Lead, copper and zinc post gains

Some short-term relief looks likely for metals prices as three factors — volatile nearby spreads, an improving technical picture, and production cuts stemming from California’s power shortages — continue to divert attention from global economic worries. Major gainers during the report period Jan. 22-26 were lead and aluminum, with cash prices gaining 5.8% and 2.6%, respectively, followed by copper and zinc, both of which were up 0.9%.

Despite the tightness in nearby spreads, metal continues to be shipped out of London Metal Exchange (LME) warehouses. The increase in net aluminum deliveries has slowed, and so far there is little direct evidence that global demand for metals has contracted dramatically (though there are clearly areas of weakness in some key markets). The growing realization that supply growth in aluminum, copper, lead and probably zinc is likely to be slow means that, under all but the most pessimistic of economic scenarios, LME stocks are unlikely to climb substantially in 2001. This factor should limit the downside since few market participants will want to risk getting caught in the kind of squeezes we are seeing at present. On the demand side, consumers have been notable by their absence so far this year, and many are probably under-hedged. Encouraging news from the U.S. is that January car sales and retail sales were stronger than expected. If the economic picture does improve, the backwardated nature of most markets (plus the recovery of the euro) may encourage consumer buying further, adding to upside price potential as the market moves into the seasonally busy second quarter.

Copper prices continued to strengthen. Although the market weakened on Jan. 24, support at US$1,785 per tonne held, ensuring that the uptrend in prices established so far this year remains in place. The subsequent rebound elevated LME 3-month prices to US$1,810 per tonne, and a break above US$1,840 per tonne in the short term could see further upside momentum develop. The recovery during the period under review was aided by further declines in LME stocks, news that high power prices in the American southwest could result in production cuts there, and some better U.S. economic news. Although the market moved back into a cash-to-3-month contango, there are signs that the tightness in March is moving forward into April, with the April-May spread moving into backwardation. However, the market remains vulnerable to bad economic and fundamental news, and support in the US$1,775-per-tonne region could still be tested over the next few weeks or so.

However, if spread tightness persists, then the downside for copper prices is limited since market participants will be wary of going short and being caught in a squeeze. However, LME stocks are right on the borderline where traditionally the market has swung between backwardation and contango. If LME stocks were to climb back toward 400,000 tonnes, it is unlikely nearby spreads would remain in backwardation.

The warning from Phelps Dodge that a 65% increase in its power costs since the fourth quarter of 1999 puts at risk a portion (as yet undisclosed) of its 240,000 tonnes of copper production at the Chino, Tyrone and Sierrita operations also raises questions about Grupo Mexico’s former Asarco operations, also in the southwestern U.S. GM runs the Mission and Ray copper mines (90,000 tonnes and 160,000 tonnes, respectively), as well as the Hayden smelter (165,000 tonnes) and Amarillo refinery (315,000 tonnes). Copper production consumes a relatively small amount of power relative to other metals, with energy accounting for only around 8% of production costs. However, copper production in the southwestern U.S. is an expensive activity, with cash costs ranging from US65 to US85 per lb. at individual mines even before the hike in energy costs. Because of the location, copper producers there must compete for electricity and gas supplies with Californian consumers. Consequently, average electricity costs have risen to US14 from US11 per kWh in the fourth quarter, adding 2 per lb to Phelps Dodge’s production costs.

The ongoing tight power situation in California continues to underpin prices for aluminum. LME 3-month prices broke convincingly through the US$1,600-per-tonne level of resistance early in the report period and, on Jan. 26, moved up to challenge the next resistance level at US$1,630-1,640 per tonne. Fresh fund buying has been the main driving force, pushing prices higher with consumers remaining very much on the sidelines. Producer-selling capped the Jan. 26 rally and continues to keep the market in steep backwardation. Nearby spreads eased mid-week as lending came into the market but moved out again sharply on Jan. 26, with the cash-to-3-month backwardation climbing back to more than US$70 per tonne from a low of US$47 per tonne on Jan. 24. Despite spread tightness, the rise in LME stocks was small at just 8,500 tonnes. There are rumours of off-warrant stocks of more than 200,000 tonnes in the American midwest, which we suspect are accurate. But we estimate a cash-to-3-month backwardation of more than US$120 per tonne is required in order to draw this material into LME warehouses.

Zinc prices continue to make upside progress, with the US$1,070-1,080-per-tonne level providing a seemingly impenetrable barrier of resistance. Prices weakened sharply, along with the rest of the base metals complex on Jan. 24 but did not test their recent lows, with support holding at US$1,044 per tonne for LME 3-months. In the second half of the report period, prices recovered encouragingly, and they now look set for another test of the US$1,070-1,080-per-tonne level, supported by emerging tightness in nearby spreads.

Zinc’s performance is poor, given the strength that is evident elsewhere in base metals. The decline in LME stocks is clearly slowing down now (net withdrawals totalled only 275 tonnes during the report period), but even so, prices still look undervalued, with stocks below 200,000 tonnes. The problem for zinc is that without a compelling supply-side story, it is attracting little speculative interest, and this, in turn, contributing to an already-unimpressive technical picture. Could high power prices help improve the outlook for zinc? Cominco’s power-for-metal swap, which resulted in a further large cut in production at its 290,000-tonne-per-year Trail smelter in British Columbia (where output by August will be just 210,000 tonnes per year) has so far had little impact on the zinc price. However, zinc production is electricity-intensive (not as much as aluminum, but considerably more so than copper), so further deals of this sort should probably not yet be ruled out. They could even help to improve price prospects.

After finding firm support for most of the week at US$6,700 per tonne, nickel weakened considerably on Jan. 26. Once the US$6,700-per-tonne support level had been broken, prices drifted lower on follow-through selling, pushing the 3-month price below the recent trading range of US$6,600-6,800 per tonne.

Toward the end of the report period, there were signs that the steep backwardation in nickel prices was starting to ease, with the cash-to-3-month price narrowing slightly to US$265 per lb. The nearby spreads also contracted, with the cash-to-February price contracting by US$50 on Jan. 25. This resilience is partly due to the steep backwardation.

Although stocks remain at historically low levels, the steep backwardation is starting to attract material into warehouses. Stock increases during the first part of the report period pushed levels above 10,000 tonnes, though they remained fairly static during the second half. The emergence of fresh stocks, combined with signs that the backwardation is narrowing, may make nervous holders even more jittery. Despite the weaker technical picture, prompt nickel supplies are still thin. Moreover, the downside risks are limited for the time being, with support at US$6,400 per tonne expected to hold.

Gold‘s inability to benefit from the recent Bank of England auction (which, in many respects, was the best yet) underscores the market’s current weakness. A temporary rally was all it could manage just before the results of the auction were announced. Although prices moved through both the 10- and 30 day moving averages, to reach a high of US$269 per oz. on Jan. 23, they had, by the end of the week in London, fallen to US$262.5 per oz. — the second-lowest level since prices broke through support at US$270 per oz. in October 2000.

The disappointing end to the week is a little surprising, given that the auction was widely interpreted as being the strongest yet. The cover ratio (the number of times the gold on offer was over-subscribed) was 4.8, the third-highest level. Also, the differential between the allotment price and the morning fix on the morning of the auction was the highest recorded. Furthermore, the scaling factor at the allotment price (35.8%) was below average, showing that there was a significant amount of bids above this level, whereas the number of bids below was relatively small.

The subsequent price action reflects the volatility of prices and the consensual belief that attempts to move higher will be frustrated and capped by holders selling into any rally. Gold remains the weakest precious metal, as silver prices consolidated further between US$4.75 and US$4.82 per oz. Although platinum lost some ground, prices remained well-supported at US$600 per oz. Palladium continued to be the star performer with the fix on Jan. 26 reaching a new all-time high of US$1,094 per tonne.

Against this backdrop, gold’s performance looks even more dismal. Technically, the charts also offer no room for optimism, with prices now well below the 10-day moving average and the differential between the 10- and 30-day MA widening to almost US$4. In the short term, the strength of support at US$262 per oz. will be a crucial factor in determining price direction. If this level fails to hold, it could be definitive.

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