Leading indicators turn north for base metals

After a wobble early on in the report period March 25-28, the base metals markets regained their poise, helped by encouraging economic data out of both the U.S. and Europe. Nonetheless, the funds remain the main drivers of the market, and there is a risk that with first-quarter portfolio valuation now out of the way, some may decide to cash in their chips. On the other hand, as long as the recovery continues, others are likely to take their place, and solid prospects appear likely in the short term.

There remains a troubling dichotomy between the widespread upturn in leading indicators for metals consumption in most regions and the performance of actual demand for metal itself, which has been depressed for some time. However, tentative signs of improvement are now apparent. In the aluminum sector, for example, Alcan reported an improvement in its order books, though there’s no guarantee that this will be sustainable. Meanwhile, General Motors, one of the world’s largest consumers of base metals, has expressed optimism about auto production in the second quarter and, accordingly, revised its sales projections for 2002. And in the Far East, Korea is buying copper and aluminum while Japanese brass mills and aluminum fabricators are now forecasting a return to growth in the forthcoming fiscal year. How much of this has already been priced-in by the market? Only time will tell.

Copper prices ended the week strongly, gaining US$20 per tonne on March 28 to close at more than US$1,650 per tonne. Good economic data from the U.S. and Europe provided a firm backdrop to copper’s gains. Although signs of better physical demand are slim, for the time being, at least, it looks as if copper will continue to prosper.

Rumours that the Chinese are buying up copper for its strategic reserve have boosted sentiment recently. In the past, the SRB (Chinese State Reserve Bureau) has been a big buyer — most recently in 1996, when it bought 150,000 tonnes. This time, there are reports it has been buying between 7,500 and 25,000 tonnes. Local sources say this is related to fears of an interruption in supplies due to an escalation in Middle East tensions but that further purchasing is unlikely unless prices fall. Some brokers believe the buying is simply part of the regular business that the SRB conducts from time to time and so is unremarkable. Infrastructure development in China certainly needs large amounts of copper, but with local exchange stocks in excess of 210,000 tonnes, it’s mystifying as to why the SRB needs to buy on the international market right now.

The market also received a temporary boost on March 29, when Noranda announced that a previously announced 6-month closure of its 120,000-tonne-per-year Gasp smelter would be made permanent. However, this development will have no impact on refined supply; rather, it is a symptom of the tighter concentrate market, resulting from mine cuts already made. Noranda’s 360,000-tonne-per-year CCR refinery will now receive extra blister from the recently expanded Altonorte smelter in Chile.

After finding good support below US$1,400 per tonne, aluminum prices look poised to make further gains. Some consumer buying interest emerged at the lower numbers, which is a promising sign. If US$1,400 per tonne can be hurdled convincingly, a move back above US$1,420 per tonne looks likely.

Spot power prices in the northwestern U.S. have moved up to around US$40 per megawatt-hour from US$25 per MWh a month ago. Under take or pay contracts which the Bonneville Power Administration (BPA) has with Longview and Golden Northwest, it is now more profitable for the BPA to sell power on the spot market than to enforce its contracts with the smelters, under which it gets only US$34.70 per MWh. There could now be a change to Longview’s plans to restart a 55,000-tonne-per-year potline by the end of April, which was only considered an option because it meant that less money would be lost than if it paid the penalty of not taking BPA power. Data from London-based CRU International show that Longview breaks even at an aluminum price of US$1,475 per tonne at US$34.70 per MWh. Under its contract with the BPA in the northwestern U.S., if Longview does not take the BPA’s power, it must pay that organization the difference between the spot price and the contract price. If the recent increase in regional power prices is sustained (which appears likely as peak summer demand approaches), the likelihood of restarts at either company is substantially reduced.

Zinc prices moved up sharply on March 26 as news of a strike at a major European smelter hit the newswires. However, fund profit-taking soon capped the move at US$850-860 per tonne. Zinc prices then moved down steadily over the course of the rest of the week and failed to benefit from strength in copper and aluminum toward the weekend. In the short term, a move back down to support at US$840 per tonne looks probable.

Zinc’s faltering response to the strike that hit Umicore’s 260,000-tonne-per-year smelter in Auby, France, illustrates once again how weak the market is at present, and is hardly surprising given the relentless rise in exchange stocks. Although recent mine production cuts total almost 750,000 tonnes (8% of global mine capacity), there is little sign yet of price-related cuts being made on a similar scale in the smelting sector. A small handful of smelters have extended summer maintenance programs (Teck Cominco at Trail, B.C., and Cajamarquila, Peru; Outokumpu at Kokkola, Finland; and Big River at Sauget, Ill.), resulting in the loss of around 100,000 tonnes of output in 2002. But it will take a lot more than this to bring the market back into balance.

Without further production cuts, we estimate that zinc demand will need to grow by more than 7% simply to balance the market in 2002. Even if this does happen (which appears unlikely given that zinc’s long-term trend rate of growth is just 2%), the market will still be left with an uncomfortably high level of inventory, currently touching almost eight weeks of consumption.

Nickel remains one of the strongest base metals; price dips on the downside have been shallow and moves toward support levels have never threatened a serious break of technical ranges. On the charts, nickel looks stable at current higher trading levels, having formed a steady range between US$6,600 and US$6,800 per tonne.

The resilience of the rest of the base metals complex in the face of threats of large-scale fund liquidation and the continued flow of encouraging economic data, particularly from the U.S., has reinforced support areas. Fundamentally, further stock falls (down 282 tonnes in the report period) also highlight the increased levels of tightness in nearby supplies, and the return of the cash-to-3-month backwardation has acted as a reminder that, in the short term, speculative funds and commodity trading advisors are unlikely to play the nickel market aggressively from the short side. Given these factors, prices should continue to remain supported over the immediate term. Fresh price gains are unlikely at these levels, but nickel should be capable of stabilizing and consolidating the range above US$6,600 per tonne.

Meanwhile, Anaconda’s Murrin Murrin laterite plant in Australia continues to face production and financial problems, and majority owner Glencore has provided a US$10-million loan. This covers production for three months, though, with output levels still poor and production costs inevitably increasing, the plant’s long-term viability remains uncertain.

Although the headline closing price on March 28 would indicate a strong performance for gold prices, their performance, on the whole, was sluggish during the period under review. Record increases in the South African gold equities market look robust in the context of gold’s peak at just above US$300 per oz. This calls into question the strength of the traditional link between gold equities and gold prices, and leads to some suspicions regarding just how genuine and long-lasting recent investments in gold equi
ties have been. Do they indicate a flight to quality or the actions of predatory funds adopting positions in what is perceived to be a market in the process of consolidation?

The strength in gold prices reflects the fact that speculative funds are eager to push the figure above US$300 per oz. for quarter-end portfolio valuation purposes. With investment funds having held a sizable and steady net long position throughout the first quarter, speculators have been calling the shots in what has otherwise been a thin market. Although a good quarter-end closing price may reflect the short-term vested interests of speculative trading funds, it does not mitigate the risks associated with fund liquidation early in the second quarter. Having maintained the net long position to the end of the financial quarter, these same funds are unlikely to remain in this position throughout the second quarter. More likely are profit-taking and liquidation, highlighting the vulnerability of gold prices at these higher levels.

Short-term price risks to the upside still exist, but whether they reflect a fundamental and sustainable sea change in investor attitudes or a coincidental merger of short-term influences is debatable.

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