Liquidation takes toll on prices

Large-scale fund long liquidation ravaged base metals markets late on Friday, Feb. 9 and continued into the following Monday, erasing almost all this year’s gains in copper, nickel and zinc prices. Aluminum prices also weakened, and the cash to 3-month backwardation eased considerably during the report period Feb. 5-9. On the other hand, dips below US$1,600 per tonne saw particularly good levels of consumer buying, suggesting that, despite the U.S. slowdown, pent-up demand for metals could emerge once the economic outlook improves.

Data released from Germany, Belgium and the Netherlands surprised the upside, suggesting that although the European economy is slowing, it is still heading for another year of above trend growth (albeit well below last year’s level). Despite softer-than-expected metals consumption in the first quarter and a build-up of stocks in some key markets (notably Germany), sentiment remains positive. Indeed, demand is expected to accelerate again in the second quarter.

Attention is focused on the U.S. once again, as Federal Reserve Chairman Alan Greenspan is expected to outline his views on that country’s economy and the scope that exists for further rate cuts. Meanwhile, metals market participants will be watching for news of further production cuts in aluminum (at Alcoa’s Longview reduction plant in Washington state) and copper (at the operations of Phelps Dodge).

Copper prices attempted unsuccessfully to overcome resistance at US$1,800 per tonne before disappointed long liquidation on Feb. 9 drove London Metal Exchange (LME) 3-month prices down to US$1,773 per tonne. Forward spreads eased a little but are still quite tight for April-May; on Feb. 9 they were trading at a US$2 backwardation. While the decline in global exchange stocks continues and uncertainty over production cuts remains, there is limited downside to copper prices, particularly since small U.S. funds are not over-long. In the short term, we expect copper 3-month prices to find support in the region of US$1,760-1,780 per tonne, and if US$1,800-per-tonne resistance is broken, the next target will be US$1,820.

Up to now, copper has not suffered from the same dramatic decline in U.S. semi-fabricated product orders that has affected the aluminum sector. The main reason is copper’s heavy reliance on the construction sector, which, though trending down in terms of activity, is still relatively strong. However, recent data show that mortgage loans have fallen to their second-lowest level in the past 10 years, suggesting that the risk of a sharp contraction in U.S. construction activity is rising.

Meanwhile, there is little agreement among analysts concerning the size of last year’s copper market deficit. The range is from 90,000 tonnes, according to Brook Hunt, to 468,000 tonnes, according to the International Copper Study Group, with CRU International in the middle at 329,000 tonnes. If we assume a 3% growth in production in 2001, then, using the ICSG figures, a fall in global copper demand of 0.5% will still leave the market in balance. Using Brook Hunt’s figures, demand must rise 2.4% this year just to keep the market balanced.

Aluminum prices closed poorly on Feb. 9, re-testing support at US$1,589 per tonne after earlier testing the week’s high at US$1,610. Despite the narrow range, trading was characterized by high volumes as scaled-down consumer buying below US$1,600 per tonne helped to absorb large fund liquidation. In the week ahead, support is expected to hold at US$1,575-1,580 per tonne. We favour another test of the upside at some stage, with initial resistance at US$1,610-1,615 per tonne.

LME stocks of nickel dipped below 9,000 tonnes for the first time since late 1991, but this event proved less than momentous as LME prices fell sharply on Feb. 9 to a 5-week low of US$6,250 per tonne on the back of heavy commodity-trading-advisor fund liquidation. Leading up to the Feb. 9 drop, LME 3-month nickel prices had been trading in an ever-narrower range, culminating in a spread between high and low, on Feb. 8, of just US$110 per tonne. In contrast, the price range at the end of the report period widened out to US$500 per tonne as LME 3-month prices fell. Some consolidation is now due in nickel, but a test of the low for the year so far of US$6,100 per tonne looks likely in the short term.

We continue to believe there is potential for a nickel price spike, but this is heavily dependent on a pick-up in demand and strength elsewhere in the base metals complex.

Zinc prices hit a low of US$1,018 per tonne on Feb. 6, their lowest since June 1999. The immediate cause of the slump was an unexpected and uprecedentedly large 43,000-tonne increase in LME stocks, reported earlier in the day. However, prices had been on a downtrend since the previous Wednesday, and the main seller of zinc during this period was also the same trader that delivered the physical metal a few days later. In the short term, zinc prices will have to struggle to rise above US$1,040-1,050 per tonne, where there is likely to be solid resistance (both 10- and 30-day moving averages). Another test of US$1,020 per tonne cannot be ruled out.

Perhaps the market should not have been too surprised at the increase in stocks. Estimates of the market surplus last year range from 64,000 tonnes, according to the International Lead Zinc Study Group, to 97,000 tonnes, reported by Brook Hunt. But during 2000, LME stocks fell by 46,000 tonnes, implying a build-up in off-warrant stocks, over the corresponding period, of 100,000-140,000 tonnes.

Reports from China suggest there is a possible lull in that country’s zinc exports, following last year’s record annual level of 560,000 tonnes. The reasons cited are lower U.S. demand, falling international prices and better domestic demand. Exports certainly tailed off late last year, owing to smelter maintenance and low prices. What’s more, after recent investments in galvanized sheet capacity, China’s own zinc demand is likely to grow rapidly over the next few years. On the other hand, Chinese smelting capacity is also set to rise substantially. We therefore expect growth in Chinese zinc production to match that of consumption, with exports remaining close to last year’s levels for some time.

Gold prices fixed at a 16-month low of US$258.75 per oz. on the afternoon of Feb. 9 as the market continued to ignore the potential for short-covering arising from a large net short-speculative position (53,000 lots) on Comex. Producer hedge selling and a stronger U.S. dollar were the key factors pushing gold lower.

In the short term, gold prices are expected to remain under pressure, with further lows likely. The large fund short position remains a concern and presents a significant upside risk. However, short-covering is only likely to be triggered if prices break above the recent upside resistance level of US$268 per oz., which we think unlikely.

The catalyst for the recent move lower was announcements by two major gold producers concerning their activity in forward sales, both of which were interpreted bearishly by the market. News that AngloGold is to continue hedging forward half of its production actually represents little change to an already-established policy and is unlikely to result in any extra gold sales by the company. However, the announcement is viewed as highly symbolic since Anglo was one of the group of gold companies that last year said it would place a moratorium on fresh hedging activity as a mark of its faith in higher future gold prices.

Of more material impact is Harmony Gold Mining’s purchase of 1 million oz. of put options in the US$250-260-per-oz. region. Harmony has traditionally been an anti-hedger, but it had to purchase the puts as part of its financing deal to buy two of AngloGold’s mines in South Africa. The consensus in the gold industry is that consolidation is far from over and that more company tie-ups are required. The financing for this consolidation is likely to be tied to forward sales of gold, and this is almost certain to exert downward pressure on prices.

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