(The following excerpt from The Commodity Refiner, a monthly publication of Barclays Capital Research, provides an overview of current nickel and zinc markets.)
There are reasons to argue that nickel prices deserve to be strong, but not excessively high.
The potential for new price spikes was certainly removed by the announcement from
The announcement that European stainless steel producer Arcelor is reducing melt production (by 50,000 tonnes per month) during a 3-month period over the summer is the first evidence of response to underlying demand weakness. The company pointed to high stainless steel inventories (as we have been fearing), negative effects on demand from SARS, and adverse currency moves. In addition, ThyssenKrupp confirmed it would be accelerating its fourth-quarter maintenance plans and would cut production by approximately 120,000 tonnes per year. We estimate these curtailments in stainless steel production could result in a 10,000-tonne-per-year reduction in nickel demand.
However, this is not the full story for nickel. For one, after more than a month of strike action at Inco (and an almost immediate declaration of force majeure), there is still no evidence the strike will end any time soon. We estimate the strike is reducing availability by 2,000 tonnes per week, and the strike has continued longer than the operation’s previous, 1-month strike in 1997. Any signs that the strike is nearing an end are, however, likely to withdraw some speculative support to the price.
Second, there is still strong demand growth of refined nickel in China. The latest trade statistics, for May, show that imports are now more than double the monthly import volumes of last year, as nickel production facilities in China are limited and as capacity of stainless steel is being expanded aggressively. If this trend continues, the Western World market could return to balanced market conditions quickly.
In short, while current nickel market conditions are now considerably looser, the outlook for the next few years has strengthened. As a result, we now expect extensive supply deficits in 2004 and 2005 and have therefore revised our 2005 price forecast higher by 10% to US$8,150 per tonne. We have also made the assumptions that Norilsk Nickel has more metal stockpiled in Russia for release at times of extreme market tightness, with an estimated 10,000 tonnes per year likely to be released over the next couple of years. This would again work against sharp price spikes and be in line with Norilsk Nickel’s aim to stabilize the market.
As a result of the reductions in European production rates at stainless steel mills, the rise in stainless steel prices has stabilized and steel prices overall are under pressure. London-based CRU International reported that its global steel price index has fallen by about 8% from the end of the first quarter to June. Stainless steel prices are unlikely to resume their upward trend in the near term with a seasonally quiet third quarter ahead.
The positive relationship between London Metal Exchange (LME) futures open interest data for nickel and prices remains strong. The rising trends of both for most of this year suggest prices have been driven higher by fresh (long) buying. By the end of the second quarter, however, these trends were sharply reversed after fundamental developments suggested market tightness would significantly ease over the near term. As a result, a large number of long positions have been liquidated, which pushed prices about 14% lower.
The level of trading volumes in nickel has been increasing steadily since February this year, and reached 364,000 contracts by May. This is growth of 53%, year over year, and has been accompanied by a 23% rise in the price of nickel. The steep backwardation eased somewhat following the announcement that Norilsk Nickel is making material available to the market, which has helped ease immediate market tightness considerably.
However, strike action at Inco coupled with strong import demand from China is likely to keep the forward curve in backwardation for the foreseeable future. After having balanced between contango and backwardation throughout the start of this year, the nearby spread (cash to three months) has experienced a period of extended tightness during the second quarter.
While physical spot premiums in the U.S. have been rising in light of the Inco strike and robust stainless steel production in the region, European nickel premiums have been largely stable, as large-scale buyers have adopted a more hesitant attitude in the face of high price volatility and possible price erosion ahead.
LME nickel inventory movements have continued to be volatile, though the total level remains low by historical standards (at about 22,000 tonnes).
Sharp increases in cancelled warrants during the first part of the year were followed by periods of inventory drawdowns and price strength. Although cancelled warrants are now relatively lower, another 2,000 tonnes (or about 10% of the remaining LME stockpile) are still awaiting outward shipment. This is likely to keep the inventory level low overall for now.
According to the latest statistics from the International Nickel Study Group (INSG), producer inventories had risen close to 97,600 tonnes by the end of April. The reported producer stockpile was last above 100,000 tonnes, albeit temporarily, in mid-2001. However, the longer-term downward trend in the total reported nickel stockpile remains in place since the peak in 1994.
Owing to overall strong demand for refined mickel from the stainless steel industry, and subsequent low inventory levels, the stock-to-consumption ratio remains low by historical standards — at an estimated 6.5 weeks in the second quarter. However, because of a slight pickup in inventories during the second quarter, this is marginally above the first-quarter figure at 63 weeks, which is the lowest on record.
While global refined nickel consumption is now growing at a somewhat slower pace, Chinese imports remain strong. The latest official statistics show net imports of 5,400 tonnes in May, which is almost double the average monthly import figure of last year. As a result, China has imported 29,100 tonnes for the period Janurary-to-May, compared with our expectations of 50,000 tonnes for the full year. If this rate of imports continues, the global nickel market could return to balanced conditions this year, according to our assumptions, despite the release of Norilsk Nickel’s consignment stockpile, a reduction of demand from European stainless steel mills, and an end to the Inco strike after a month.
Statistics from the INSG show the global nickel market was in a modest 6,300-tonne surplus in the first four months of the year (and a 500-tonne deficit in April alone). In April, global refined output was a modest 1.4% higher (at 101,300 tonnes), year over year, whereas growth in global consumption has slowed (+2.8%, year over year, and -3%, month over month, in April). Mine output rose to 104,000 tonnes in April, up by 1.4%, year over year, but was 5.1% lower from the previous month. The lack of new production projects over the next few years remains a key feature in the nickel market and is likely to cause deficit market conditions in 2004 and 2005.
Zinc
If economic activity were to surprise on the upside, then zinc could be one of the base metals likely to benefit the most, as demand for it has the highest correlation with industrial production among
the base metals. The fact that zinc prices remain close to all-time lows and that a significant amount of zinc capacity has now been removed from the market could prove dynamic in such a scenario.
So far, the main impact from this year’s extensive capacity closures, of approximately 400,000 tonnes per year, has been on European physical premiums. Lately, the 39,000-tonne-per-year Titov Veles smelter in the former Yugoslav republic of Macedonia has closed, while output at the 177,000-tonne-per-year Porto Vesme continues to operate at only 70% of full capacity because of high power costs.
A key threat to the outlook for zinc is any increased availability of raw material feed, which would allow improved operating rates at Chinese smelters. Smelting capacity utilization in the region is at a maximum of only 80%. Constrained refined production and strong domestic demand in China are evident from customs trade statistics, which in May were encouraging for the Western World balance, as current export volumes are only a third of what they were a year ago.
Is the unresponsiveness in zinc prices a sign that the zinc market is caught in a vicious circle? Smelting closures in response to the low price environment are freeing up concentrates for increased production elsewhere (probably China), while any improvements in the LME price are likely to increase Chinese exports to the Western World, which would put pressure on the LME price. Already, we have seen a recent pick-up in fund activity in the hope of an improved fundamental outlook, only to be met by Chinese selling at the higher end of the range. This vicious circle could be breached, at least for a period, by improved economic conditions in conjunction with further U.S. dollar weakness.
In fact, demand improvements have been evident. Despite an ailing European economy and news that steel producers are reducing output over the summer, Spanish construction (including infrastructure) is booming and domestic auto production is strong. In the U.S., reports suggest that major steel mills have been taking more zinc than normal over the past month, which would be in line with improvements in economic data in the manufacturing sector.
In addition, because of recent currency moves (euro strength), imported galvanized sheet has become increasingly competitive in Europe, while the Chinese market has slowed (at least for now), which could displace material to Europe. In the absence of a pick-up in underlying growth, zinc smelters are likely to feel the impact.
Data for LME open interest and prices have continued to diverge in recent months; they suggest that, early in the second quarter, prices were pushed lower by fresh short selling, while the combination of a rising price trend and falling open interest suggests that a lot of those shorts have been covered. Clearly, high inventory levels and an uncertain macro outlook are still discouraging fresh buying. The general uptrend in volumes that has been in place in the zinc market for much of the past year continued in May, with the level of contracts traded increasing by 3%, month over month, and 25%, year over year, to 857,000 contracts. This confirmed zinc as the third most actively traded metal on the LME behind aluminum and copper.
Zinc prices for all future traded dates remain marginally above levels traded over the past couple of months. The shape is also largely unchanged, with the contango reflecting good availability of the metal over the coming 27 months.
The zinc concentrates market remains tight overall, with spot treatment charges in both Europe and Asia remaining low. However, spot treatment charges in main Chinese ports are at US$130 per tonne, and the freight differential has resulted in traders accepting slightly higher treatment charges in Europe too. Annual contract negotiations are practically complete, with European smelters having settled similar terms with both European and Asian miners. European physical premiums have continued to strengthen, reflecting the combination of smelter closures earlier in the year and high operating rates at steel mills. However, U.S. and Asian spot premiums have eased in recent times, indicating sluggish demand and an imbalance between supply and demand.
Recent trends in LME inventory movements have continued (also mirrored in data for physical premiums), with European stockpiles still falling and Asian and U.S. stockpiles continuing their overall upward trends. European drawdowns are related to production curtailments in the region, while changes in the other regions reflect the soft demand environment and ample supplies. The net result of these diverging trends in LME inventories was a rise of 48,000 tonnes during the first half of the year. In contrast to most other base metals, LME zinc inventories remain in a long-term upward trend, which is discouraging for the outlook.
Total reported inventories of zinc stood at an estimated 1.1 million tonnes at the end of the second quarter, which is the highest since the end of 1995. The International Lead and Zinc Study Group (ILZSG) reports that producer and consumer stocks have risen to about 320,000 tonnes and 114,000 tonnes, respectively. Because of rising inventories in all categories (LME, producer, consumer and merchant), the total reported zinc stockpile now represents 8.4 weeks of the current rate of Western World consumption. In fact, this is the highest figure since 1996, reflecting continued poor market conditions for zinc, even though the global supply and demand balance has improved.
Chinese net exports of zinc were sharply lower again in May, at 10,000 tonnes, well below the monthly average of 33,700 tonnes of a year earlier. In the first five months of this year, net exports were 90,000 tonnes, which is more than half of the export volume to the Western World in the same period a year earlier. If current low export volumes (derived from low LME prices) are maintained, then the Western market could move into a meaningful deficit this year.
ILZSG statistics for April show a reduction in the large global refined zinc surplus of last year — the aggregate surplus in the first four months of this year was 26,000 tonnes, compared with 175,900 tonnes in the same period last year. Consumption has picked up strongly compared with last year (+10% in April), albeit slightly below the previous month’s level (-2%). Mine output remains subdued overall, which is keeping refined output growth restricted (+0.2% year over year).
— Kevin Norrish is head of commodities research/energy and Ingrid Sternby is the base metals analyst for Barclays Capital Research. The opinions presented are the authors’ 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 the authors at kevin.norrish@barcap.com and ingrid.sternby@barcap.com
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