Metals forecast

Metal investors can be forgiven if they feel like popping an extra bottle of Dom Prignon this New Year’s Eve. It’s been a rollicking 12-month ride for metal prices, and the shares of many of the companies tied to them.

But lingering behind the jubilation of the astute investor is a voice of skepticism. Can uranium prices really go any higher? What of record prices for copper, nickel and zinc? Is a major correction imminent?

The Northern Miner spoke with some experts to get their take on what the coming year may hold.

In 2006, the price of gold has increased 14% or roughly US$76 — and that’s after corrections in September and October.

While such gains could cause some to ruminate over a drop, Charles Oliver, senior vice-president and portfolio manager at AGF Funds, part of AGF Management (AGF.B-T), doesn’t think so.

“I’m most enamoured by the yellow metal,” says Oliver, referring to potential gains in metal prices over the coming year.

The AGF Precious Metals Fund, which Oliver co-manages, has risen by 82% over the last year. Its three top holdings, listed by portfolio weighting, are: Kinross Gold (K-T, KGC-N), Inmet Mining (IMN-T, IEMMF-O) and Aurelian Resources (ARU-V, AUREF-O).

The fund manages a total of $440 million in assets and currently has a five-star rating on globefund.com, an investor website.

Oliver opines that with the U.S. Federal Reserve in a flat-to-lowering mode on interest rates, “it doesn’t pay to own the U.S. dollar.” Instead, he says: “Start to look at a bit of gold — it’s one of the most attractive options.”

There is also a growing sense that China will add to the quantity of gold it holds in reserves. Currently, gold makes up just 1.3% of the Asian giant’s reserve holdings. That compares with the roughly 14% that European Union countries must possess and roughly 75% that the U.S. holds.

And then there’s that “unnamed Chinese official” who occasionally surfaces to say the amount of gold in the country’s reserves could rise to as much as 5%.

Officially, the chief of the Central Bank of China will only say that the country is looking at alternatives to the U.S. dollars that currently make up the bulk of its reserves.

“Like all other major currencies, it would probably be that they need to add gold over time,” Oliver says. “I have a personal expectation that they will, though it’s still not been clearly communicated to the market.”

As for ongoing troubles in the Middle East, Oliver says that while a blow-up there would jolt the price of gold, geopolitical disruptions generally cause gold to rise in the short term but then subside to pre-incident levels.

Political destabilization, therefore, is not a key metric in his bullish forecast, which puts the gold price in the US$1,000-per-oz. range within two to four years.

Star metals

While Patricia Mohr, vice-president of industry and commodity market research at Bank of Nova Scotia (BNS-T), also says gold prices have room to rise in the coming year, she looks to uranium, zinc, and silver as the star metals for 2007.

Despite uranium’s continuing big gains — the price of the metal has increased roughly 45% to around US$62 per lb. from roughly US$43 per lb. at the beginning of the year — Mohr sees further growth in the new year. She expects the price will rise to around US$70 per lb. by the end of 2007.

“There’s tremendous expansion around the world in nuclear power,” she says, noting much of the impetus is coming from the realization that nuclear reactors don’t produce greenhouse gases. “There’s interest in new facilities, not only in China, but also in India, Eastern Europe and the U.S.”

Mohr says while mine supplies are increasing, they are doing so slowly, and notes that yellowcake production was actually down for the first half of this year.

A production delay caused by flooding at Cameco’s (CCO-T, CCJ-N) Cigar Lake uranium project in Saskatchewan — which was slated to provide the first large incremental supply of uranium to the market early next year — has also exacerbated the tightness of supply.

While zinc prices don’t share the same underlying fundamentals of uranium, Mohr says the metal will at least hold on to the massive gains it made this year.

The huge deficit between consumption and production of refined metals — as reflected in the dramatic drop in zinc inventories — will ensure prices don’t plunge anytime soon.

Zinc stockpiles, monitored by the London Metal Exchange (LME), plunged nearly 80% in the past year, sending them to their lowest levels since 1991. The drop caused zinc to reach record prices north of US$2 per lb.

“There’s not much new mine supply for zinc until the second half of next year, so it will take a while to ramp up,” Mohr says. “It won’t be until late next year or early 2008 before we see an incremental supply increase.”

The last metal in the limelight for 2007, in Mohr’s estimation, is silver.

Buoying her confidence are new applications for the metal — notably in medicine and electronics — which more than offset the loss of demand from the photography industry, she says.

Silver is used in film manufacturing, but the advent and popularity of digital photography has decimated that particular market.

Mohr says the declining U.S. dollar will also help boost silver prices, as the metal is tied to gold as an alternative to cash currency.

She notes that silver has actually outperformed gold for the last two years. In 2004, silver gained 14% compared with gold’s 6% gain; in 2005, it gained 30% compared with gold’s 20%; and so far this year, silver is up 39% compared with gold’s 14% gain.

The dogs

So much for the stars of 2007; what of the dogs? With so many metals burning up price charts, surely some are due to come off in the coming year?

Oliver and Mohr both believe in the continued strength of metal prices going forward, but see slight corrections in the copper price.

“We think global growth in 2007 will be slower than in recent years, partly because of a slowdown in U.S. housing activity and partly because of somewhat lower consumer spending in the U.S.,” Mohr says. “Also, the pace of economic expansion in China will probably be a little slower than in recent years.”

This year will be the fourth consecutive year that China’s economy will grow by more than 10%. While remarkable, both Mohr and Oliver say such a pace is not sustainable in the long term.

Mohr anticipates a drop in economic growth to 9.8% from 10.5%, and says such a decrease, while not major, could have a psychological impact on demand.

“Business investment gains are slowing because the Chinese authorities are trying to cool down the economy to prevent overheating,” she says, explaining that by “cooling down” the economy she doesn’t mean the Chinese will fight rising inflation by raising interest rates. Rather, she says, they are targeting excessive investment in some sectors — like steel and real estate — so that a more sustainable pace prevails. Only then can a buildup in excessive capacity in certain industries be prevented.

Mohr projects US$2.50 per lb. copper for the coming year. And while lower than this year’s average, which will come in around US$3.06 per lb., she emphasizes that the lower mark is still an extraordinary price for copper.

Oliver adds another note of caution on copper.

“One problem is, not everyone who wants to use copper or nickel is able to get it,” he says. “So you are seeing a natural demand destruction occur, because some businesses can’t get it or it’s not economic to run their business in this price range. That will act as a natural check on prices.”

But Oliver, like Mohr, insists he’s no copper bear. He argues against those who predict a drastic decline in copper prices — based, they say, on the fact that supplies have become sufficient and prices can’t continue to be supported at current levels.

“I’m not expecting a major correction to long-term prices,” Oliver says.
“I don’t expect to see ninety-five-cent copper for many years.”

Against the copper bears, Oliver cautions against putting stock in reports that cite copper inventory growths of 100% over a short-term period. He says such figures can be misleading if they don’t take into account the larger trend, which has seen copper inventories decrease to 20% of what they were five years ago.

“If you had ten cars and then went down to just one, and someone gave you another car, sure you’d have a 100% increase, but you’d still only have 2 cars compared to the 10 you once had,” he says.