Metals markets stay focused on fundamentals

There has been a clear split in metals price movements during the report period May 6-10 as copper and nickel held on to higher levels, while aluminum and zinc fell sharply. This is evidence of a greater tendency in current markets to follow their own fundamentals rather than an over-optimistic and generic macro-economic growth scenario, as was the case for most of the first quarter.

However, the return to price movements that reflect prevailing fundamentals does not necessarily mark a return to a downtrend in the base metals complex. Nickel, for example, remains near its highest level in a year, and the fall in copper’s inventory levels has strengthened the view that, during the second quarter, US$1,600 per tonne should act as a benchmark trading area. The trading environment also suggests that prices should be able to avoid reversing much of the progress that took place earlier this year. True, consumer activity has been slow to take off, but all recent indicators suggest that the undercurrent of recovery in the U.S. remains constant. Although this is not yet sufficient to break ground on the upside, it at least points to greater downside protection going forward.

After having traded predominantly on the steady flow of U.S. economic data, metals markets are returning to fundamental facts by way of a pricing mechanism. The Producers Price Index, out of the U.S., would seem to suggest that the recovery remains solid. Greater consideration is now being given to basic figures of demand, supply and inventories. The large jump in aluminum and zinc stocks is a reminder that, expected demand improvements notwithstanding, the inventory buildup that occurred during the downturn will be a stubborn obstacle to higher prices without a significant ramp-up in demand. If the rest of the complex also returns to trading on its fundamentals, indications are that attempts to climb higher may be similarly handicapped.

Copper enjoyed a stable week and ignored the weakness in aluminum. We ascribe copper’s relative strength to recent inventory declines on the London Metal Exchange and to market expectations that Chinese activity will deliver additional stock reductions. The consensus is that 200,000 tonnes of copper will be shipped to China over the next few months. Much of this is factored into current prices, and upside risk remains limited. The net effect is to reinforce support below US$1,600 per tonne.

Aluminum‘s failure to break ground above US$1,385 per tonne is not surprising, and the recent price weakness reflects the extent to which prices have not reflected all aspects of the market’s fundamentals. With stocks up nearly 18,000 tonnes during the report period, the supply-side factors provide a clear reminder that until consumer activity moves up a gear, upside price risks should be moderate. We expect moves towards US$1,360 per tonne to attract buying, with US$1,385 per tonne providing resistance.

Tighter spreads in the cash-to-3-month contract provided adequate support for nickel prices after they dipped briefly below US$6,800 per tonne. The close on May 10 above US$7,000 per tonne provides additional technical support. Stocks have already begun to climb (474 tonnes during the week under review). However, if nickel returns to a backwardated market, further material could be delivered back into warehouses. This would be in line with our view that significant gains above US$7,200 per tonne would be difficult, and we still expect resistance here to cap any gains.

Zinc more than fulfilled our near-term price expectations by falling, on May 10, below US$800 per tonne. Further deterioration down to US$790 per tonne reflected another week of large stock increases (plus 21,725 tonnes) and the release of market balance figures by the International Lead and Zinc Study Group, which predicts a 2002 surplus of 500,000 tonnes. With prices now below US$800 per tonne, we expect a period of depressed trading conditions in zinc rather than a sudden bounce and quick return to the US$820-to-$840-per-tonne area. Buying interest could provide support.

A quiet end to the week in gold left prices in the US$310-312-per-oz. range after avoiding a break below US$307 per oz. earlier in the 5-day period. A tighter borrowing market in silver and higher silver spot prices provided some support, as did foreign-exchange developments. Although the U.S. dollar was able to claw back some of its recent losses, it’s clear that investor confidence in greenback-denominated assets is still wanting — this, despite a strong increase in productivity data and a weaker-than-expected Producers Price Index for April. However, as long as currency moves continue to suggest a lack of confidence, we expect gold to hold on to current levels. Gold equities continue to perform strongly and underpin bullion prices at current levels though there are signs that this chapter of gold’s bullish story has already been factored in. The Johannesburg Gold Index reached fresh highs, while gold prices shed almost US$5 per oz. in one day. The key factors over the short term will likely be foreign-exchange-related, and this should have an impact on investor confidence in other assets.

With speculative interest in gold still at near record high levels, prices continue to tread a fine balance of risks between fresh buying interest above US$310 per oz. and a sharp retracement on the downside. Over the short term, it seems this will last only as long as the U.S. dollar continues to underperform against the euro. However, once the dollar factors in greater optimism, gold, at its current level, may begin to look overdone. We remain in a gold-friendly environment; the Producers Price Index for April suggests that pressure on the Federal Reserve Board to increase interest rates is limited. Also, gold equities remain strong, and producers continue to air anti-hedging sentiments. Speculative interest has been resilient. Given these factors, we do not expect a severe meltdown in price prospects if and when the greenback regains its poise. However, firmer sentiment in U.S.-dollar-related assets should take some of the wind out of gold’s sails and bring the US$300-per-oz. area nearer into view.

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