Nickel’s climb continues

Another quiet week for base metals saw zinc and nickel move to centre stage as aluminum and copper prices continued to trade within their recent ranges.

During the report period Aug. 14-18, zinc gained dramatic momentum as short-covering against September options positions drove prices to their highest level since January, only to fall back again. Meanwhile, nickel prices continued their steady climb, and, with concerns about future supply and falling stocks coming once again to the fore, further gains look likely.

Despite their lack of price movement, London Metal Exchange (LME) stocks for both aluminum and copper continued to fall (down 12,150 and 9,475 tonnes, respectively), hardening suspicions that material is being delivered into off-warrant warehouses. Indeed, such has been the extent of speculation surrounding this issue that one new internet trading company was moved to deny it was building up physical inventory in advance of its launch.

An analysis of changes in exchange inventory compared with estimates of each metal’s global market balance during the first half of the year shows that, apart from zinc, there was little net build-up in off-warrant stocks for any LME metals during the first half of the year and that aluminum experienced a sizable fall. Although there is evidence for off-warrant stock increases in certain metals in parts of the world, it appears that, on a global basis, declines in other areas (principally, we suspect, Europe) have offset increases elsewhere.

Copper prices continued to trade, with little direction, in the US$1,860-1,900-per-tonne range. Technical indicators are neutral, and with LME stock falls slowing (the daily average during the report period was just 1,895 tonnes, compared with an average of 3,650 tonnes since the end of July), upside in days ahead looks limited.

China’s imports of refined copper rose 55% in the first seven months of the year to reach 418,000 tonnes, according to the China Metals Newsletter. Imports in July reached 80,000 tonnes but are expected to fall sharply to 30,000 tonnes per month (only half the monthly average for the year so far) for the rest of the year. The expected drop is a reflection of the fact that arbitrage opportunities between the LME and the Shanghai Futures Exchange have been eroded by declining local copper prices.

We estimate the build-up in Chinese copper stocks so far this year to be 100,000 tonnes, about 30,000 tonnes of which are visible in Shanghai Futures Exchange warehouses, the rest being stored off-warrant. We also believe that there has been a build-up of about 50,000 tonnes in off-warrant stocks. However, the net global change in off-warrant stocks in the first half of this year (that is, the amount by which the fall in total exchange stocks has exceeded the global market deficit) is only 12,000 tonnes.

There must have been significant declines in off-warrant stocks elsewhere (of around 140,000 tonnes, most probably in Europe) in order to offset the build-up in China and the U.S. The fall in reported stocks so far this year has been a reasonably good guide to the underlying market balance, and even if, as we expect, the market moves back into surplus over the remainder of the year, visible stocks could continue to fall if European consumers decide to re-stock.

Aluminum‘s fourth consecutive day of stronger closes on Aug. 15 took the LME 3-month price to a high of US$1,561 per tonne. But the momentum was not sustained, and prices once again drifted back to continue trading in the lower part of the US$1,540-to-$1,560-per-tonne range. LME stocks continue to fall at an unusually rapid rate, and physical premiums in most regions remain firm. However, this is not yet being translated into higher prices, and there is still the possibility that the chart gap at US$1,515-1,525 per tonne needs to be filled.

Aluminum prices are extremely low in relation to current LME stock levels. One factor keeping prices low is the suspicion that LME stock withdrawals are heading for off-warrant stocks. Analysis shows, however, that the first-half decline in aluminum exchange inventory was much less than the estimated market balance, suggesting there has been a significant fall in off-warrant stocks of around 180,000 tonnes so far this year.

A large part of this is accounted for by the 113,000-tonne fall in International Primary Aluminium Institute producer stocks in the first half of the year, but if the 27,000-tonne first-half increase in Japanese port stocks is factored into the equation, then other off-warrant stocks, presumably those held by consumers and non-reporting merchants, can be said to have fallen by 100,000 tonnes.

The conclusion to be drawn from this analysis is that unreported stocks of aluminum are currently less than they were at the start of the year. The big decline in off-warrant stocks almost certainly came early in the year, when off-warrant material was delivered into an LME squeeze. However, because of the strength of demand, off-warrant stocks have still not been restored to their previous levels. With profitable financing of off-warrant stocks via the contango still possible (especially if low rents can be negotiated), there appears to be plenty of scope for off-warrant stocks to continue to be rebuilt over the next few months and for reported stock levels to fall.

Nickel prices continued to climb steadily, supported by falling stocks, the re-emergence of supply concerns, and a widening in the cash-to-3-months backwardation. Prices have now regained almost US$500 from their early August lows, and the LME 3-month price looks likely to test the US$8,000-per-tonne level.

The market is becoming a little more nervous regarding the possibility of a prolonged strike at Falconbridge’s Sudbury, Ont., operations, since there is no renewal of negotiations planned and the unions appear to be in a hostile mood. These nerves were only partially soothed by the announcement that Falconbridge has restarted its nickel smelter using supervisory staff and that it will soon be operating at about 50-60% of capacity (2,700-3,200 tonnes per month). The major now says it will not have to declare force majeure on nickel deliveries until October.

The other major supply-side concern for the market is Russian shipments. Russian exports in the first half of the year rose strongly, climbing by 31% to 120,400 tonnes. Second-half shipments from Russia are normally higher than those in the first half. However, reports indicate that this year’s second-half exports could be 30,000 tonnes lower year-on-year, putting them at 121,000 tonnes, only marginally higher than first-half levels.

Meanwhile, LME stocks resumed their downtrend, falling by 1,464 tonnes. The resumption of the downtrend came as a surprise to many market participants who had expected the LME stock increases in early August to be sustained because of slower seasonal demand. A shortage of prompt material has once again bid up the cash price, resulting in a widening of the cash-to-3-months backwardation to more than US$200 per tonne. Nearby tightness is underlined by the US$70 backwardation that exists between cash and September prices.

Volatility in the zinc market eased after zinc prices gained US$60 in the first two trading days of the report period. The move took the LME 3-month price to US$1,214 per tonne — its highest level since January. However, gains were soon capped by Chinese producer selling, and prices fell back to trade in the US$1,180-1,190-per-tonne range.

With prices likely to trend toward the large number of September options positions around the US$1,175-per-tonne level, volatility in zinc prices should ease over the next few weeks. On the other hand, the low level of industry stocks and high premiums for prompt material, particularly in Europe, will likely keep many market participants nervous.

The gold spot price surged higher on fund short-covering in the middle of the report period, reaching a peak of US$279.65 per oz., but was unable to hang on to its gains. The price fell back to just above US$275 per oz. in late London trading, undermined by producer selling and a stronger U.S. dollar.

Prior to the rally, speculative short positions on the Comex division of the New York Mercantile Exchange had risen to 77.8 tonnes (to Aug. 8) — the highest level since May. Therefore, the short-covering rally should have come as no great surprise. With the bulk of short-covering now over, the prospects are for a drift downward in prices.

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