Base metal prices on the London Metal Exchange (LME) were fairly stable during the report period March 5-9, the only exceptions being copper, which saw a gain in the weekly average cash price of 2.4%, and nickel, which fell 2.4%. Copper’s gain was due to options-related short-covering early in the week, but prices fell back quickly, following two large increases in LME stocks on March 8 and March 9. Nickel prices continued their steady downtrend, but a recovery on March 9 suggests that the crucial US$6,000-per-tonne level should hold for the time being.
One interesting facet of recent trading has been the erosion of nearby spread tightness in aluminum, copper, zinc and, to a lesser extent, nickel. At presstime (March 12), the first three were all back in fairly substantial nearby contangos, though nickel remains in backwardation (but much less so than a month ago), as does lead. Lead and nickel coincidentally are the only LME metals not to register sharp increases in LME stocks over the past month. The recent increase in LME stocks of copper appears to have been engineered in response to a tightening in spreads. LME stocks still remain substantially below last year’s levels for all the major base metals, but the speed with which large deliveries have been made in recent weeks is a warning that current LME inventory levels may not be telling the whole story and that substantial off-warrant stocks exist in most metals at present. This suggests three things: the peak in seasonal demand over the next few months can comfortably be met from available stocks; the easier tone to the physical market will persist; and there will likely be only limited fundamentally inspired upward pressure on prices for the next few months.
There was marked volatility in copper prices during the report period, though ultimately the LME 3-month price ended at the same level at which it had started the week. Fund short-covering in the run-up to the March 7 options declaration pushed prices to a peak of US$1,844 per tonne, the highest since late December 2000, early in the week. However, tighter spreads then persuaded a large holder of off-warrant metal to carry through on a long-rumoured delivery of copper into LME warehouses, ending the tightness and sending prices back to US$1,800 per tonne.
By March 9, LME stocks had climbed 51,300 tonnes from week-ago levels, and a further 3,775 tonnes had been delivered by presstime. This material is believed to have originated in Chile, under the control of a major merchant, and has been due for delivery for some time now.
Despite the increase, LME stocks are still relatively low (at the same time last year, they exceeded 835,000 tonnes), while cancelled warrants are high, at 45,000 tonnes — all of which suggests that the recent increase may even soon be reversed.
This is traditionally the busiest time of year for copper demand, but, owing to the slowdown in the U.S. economy and a decrease in Chinese buying, the physical market is fairly quiet at present and premiums static. The International Copper Study Group (ICSG) reports that the copper market moved into a large surplus of 149,000 tonnes in December 2000, partly as a result of seasonal factors but also because of a slowdown in Chinese copper imports. These have yet to pick up, and the current Shanghai/LME price arbitrage, at US$313 per tonne, is too low to encourage buying.
For the time being, the easier tone to the physical market is persisting, and it is difficult to see any compelling reason for prices to break out of the recent US$1,740-to-1,840-per-tonne range for the LME 3-month price. We are therefore sticking with an average cash price forecast for this year of US$2,050 per tonne (the average for the year to date is US$1,779 per tonne). However, we will need to see evidence of much better fundamentals in the next two months if this is not to be downgraded.
LME 3-month prices for aluminum shed almost US$60 per tonne, as a failure to pierce resistance at US$1,600 per tonne gave way to disappointed long liquidation, dragging the LME 3-month quote down to a 2-week low of US$1,538 per tonne on March 9, before a muted recovery saw a rebound to US$1,550 per tonne. Consumer buying, notable in February on dips to US$1,570-1,580 per tonne, has been absent this time around despite the recent strength of the euro and better-than- expected U.S. car sales in February (17.5 million on an annual basis — much lower than the 18.9 million registered in February 2000 but well ahead of the 16-million-to-16.5-million level auto companies are themselves forecasting for 2001).
Nor did the downtrend in aluminum stocks help support prices, since there is a perception that there is significant off-warrant material, particularly in the U.S., where spot premiums remain depressed despite the capacity closures that have taken place recently. Meanwhile, aluminum spreads have continued to ease, with the cash-to-3-month price moving out to a US$20-per-tonne contango, compared with a US$3-per-tonne contango in the previous week. In the short term, initial support will be at US$1,530-1,540 per tonne for the LME 3-month price, with strong resistance likely at US$1,560-1,570 per tonne.
Rumours abound about the next production cut in the northwestern U.S., where only 340,000 tonnes of 1.65 million tonnes of smelter capacity is still in operation. Speculation that Alcoa is planning to cut its workforce by 25% at the 228,000-tonne-per-year Wenatchee smelter, in Washington state, has given rise to fears that it may be the next smelter in the region to close. The plant is currently operating at 105,000 tonnes per year.
Meanwhile, in India, a strike at the 100,000-tonne-per-year smelter of Balco (Bharat Aluminium Co.) could result in a significant amount of lost output this year. Potlines were reported to be freezing over as the strike entered its seventh day on March 9. The plant’s general manager says that even without further deterioration, a restart could take three to six months. In 1998, when potlines froze at the 218,000-tonne-per-year smelter in India’s Orissa state, owner National Aluminium Co. (Nalco) lost almost 60,000 tonnes of production. Moreover, it took 15 months to get the smelter operating normally again. For the time being, we remain comfortable with our average aluminum cash price forecast for this year of US$1,650 per tonne (the average for the year so far is US$1,602) and continue to believe there is significant upside risk to prices.
Nickel continues to display signs of resilience as the LME 3-month price managed a recovery on March 9 after briefly breaking below the US$6,000-tonne support level earlier on. However, nickel prices remain on a clear downward trend despite further falls in inventory that shaved 366 tonnes off LME stock levels in the report period. One factor that could help slow the trend is a tightening in nearby spreads, which became evident late on March 9.
At present, the nickel market is largely ignoring the activity of the base metals complex as a whole. Indeed, nickel is still forging its own trading pattern and, in doing so, testing ever-lower levels of support. The area around US$6,000 per tonne has come under considerable pressure, despite the moves higher in both the copper and aluminum markets, and look set to give way soon.
As predicted, zinc prices failed to benefit from options-related covering in the run-up to the March 7 declaration. LME 3-month prices broke briefly through US$1,040 per tonne but failed to trigger covering against modest open interest at US$1,050 and US$1,075 per tonne. By the end of the report period, prices were back in the well-worn US$1,020-to-1,040-per-tonne range. As the options date passed, spreads also eased, with the cash-to-3-month price moving from a US$2-per-tonne backwardation to a contango.
It is difficult to find anything positive to say about zinc. Although prices have not fallen back quite as sharply as some other LME base metals, it should be remembered that zinc has been trading in a depressed fashion since September 2000, and so it had less far to fall. In the short term, we see no reason for zinc prices to move much outside the US$1,020-to-1.040-per-tonne range for the LME 3-month price, unless there are significant moves elsewhere in the base metals complex.
Gold lease rates again spiked higher toward the end of the report period, leaving many in the market to wonder exactly what is causing these sharp increases. After testing support at US$260 per oz. earlier in the week, the precious metal’s fortune turned, with prices breaking the US$270-per-oz. level of resistance at one point (albeit in thin volume), before achieving the highest close in London of the year so far.
With the lending market again scrambling for material, lease rates moved up to beyond 5% again on March 9, and a mild sense of panic was detectable in the market. The size of the fund short position on the Comex division of the New York Mercantile Exchange was also cited as posing a risk for prices on the upside as speculative shorts rushed to cover positions.
The source of lease-rate volatility is still a mystery. We have seen nothing in our trading activities to suggest any recent restriction in liquidity by central banks. One possible explanation is that Australian producers are borrowing short-term gold in order to increase their hedge positions as gold prices in their local currency continue to climb (the Australian dollar fell to a record low on March 8, against the U.S. greenback). A further possible explanation is that there has been an increasing tendency for central banks to lend into longer-dated maturities in order to take advantage of generally higher lease rates at the back end of the curve, which may be leaving the front end of the market tighter than usual.
Behind these theories, however, the hard reality for gold prices remains intact: central bank stocks are more than sufficient to satisfy the lending market and will continue to provide the market with the required level of liquidity. At current depletion levels, official stocks will take more than 60 years to be exhausted, and they are sufficient to feed fabricated demand for a decade. Against this fundamental reality, the current price level looks unsustainable.
— The opinions presented are solely the author’s and do not necessarily represent those of the Barclays group.
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