Prices struggle under consumer apathy

Uncertainty over the global economic outlook continued to dampen consumer buying interest during the report period Oct. 1-5, resulting in another dull week for base metals markets. Prices continued to trend gradually down, with copper especially hard-hit. The price of the red metal fell 2% from the previous week. Tin, on the other hand, made some modest gains and nickel held steady, thanks to merchant profit-taking which initiated a mini-rally mid-week.

Even if the U.S.-led military campaign is concluded quickly, there is little likelihood consumers will need to begin buying metal anytime soon. Then again, not all of the recent economic data have been poor, and the announcement of better-than-expected car sales in the U.S. might, under other circumstances, have provided a boost for base metals prices. For the time being, the metals market appears set to sit back and watch for signs that monetary easing and increased government spending are having the desired effect on the American and the global economy. However, it will likely be some time before the impact is reflected in metals prices.

Copper prices suffered a 28-month low at just above US$1,400 per tonne and look set to test support at the 1999 lows of around US$1,360-1,370 per tonne. Will that level hold? The London Metal Exchange (LME) 3-month figure bounced from it several times during February to May 1999, suggesting that it should continue to be a good psychological support level. This time around, however, the market outlook is much worse. In 1999, the global economic cycle was turning up again, following the Asian and Russian financial crises, and more than 1 million tonnes of annual copper mine capacity had been cut. Today, the U.S. is in a recession and the rest of the global economy appears poised to join it. Very little mine capacity has yet been cut (owing, in part, to the strength of the U.S. dollar during most of the past year), but we estimate that more than 20% of Western copper production is now unable to cover its cash costs and that almost 40% is struggling to cover full costs. This suggests that production cuts are imminent, and if they are made soon, US$1,360-1,370 per tonne may again prove to be the low. Still, if copper producers resist cutting back, as zinc producers have, it may prove more difficult to pick the trough.

LME copper stocks have now risen 73,000 tonnes since September 11 and are only around 100,000 tonnes below the March 1999 peak of 843,000 tonnes. However, total exchange stocks, at 972,000 tonnes, are only 50,000 tonnes below their 1999 peak of 1 million tonnes. Although Shanghai stocks are lower, at 48,000 tonnes compared with 98,000 tonnes in 1999, Comex stocks are 100,000 tonnes higher at 183,000 tonnes.

Aluminum prices performed poorly, with the LME 3-month figure falling steadily to trade at a new low, in the current cycle, of US$1,311 per tonne on Oct. 5. Small amounts of consumer buying helped slow the price fall. Auto-makers are showing almost no interest at all, despite a sharp fall in forward quotes that has pushed prices forward for 2003-2005 to what now look like bargain levels (between US$1,370 and $1,400 per tonne).

The market is now focused on the deteriorating macroeconomic situation to the extent that any positive demand or supply-side news is more or less ignored. The better-than-expected U.S. auto sales data passed without notices (GM and Ford saw September sales fall 3% and 9.7%, respectively, much less than the 15-20% predicted by analysts).

In the same vein, a strike at BHP Billiton’s 250,000-tonne-per-year Mozal smelter failed to fray any nerves, even though the company admitted that the dispute is resulting in lost output. BHP Billiton is transferring workers from its 500,000-tonne-per-year Hillside plant in South Africa to maintain operations at Mozal. However, unions representing the company’s 8,000 South African workers are considering solidarity action that could put around 750,000 tonnes of production at risk of disruption.

In another disastrous week for the zinc market, a new low was hit in the current cycle of just US$781 per oz. for the LME 3-month price. In real (inflation-adjusted) terms, zinc prices are at their lowest levels since the 1930s, and without production cuts, they will continue ratcheting lower.

The 19,125-tonne increase in LME stocks during the report period testifies to the current excess of supply over demand. LME stocks, at 385,000 tonnes, are still below their highs of recent years, but considerable material is being held outside of LME warehouses as well. Chinese exports have moderated a little in recent months, but production remains high and there are at least 30,000 tonnes of zinc ready to be exported should prices recover to the US$900-per-tonne level. Off-warrant stocks in the West are also high.

In this environment, the last thing that is required is extra production, yet a plethora of recent developments would seem to indicate just that. First, Hudson Bay Mining & Smelting announced the early completion of a 15% increase in zinc production capacity, boosting annual output to 114,000 tonnes. Then Brazil’s Cia Mineira de Metais said it was bringing on-stream 50,000 tonnes per year of new capacity. Finally, Sumitomo of Japan said it had raised by 6% its zinc production forecast to 61,400 tonnes for October 2001-March 2002, compared with the year-earlier period. Increases by other Japanese producers are expected to raise output by 3.3% over the same period.

Nickel prices bucked the general trend in base metals, holding steady in the previous week’s trading range of between US$4,800 and US$5,000 per tonne before spiking sharply above US$5,000 per tonne on Oct. 4. However, the rally proved short-lived and soon dropped back into their previous range. The main factor behind the increase was the buy-back of an in-the-money hedge position by a major nickel trader, and, once completed, there was little to sustain it. A rebound on Oct. 5 from the US$4,800-per-tonne level suggests that, in the short term, this should continue to act as the support level for the LME 3-month price.

There was further evidence that Russia is failing to make good on its promise to reduce exports to the West. Exports during the January-to-August period reached 115,400 tonnes, only 4,200 tonnes below last year’s levels, according to the State Customs Committee. Earlier in the year, Noril’sk announced it would cut exports by around 20,000 tonnes from last year’s levels. On the other hand, Ufaleynickel, which normally produces around 12,000 tonnes annually, says it will be cutting output by half, and so Russian exports for the remainder of 2001 may fall after all. The producer said the cut is necessary because of low nickel prices and an increase in freight costs, which have risen sharply since August, when a distinction between domestic and export freight rates was abolished.

Gold prices picked up toward the end of the report period, as book-squaring ahead of a long weekend provided some gentle upward momentum. Earlier in the week, prices had tested the downside, with good levels of spot buying providing solid support at around US$288 per oz. Gold’s performance over the past week or so might be termed something of a disappointment given its inability to break above the US$294-per-oz. level. However, prices have now remained at or around US$290 per oz. for several weeks — their best performance since the producer-hedging announcement spike of early 2000.

But the jury is still out on whether or not gold will derive lasting benefit from recent events. Gold bulls are painting a picture of a world that has changed irrevocably since Sept. 11 and that now faces a much greater degree of risk and uncertainty. That may turn out to be the case, but it is too early to say so with any certainty. A short and successful campaign in Afghanistan may restore a feeling of normality to global affairs more quickly than some expect.

Evidence of safe-haven buying has so far been mixed. The main buyers on the exchanges have been private Japanese investors and American commodity trading advisors — both in relatively small volume. In the physical markets, demand has been mixed with strong buying of gold coins in North America and South Africa, but there has been little interest from India, where recent price volatility has reduced buying interest among traditionally price-sensitive clients.

If gold prices can break through the US$295-300-per-oz. level, short-covering by producers could add substantially to upward momentum, but a significant ratcheting-up of global tensions may be required in order for this to be achieved.

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