The U.S. economy is entering a critical period. Confidence in the recovery has begun to wane, economic data have failed to provide a completely comprehensive and convincing picture, and even better-than-expected economic data seem largely to have been factored in.
The latest manifestations of this faltering confidence are weakness in the U.S. dollar and strength in the euro. Although this situation provides European metals consumers with some tactical buying opportunities, it also indicates the extent to which investor willingness to extend the risk boundaries in U.S. assets is being handicapped by recovery concerns. For metals prices, this is a key concern. Having ridden on the wave of aggressive fund buying, base metals are now in a state of limbo as they stabilize after a period of strong fund buying and hover before the beginning of a period of consumer-based buying. Until this buying emerges, upside price prospects look limited; equally, until expectations of increased consumption abate, risks to the downside look limited.
These conditions left most London Metal Exchange (LME) prices between a rock and a hard place during the report period April 22-26 as prices treaded water and took economic data releases in their stride. Prices reacted on the upside to the April 26 release of positive figures for the U.S. gross domestic product, though they remained within well-established ranges. This seemingly bullish behaviour looks likely to give way to a period of inertia, albeit one with risks biased toward the upside. Main movements look more likely to come from foreign-exchange developments as, despite the positive data, U.S. dollar movements reflect investor nerves. However, with euro strength expected to be short-lived and metals prices (in U.S. dollars) likely to be reasonably stable throughout the second and third quarters, European consumers should be aware of buying opportunities (particularly if the metals complex experiences further dips) which could arise.
It’s clear that base metals markets, particularly copper, are at an important juncture. After peaking earlier this month at more than US$1,650 per tonne, the lack of consumer activity, the overbearing influence of long speculative funds, and weaker-than-expected U.S. data combined to push the red metal back below key support areas toward US$1,560 per tonne. However, improved levels of buying interest toward price dips suggest that support areas are beginning to edge higher. With the latest U.S. data confirming that economic recovery during the first quarter was stronger than even bullish expectations suggested, prices could be poised for even greater gains over the remainder of the second quarter and into the third.
It would appear that downside risks have, to a certain extent, diminished, though there remains the problem of a “demand gap” in copper’s fundamentals; that is to say, there is a delay between expected improvements in consumption being factored into prices and higher demand actually feeding through to the market. Expectations of better consumption have been factored into prices, as has the expectancy of improved U.S. economic data. Upside momentum from these sources should therefore be limited, just as buying on the dips is starting to reinforce support. In U.S.-dollar terms, therefore, we expect average copper prices of US$1,600 per tonne in both the second and third quarters. Given the recent weakness of the greenback/euro ratio, one of the main variables for European consumers could be foreign-exchange movements as copper prices (in U.S. dollars) remain stable. As we expect euro gains to be brief, European consumers should watch euro prices carefully for signs of tactical buying opportunities.
The euro factor should also be watched closely in the case of aluminum. Although we expect prices to remain relatively range-bound over the next couple of quarters, one key variable for European-based consumers could be the value of the euro (in relation to the U.S. dollar) and the changes associated with aluminum prices in euro-denominated terms. As with copper, aluminum prices have been moving toward tests of key support areas. Fundamental data have been mixed, and buying activity has been limited to the lower end of the price range. Although this, in itself, does not suggest prices are poised to rally strongly, it does suggest that support areas are being reinforced and price dips may be brief. With euro strength also expected to be brief, European consumers could be presented with buying opportunities over the second quarter. As the chart below shows, recent aluminum weakness, coupled with strength in the euro, has pushed aluminum, in euros-per-tonne terms, back to levels reported in early 2002. Although U.S. dollar prices are expected to remain stable (averaging US$1,400 per tonne in the second quarter), a reversal of the euro’s strength would result in a rising euro-per-tonne price level — a situation on which European-based consumers should be prepared to act.
The latest fundamental data support a comparatively sideways-driven price movement in aluminum over the current quarter. While the rate of decline in Japanese mill shipments continued to abate, figures from the International Aluminum Institute show primary production increasing by 1.5%. This mixture of good news and bad news should make currency issues a key variable over the remainder of the second quarter and during the following 3-month period.
After a week in which the base metals complex deteriorated and sentiment weakened, nickel was again able to emerge as the strongest performer. Despite testing support at US$7,050 and US$7,000 per tonne, prices were able to maintain the US$7,000-to-7,200-per-tonne trading range and register a close, on April 26, above support at US$7,050 per tonne. This should further enhance nickel’s technical position and keep the near-term price focus on a test of resistance at US$7,200 per tonne. After a consecutive uptrend over recent weeks and a third week of consolidation at the highest level since mid-May last year, downside risks cannot be entirely dismissed. As consumption improves, as the economic climate strengthens and as the rest of the base metals complex begins to look more secure, these risks should ease, and we continue to view US$7,000 per tonne as a benchmark price for nickel.
The low level of LME inventories continues to be supportive. Fears that the previous week’s 1,900-tonne stock increase was a precursor of Russian deliveries have been somewhat allayed by the small size of stock builds since then (stocks increased by 1,050 tonnes during the report period). Although the Murrin Murrin plant recorded the highest level of quarterly production in the first quarter, production rates, when averaged-out on a monthly basis, are far from threatening to the price strength of nickel. With nickel supply and demand expected to reach market balance in the second and third quarters, and move into a deficit in the fourth, supply fundamentals should continue to underpin price strength.
Range-bound trading has been the order of the day for zinc prices. With support drawn at US$820 per tonne and resistance at US$840 per tonne, prices have relied on stability in the rest of the complex to maintain this US$20 area. As with most metals markets over the past week, price movements have been determined more by technical factors than by fundamentals. Although fundamental news has not been universally bad, we have referred to the vulnerability of zinc prices at these higher levels for some weeks and have seen little data, of late, that would cause us to alter that opinion. Although copper, aluminum and nickel have recovered well and are now stabilizing at higher levels, stability in other areas of the metals complex could be insufficient to maintain support for zinc. Pockets of buying interest have emerged at lower levels but in volumes that suggest that the appetite to hold long positions in the current environment is small. Given that the complex seems unlikely to make significant gains over the current quarter,
and considering too the lethargy associated to date with zinc’s recovery, we expect an average price of US$800 per tonne for the second quarter.
The latest production and consumption data from the International Lead and Zinc Study Group highlights the problem with zinc as the gap between consumption and production growth increases. Although the lower Chinese exports in the first quarter (down by 12%, year over year) are supportive, they may not be sufficient to halt renewed price weakness, and we expect upside price risks going forward to diminish.
— The opinions presented are the author’s and do not necessarily represent those of the Barclays group.
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