Short-term prospects dim in mineral commodity markets

It’s annual-report season, and given the difficult trading conditions of late, it isn’t surprising that many companies are reporting mixed results. What is cause for concern, however, is that most mining companies are giving the thumbs-down to short-term market prospects.

Representatives of BHP Billiton say there is little sign of a recovery in any of the major economies and trading conditions will likely remain difficult until the second half of the year. Meanwhile, Belgian copper and zinc producer Umicore says it does not expect much improvement in either market in 2002, echoing comments made in late January 2001 by Rio Tinto that a recovery in mineral commodity markets is not expected until late this year.

Companies can be forgiven for being overcautious at this stage of the economic cycle, but the plain fact is there is little physical evidence to contradict these downbeat assessments. Consumer demand remains weak across the board, and premiums are still depressed. Indeed, global engineering conglomerate and major base metals consumer ABB has joined the chorus, saying it sees little sign yet of a recovery in 2002 and is budgeting for its business to be flat. The only glimmer of hope comes from Avesta, the world’s second-largest manufacturer of stainless steel: it says stocks are now low in many regions, and that the market is therefore beginning the year in healthy fashion. As a result, demand for nickel should increase. Even so, Avesta expects nickel to remain in surplus in 2002. Metal trading funds have correctly anticipated recoveries in previous cycles, but the evidence appears persuasive that, this time around, they may have pushed the market ahead of itself.

After surging to an 8-month peak of US$1,635 per tonne, for 3-month copper prices on the London Metal Exchange (LME) descended gradually to end the report period Feb. 4-10 in the middle of their previous trading range, that is, US$1,585-1,615 per tonne. With fundamentals still uninspiring and speculative interest high, a test of support at US$1,600 and then US$1,585 per tonne looks imminent.

Many analysts have expressed skepticism about the degree of fundamental support for the current rally in copper. The consensus is that there is little justification for a strong rally until the second half of 2002. So far this year, fundamentals have been largely as expected (i.e. poor), but prices have outperformed by a considerable margin. January’s Reuters survey of forecasts produced an average of US$1,623 per tonne, close to current levels, suggesting there will be substantial upward revisions to forecasts unless prices fall back soon.

That could happen. It did in 1999, under similar conditions. The recent turnaround in fund positions from short to very long is reminiscent of that period and does suggest that some fragility in prices could emerge if consumers don’t take up the running soon. A key difference now, however, is that producers have cut output early. In 1999, it was the second move down to US$1,360 per tonne that did it; this time, it was the first. We still think a fall back in price is likely, but this time the floor is likely to be much higher at around US$1,480-1,500 per tonne.

Aluminum prices made a brief attempt to follow copper higher mid-week, climbing to a peak of US$1,411 per tonne on the back of knee-jerk speculative buying. They then fell back sharply, ending the week at the bottom of the recent US$1,370-to-1,410-per-tonne trading range. Nearby spreads remain tight, drawing substantial tonnages into LME warehouses — specifically +12,000 tonnes during the report period.

Supply-side concerns continue to influence the direction of zinc prices — a situation which we believe will hamper any attempt by prices later in the year to climb above US$1,000 per tonne. Although demand indicators continue to look unencouraging, focus has turned increasingly to supply-side issues (and not only in zinc). With the latest announcements on zinc production focusing on refined material, it may be that the issue of oversupply is at least starting to be addressed?

The way prices reacted to the recent announcement of production cuts by Big River Zinc and Teck Cominco suggest that moves made so far have been ill-received. Prices remain embedded in the US$20 trading range between US$780 and US$800 per tonne and show little sign of breaking through this range. In fact, with more pressure on support at US$780 per tonne, it’s clear that the scale on which zinc supply-side corrections have been judged by the market is inadequate. This is not surprising. The announcement by Teck Cominco centred on a 55,000-tonne cut in 2001 output from two smelters (Trail and Cajamarquilla), whereas Big River reported it was “considering” closing its 90,000-tonne-per-year smelter in Illinois. Against a forecast supply surplus of around 360,000 tonnes per year, more sizable cuts will be needed if a concerted price reaction is to take place.

Operating in a thin market and against the backdrop of a base metals complex struggling to find a clear direction, nickel prices have been left to tread water. Little occurred over the report period to offer a clear indication of the direction prices will take. Right now, they remain hemmed in a narrow range between support at US$5,900 per tonne and resistance at US$6,100 per tonne, but outside of these levels, the jury is still out. Are prices forming a solid area of technical support from which they can launch a move to even higher ranges, or have they reached an area of insurmountable resistance. If the latter, they may be poised for a bout of disappointed long liquidation and waves of fresh short-selling by the funds.

Given this, we do not expect fundamental events to indicate price direction in the short term. This largely leaves nickel prices in the hands of the base metals complex and, more specifically, speculative funds. Viewed from this perspective, prices looked more protected on the downside. Funds in copper and aluminum continue to show surprising resilience, and, based on recent price dips to US$5,800 per tonne and below, funds in nickel show a similar reluctance to test support. While this is supported by static LME stock levels and the continued backwardation, prices should be able to find further stability above US$5,800 per tonne.

Considering the risks gold prices faced over the report period week, their current position can be said to have strengthened substantially. Although prices have not made absolute progress above US$300 per oz., the relative gains are significant. Prices avoided a test of support at US$296 per oz. despite several factors (a speculative market that has built a heavily long bias into prices at current levels, the absence of Japanese buying, the Chinese holiday period, and the normally sensitive catalyst of a long U.S. holiday weekend, Feb. 16-18). Furthermore, the price resilience has also countered sometimes heavy levels of non-producer-related selling to close firmly and maintain expectations of additional gains above US$300 per oz. The move by technical indicators into neutral territory reinforces these expectations, as does the promise of further Japanese buying by investors grappling with declining confidence in the national currency and the banking system that supports it. With New York closed for Presidents’ Day on Feb. 18, a quiet start to the week was expected. Thereafter, however, gold will be pressured to prove it can continue to ride the crest of its US$300-per-oz. wave, rather than, as with previous rallies, crash under a wave of long liquidation.

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