Signs of hope for base metals

In the immediate term, base metals prices are in a more robust state than they have been for some time. Copper prices ended the report period Nov. 12-16 up 7.1%, aluminum was 6.7% stronger, and zinc gained 5.7%, while nickel reversed five months of losses by soaring 15.4%.

The only aspect of the technical rally that is uncertain is its timing. The length of the downtrend, the scale of production curtailments in copper and aluminum, and the extent to which prices have been exposed to relentless short-selling by funds and commodity trading advisors all suggested that a price correction on the upside was imminent. True, exaggerated price movements based on technical correction tend to give way to a dose of correction in the opposite direction. But there are tangible signs that recent increases cannot be dismissed entirely as brief, short-term, short-covering rallies. Fundamental developments acted as the catalyst of the rally and are capable of supporting it, while economic data show that the gloom over the U.S. economy is at least starting to clear. So, beyond the immediate term, how much more robust are prices now?

Two arguments suggest the situation is improving. For one thing, recent cutbacks in copper mine production indicate that, even assuming only a mild recovery in consumption next year, the copper market will now join aluminum in heading for a supply deficit in 2002. On the demand side, strong sales data in the U.S. prepare the way for a turnaround in orders and production in the first quarter of 2002 as inventories are further run down. For metals prices, it is still too early to say a sustained recovery is under way, but these developments do suggest that the foundations of a recovery are at last being laid.

After copper’s recent rally to a peak of US$1,515 per tonne (London Metal Exchange 3-month price), the big question is whether short-covering is over yet. Prior to the rally, data from the Commodity Futures Trading Commission showed the Comex net short speculative position at a record high of 26,769 lots. Since then, open interest has fallen by around 11,000 lots, suggesting that a large net short position still exists. Short-covering rallies are therefore still a risk in copper, especially if, as we expect, more supply cuts are announced soon.

Aluminum‘s recent price gains exactly matched those of copper — LME 3-month figures for both showed gains of 13% from trough to the peak of the report period. But we would not be surprised to see aluminum lose out relative to copper in the weeks ahead since current prices are stimulating European producer selling interest. The forward curve has flattened slightly as a result, though little business has been done yet. In the short term, US$1,350 per tonne is likely to be the key support level, and, below that, US$1,340 and US$1,325.

Extreme volatility characterized nickel, with the LME 3-month price trading in a US$1,210-per-tonne band. The cash-to-3-month price has remained in backwardation, though the level has halved from a high of US$95 per tonne mid-week. Short-covering by commodity trading advisors drove the intial price recovery to a peak of US$6,090 per tonne, but, with funds then long, prices fell back almost as dramatically to test support at US$5,200 per tonne. For the time being, this has held, but the market desperately needs production cuts, and these will not occur unless the previous low of US$4,320 per tonne is broken convincingly.

Zinc prices spiked sharply higher, with the LME 3-month figure peaking at US$844 per tonne, its highest since Sept 11. However, the rally owed more to strength elsewhere in the base metals complex rather than any significant improvement in zinc’s own fundamentals. Despite about 650,000 tonnes of mine production cuts, smelter production is unlikely to be slashed just yet, and the recent small fall in LME stocks is probably illusory. Breakwater Resources has been granted a stay of grace until year-end by its banks and has also received a cash injection, so cuts in production at its mines are now unlikely.

A brief review of gold‘s performance during the report period would suggest that bullion has missed its chance of making lasting benefits in the wake of September’s terrorist attacks. Politically, the growing doubts over the coalition’s military actions in Afghanistan quickly evaporated following the overnight expulsion of the Taliban forces from Kabul. The U.S.-led alliance now looks especially strong, and the success of the military action is certain to bolster the confidence of the U.S. consumer, the U.S. economy and the U.S. dollar. Economically, some of gloom has begun to lift; the strength of October retail sales figures should help this to continue. So what role will gold play in a comparatively stable and economically more confident world?

The downside risks in current gold prices have increased, and a move down to the low US$270s now looks imminent. Assuming continued confidence in the U.S. dollar and U.S. assets, this week the chances of a revival and a return to higher trading ranges are significantly reduced. As attention turns to the Bank of England auction of Nov. 27, the difficulties associated with boosting investment demand should increase. The timing is unfortunate. Attempts to market gold as an investment tool when a major central bank is offloading its stocks is like the analogy of the cricket captain who breaks the bats just before the game is due to begin.

The success bullion had in September, in terms of attracting broad-based investment, appears to have been brief. Furthermore, with prices now in danger of moving down to US$270-272 per oz., it is also unlikely to be repeated in the short term.

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