Stronger prices tied to US recovery

Base metals markets traded sideways in thin volumes during the report period July 1-5 as U.S. stock markets and the U.S. dollar regained some poise.

A more stable outlook for U.S. financial markets would certainly help metal market sentiment, but is not a necessary precondition for a strong recovery in price, so long as the real U.S. economy continues to improve in the way that recent data (better factory orders and employment) suggest it should.

Also encouraging was the strength in Japan’s leading economic indicators, which suggest that a tentative improvement in metals demand, evident in recent months, could take wing in the second half of 2002. Add to this to the already-strong picture emerging from China, Taiwan and South Korea, and the prospects for strong base metals demand in two of three of the world’s major consuming regions looks good.

The exception is Europe, where there appear to be few signs of improvement just yet. The stronger euro is raising fears about export competitiveness, and the economy of the region’s largest metals consumer, Germany, continues to under-perform.

Physical metals demand has recovered from the abysmal levels of late last year but is still unimpressive, and many fabricators are planning summer shutdowns of double their usual length. The base metals price recovery of 1999 occurred despite depressed demand levels across much of Asia, and it showed that higher prices are possible even if the global economy is not firing on all cylinders. However, for this to happen, the U.S. economic rebound would have to be strong and Asia would need to generate substantial domestic, rather than export-related, metals demand. For the time being, the jury remains out on whether these two trends are under way.

Copper prices continued to trend lower during the report period despite several positive supply factors, ending at around US$1,650 per tonne. With fund length still at relatively high levels, the market looks vulnerable to further liquidation. A test of US$1,640, followed by US$1,620, per tonne looks likely. A supportive factor for copper has been the rapid decline in LME inventories over the past six weeks. However, with summer holidays approaching and Chinese buying now over, at least for the time being, this trend is quite likely to be reversed. Meanwhile, demand continues to show only patchy signs of improvement. In its monthly assessment of wire and cable markets, London-based CRU International estimates that global demand for wire and cable continued to fall in the first half of 2002 — by 0.2%, year over year. Although European and North American markets have recovered from the extreme weakness of late 2001, the prospects of a rapid turnaround are slim. Business is so poor in Europe that many wire rod mills are planning 3-to-4-week summer shutdowns rather than the usual 2-3 weeks.

On the supply side, the recent announcement of a 3-week closure at Noranda’s strike-hit, 220,000-tonne-per-year Horne smelter could prove more important than the market initially judged (or that the company is prepared to admit). Horne supplies two-thirds of anode requirements to Noranda’s 330,000-tonne-per-year CCR refinery. Noranda officials claim that use of inventory and purchase of third-party raw materials will prevent any drop in CCR’s output. However, given the tightness in the global blister market (particularly in North America, where Asarco is already short), it’s difficult to see where third-party anode supplies could come from. Indeed, speculation suggests that CCR is already producing at well below capacity, and the situation is likely to get worse if the strike at Horne cannot be resolved soon.

Aluminum prices appear to be settling into a narrow US$1,370-to-$1,400-per-tonne range as the sideways movement in prices, evident since the recovery of late last year, continues. The market appears to be caught between the promise of better demand to come, as foreshadowed in U.S. orders data and which point to a strong second half of the year, and a burgeoning supply picture, which threatens to swamp any upturn in consumption levels. Recent trends in LME stocks suggest that the latter factor is winning. Inventory movements so far in 2002 appear to be establishing an unwanted precedent.

Precisely how much of this increase reflects weakness in market fundamentals and how much can be attributed to the delivery into LME warehouses of metal previously financed off-warrant is a difficult question to answer. However, given that production is accelerating rapidly (up 3.1% so far this year, we estimate) and that China has switched from net importer to exporter, the upward trend is probably a good indicator of the extent to which supply growth is outpacing that of demand. Ominously, the trend has accelerated recently so that, at present, LME stocks are climbing at an average rate of more than 5,000 tonnes per day. The almost constant daily drip of announcements regarding smelter capacity increases suggests that tough times are engendering a “hunker down and go” mentality among producers, which can only serve to worsen the situation. Without a dramatic boost to demand, of which there is little sign, the market looks likely to remain in surplus for some time to come.

After failing at US$7,500 per tonne in late June, nickel prices have so far been able to avoid a sharper fall below the US$7,000-per-tonne mark. Furthermore, the neat period of consolidation between US$7,000 and US$7,250 per tonne has yet to result in any real test of technical strength or technical weakness at nickel’s key prices.

During the report period, the upward sloping trend line that has been in place since mid-May has come under some pressure, but by July 5, it had still been able to contain any weakness.

Indications suggest that nickel’s support levels may face further pressure. Fundamentals are gradually starting to be supportive of a more solid nickel price, suggesting price gains are likely towards the end of the current quarter and moving into the fourth. Furthermore, LME cancelled warrants have risen strongly.

After falling to lows of around 900 tonnes during the previous week, cancelled warrants rose sharply towards the end of the July 1-5 period. Rising to a high of 1,842 tonnes, they have now reached their highest level since late May/early June. With LME inventories having levelled off recently, this latest increase suggests that stocks may once again begin to trend lower. Over the short term, however, price moves are likely to be determined by technical developments. Further falls in the rest of the complex would increase the risks that these support areas in nickel could come under further pressure soon.

Zinc prices have continued to perform well, supported by several factors including better spot premiums, a levelling-out in the rising LME stock trend, further production cut announcements, a tight concentrates market, and lower Chinese exports.

LME 3-month prices kept recent gains intact, as support between US$810 and US$820 per tonne held firm. Given the number of positives in the market, we would not be surprised to see further price gains in the short term, but we are skeptical that medium-term fundamentals have really improved.

The initial phase of the price recovery was fuelled by short-covering from funds that had earlier been lured by the 1-way bet of a seemingly endless price downtrend. Now we also detect fresh buying by speculators, attracted because zinc has yet to make the gains achieved by other LME metals so far this year. Given this sort of interest, the short-term technical target of US$840 per tonne looks eminently achievable, even if other LME metals fail to make much progress.

The physical zinc market is showing signs of moderate improvement as tighter regional markets in Asia and Europe are helping to push up spot premiums, though from extremely low levels. There are reports of sporadic improvement in consumption.

However, improved premiums appear to be more supply- than demand-related. Lower Chinese exports plus extended maintenance at Western s
melters are the main factors. The bulk of Western production cuts are in North and South America, but an improvement in U.S. demand (partly due to the imposition of steel import duties there) has slowed the usual flow of metal to Western Europe. Metaleurop’s announcement of an end to primary production at its 90,000-tonne-per-year Noyelles Godault smelter could add further tightness to European metal supply but ultimately is unlikely to improve the global zinc balance, as the concentrate will simply be used elsewhere.

Turning to gold, the question is: Are prices consolidating at current levels before launching a further attempt to break resistance above US$320 per oz., or are they pausing before lurching lower toward a test of support at US$300 per oz.?

On the basis of recent developments in the gold price, it ought to be possible to assume that much of the momentum that had driven prices higher has been expended. The bullish signals to which prices usually respond continued to be ignored over the report period. Although the start of U.S. holidays cut short the price fall in gold as liquidity dried up, there is little doubt that risks to price falls remain an in-built function of current prices. At the time of writing, the latest data from the Commodity Futures Trading Commission had not been released, though it is almost certain to show that a significant net long position remains in place.

A close association between the value of the U.S. dollar and the euro has developed in recent weeks. The relationship indicates the direction the gold price could take once volumes return to more normal levels following U.S. independence holidays. Although our view is that the U.S. dollar weakness had a much milder and more belated impact on gold price movements than has been widely suggested, it still has an ability to affect market sentiment. Of course, the greenback is measured against more than one currency when its impact is determined on the bullion market.

The value of gold in commodity currencies, as well as local prices in key consuming countries, is determined by the relative strength of the U.S. dollar in relation to the euro. Developments here provided a different emphasis on foreign-exchange movements in relation to the gold price.

The stabilization of the yen in relationship with the U.S. dollar suggests that one source of downward pressure on the gold price has been alleviated as trading funds reduce liquidation of yen-denominated gold positions. As small investors are also a feature of the gold market in Japan, private selling has resulted from the high gold price/stronger yen. What’s unlikely, however, is that any renewed yen weakness will prompt the same level of Japanese buying interest in gold seen during the first half of the year. Even if it did, the idea that Japanese buying led to the gold price peak in the second quarter should be viewed with some skepticism.

It is our opinion that the period of higher Japanese interest in bullion simply coincided with, rather than fuelled, a rally in gold prices. A decrease in Japanese buying and the prospects of a more stable U.S. dollar appear to be depriving the gold market of two of the tenets of its recovery over the course of the current quarter. The irony is that we have never subscribed to the view that they were reasons for the improvement in gold’s fundamentals. Now that they appear to be turning against gold’s favour, however, the market appears to be subscribing to the view that they are the reason for a deterioration in price prospects, and this view is likely to deliver fresh fund liquidation over the short term.

— The opinions presented are the author’s and do not necessarily represent those of the Barclays group. For access to all of Barclays’ economic, foreign-exchange and fixed-income research, go to the web site at barclayscapital.com

The week at a glance

o Copper prices could be undermined by a slower rate of stock withdrawal in the weeks to come, but the market may be underestimating the impact of the Horne smelter closure.

o Aluminum prices continue to move sideways despite a recent acceleration in the rate of London Metal Exchange (LME) stock increase. Unless supply growth slows down, lower prices look inevitable.

o Nickel prices are trapped in a technical trading pattern. For the time being, support levels are holding.

o Zinc prices are benefiting from several positive (though, we believe, temporary) fundamental factors and look set to test the next technical level after a strong close to the week under review.

o Gold prices will likely extend their losses in the short term, given that supportive factors, such as the weaker U.S. dollar, are reversing.