Subdued demand for copper and lead

The following is the third of four instalments culled from The Commodity Refiner, published by London, U.K.-based Barclays Capital Research. This week we offer an overview of copper and lead markets.

Copper

Mid-year, BHP Billiton (BHP-N) is expected to make an announcement regarding its curtailed output of around 170,000 tonnes per year. The curtailment is widely expected to continue in an environment of depressed economic growth. In the meantime, the fourth-phase expansion of BHP’s majority-owned Escondida mine in Chile has resulted in a slight easing of the concentrate market, which, overall, remains tight in light of the absence of other major expansions and will help constrain refined output. This, together with little sign of Chinese copper demand slowing, represents the key pillars for a robust fundamental outlook.

Speculative activity is especially intense in the copper market, partly because of its Comex contract, which possibly also explains its relatively strong negative correlation with the U.S. dollar. In broad measures, we estimate that the overall speculative/physical business ratio on the LME is about 50-50 but could be even more biased towards the speculator. In light of this, systematic fund selling was the main force behind the sharp price correction at the end of Q1, while fundamentally driven market participants have been good scale-down buyers. This provides a relatively healthy platform for the start of Q2, even if demand indicators remain (unsurprisingly) discouraging. Notably, U.S. copper shipments declined by 9%, year over year, in February, as reported by the Copper Brass Servicecenter Association.

On the supply side, Grupo Mexico‘s operations are the focus of attention, where high-cost production was under severe pressure last year. The recent securing of new credit lines will facilitate production this year, though probably at modest levels. Of interest too is the non-U.S. refining industry, where output curtailments cannot be ruled out, with most attention perhaps on Japanese capacity.

We have scaled back our copper price forecast for this year, as economic data strongly suggest that demand conditions will remain subdued. However, as we have pointed out in recent reports, there are factors that support a case for restricted downside price-risk, even if there is a slight slowdown in the rate of Chinese consumption. The key factors of this mildly positive view in a depressed demand environment are currency and supply issues — factors that have rarely, in the past, initiated price rallies but that rather provided downside support. A scenario in which the trade-weighted U.S. dollar depreciates further would certainly help bring consumption forward, as well as put further pressure on production costs already constrained by low treatment and refining charges at smelters and refineries and low LME prices.

Based on this, we would regard a price drop below US$1,550 per tonne as an advantageous opportunity to buy. While we have made minor changes to our near-term price forecasts, we have also made some modification to our longer-term price prospects in that we expect a slightly larger deficit in 2005, and hence a slightly higher annual price, than previously forecast. However, we also expect producer forward sales to occur at lower price levels than in previous price cycles, and the forward curve should move into backwardation at a lower level than in the past. Price peaks will likely reflect these developments, and not be as high as in previous cycles.

The concentrates market is still tight and spot treatment and refining charges (TC/RCs) remain around their lowest for 15 years. However, as copper-in-concentrates output is on the rise, TC/RCs are likely to pick up, though any rise is unlikely to be meaningful in the near term.

A combination of low TC/RCs, falling LME prices, and a depreciating U.S. dollar translates into tough production conditions for operations outside the U.S. We believe output curtailments are taking place in Japan as a result, and production reductions could well occur in Europe for the same reasons.

The total LME copper stockpile has been steadily reduced since its all-time month-end high of 975,000 tonnes, reported a year ago. In fact, the total LME copper stockpile is now 160,000 tonnes below that level, at 815,000 tonnes.

Cancelled LME copper warrants have been fluctuating at around 15,000-50,000 tonnes in recent months, and stood at around 40,000 tonnes (or 5% of the total remaining) in early April, reflecting a decent amount of material that is still awaiting outward delivery. As a result, we think the downward trend in LME copper inventories will persist in the near term.

The total reported copper stockpile stood at an estimated 2.1 million tonnes at the end of the first quarter — some 245,000 tonnes below the all-time high reported a year ago.

This incorporates material stockpiled by Codelco, which has announced it is withholding 200,000 tonnes of refined copper until total Exchange stocks (including Comex and Shanghai) fall below 800,000 tonnes. Codelco has already stockpiled 60,000 tonnes so far this year, held near its Chuquicamata site in northern Chile.

While the copper stock-to-consumption ratio remains around historical highs, we estimate it was reduced a little during the first quarter to 9.9 weeks. We think the ratio will be gradually reduced during 2003 as the market moves into deficit and consumption picks up (modestly), which should have positive price implications.

The global refined copper market registered a 207,000-tonne surplus in 2002, according to the International Copper Study Group (ICSG). Demand conditions deteriorated at the end of 2002, with sharp month-over-month declines in both November and December. However, January consumption was healthier, in line with economic data at that time, growing by 8.9%, month over month, and 3.7%, year over year, to 1.2 million tonnes.

As a result, the global refined surplus of 145,000 tonnes in December 2002 reduced to 53,000 tonnes in January 2002, aided by depressed production numbers. Total refined output was reported at 1.3 million tonnes in January, down by 1.1%, year over year, and up by a marginal 0.8%, month over month.

Lead

As a result of permanent smelter closures, rising premiums in all key regions have been the focal point in the lead market. Nonetheless, seasonal lead demand has been disappointing on drawdowns of stockpiles of lead batteries and a weakening U.S. auto industry, though some off-take has occurred, securing metal availability in light of reduced supplies, especially in Europe.

Battery Council International reports that shipments of starting-lighting-ignition batteries rose by 2.3%, year over year, during the first 10 months of 2002, while replacement shipments were 3% higher over the same period. These reasonably robust figures probably slowed during the first part of this year, especially as U.S. auto production fell 15%, year over year, in February and further vehicle production reductions are scheduled for Q2 — by 11% at General Motors and 17% at Ford. Meanwhile, the Japanese market remains weak, with 2002 consumption of lead for the main end-use sector, batteries, now confirmed to have declined by 8%, compared with a 2% decline in the preceding year.

Meanwhile, China continues to consume large quantities of lead. The country currently accounts for about 12% of the global total, compared with Japan’s 4% share. Continued strong domestic demand was evident from Chinese trade statistics for the first part of this year, which showed a marked decline in net exports. This was also the result of an 11% decline, year over year, in refined production in February, on the back of concentrates tightness. We see this trend being a dominant theme in the lead market this year, and we expect Chinese net exports to fall from about 400,000 tonnes in 2002 towards 300,000 tonnes this year.

In Europe, an approximate 200,000-tonne-per-year capacity is being taken out of production this year, foll
owing the permanent closures of Metaleurop‘s Noyelles-Godault plant in France and one of MIM‘s lead refineries at Northfleet in the U.K., which was partly processing bullion from the now-shut Avonmouth smelter. An output reduction will also occur at Pasminco, which decided to bring forward the closure of the Crockle Creek plant. This will primarily affect lead bullion output this year but might cause a reduction in output at the Port Pirie smelter by roughly 45,000 tonnes per year in 2004.

Despite these output cuts, we estimate the lead market will remain in surplus over the bulk part of our active forecasting period (through to 2007), primarily based on low annual demand growth rates. Also, we see little reason why the price should move substantially outside its recent 5-year range of US$420-560 per tonne during this period.

Spot lead treatment charges remain at their lowest levels since mid-1995, at just below US$100 per tonne, reflecting a continually tight raw material market for lead.

The total reported stockpile of lead stood at 467,000 tonnes at the end of January, according to the International Lead and Zinc Study Group (ILZSG). This figure is down by 8,000 tonnes from the previous month and down by 27,000 tonnes over the previous 12 months. Both consumer and producer stockpiles were reduced over this period, and now stand at 136,000 tonnes and 145,000 tonnes, respectively.

With a pick-up in demand at the beginning of this year and a fall in total reported inventories, we estimate the stock-to-consumption ratio has fallen to 4.6 weeks for the first quarter. While traditionally volatile, this represents the lowest level since the fourth quarter of 2001. This is a healthy development for future prices, though we see supply-side issues as the main positive feature of this market in the near term.

Next week: Nickel and zinc.

— The opinions presented are the authors’ 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. Kevin Norrish is head of Commodities Research/ Energy for Barclays and Ingrid Sternby is a base metals analyst with the company. E-mail: kevin.norrish@barcap.com and ingrid.sternby@barcap.com