Worse-than-expected industrial production data for the U.S. and the European Monetary Union (the eurozone IP moving into negative territory, year over year, for the first time at minus 0.1% in May), together with big increases in copper stocks, put further downward pressure on base metals prices during the report period July 16-20.
Tin and zinc were the biggest losers, with average weekly cash prices shedding 4% and 1.4%, respectively. Aluminum and copper prices ended the period at the bottom of their recent trading ranges, suggesting that the week’s losses of minus 0.1% and 0.7%, respectively, will be extended in the short term. Lead was the only gainer, at +1.2% — indeed, it was the second successive week in which it bucked the overall trend in base metals markets.
At current levels, there is little doubt the markets are pricing-in a long period of subdued demand for metals, and attention is now turning to producers to make the supply cuts necessary to bring the markets back into balance. In aluminum, this has already been achieved, thanks to high power prices in North and South America. Similar cuts are desperately needed in zinc, and (to some extent) copper and nickel as well. With almost 60% of Western zinc mines now struggling to cover their cash costs, production cuts in zinc are more likely than in copper, where the proportion of cash-negative mines is only some 10-15% at present. So far this year, demand for oil has fallen almost as rapidly as that for base metals (witness the recent halving, to just 0.6% this year, of oil demand growth as forecast of the International Energy Agency). However, despite recent softening, oil prices are still close to the levels at which they began the year, thanks to willingness, on the part of the Organization of Petroleum Exporting Countries, to pre-empt the demand cycle by reducing output. Over to you, metals producers?
Copper prices continued to lurch lower, with the London Metal Exchange (LME) 3-month price falling to a new 25-month low of US$1,536 per tonne. Worse-than-expected industrial production data in the U.S. and Europe and a record increase in LME stocks of 99,050 tonnes were the main factors behind the intensification of the downtrend that has now been in place since September 2000. One positive factor lost among the generally bearish sentiment is the continued strength of the U.S. housing sector, which saw starts in June climb a larger-than-expected 6.3%, in comparison with year-ago figures.
Earlier in the week, a test of the upside cleared the 10-day moving average at US$1,565 per tonne but failed well below the 20-day moving average at US$1,590 per tonne. The move back to a new low was attributable to fresh fund selling (mainly attributable to commodity trading advisors), and despite the fact that trend-following speculators are holding short positions which are, in aggregate, close to the highest ever seen, there seems little likelihood of a short-covering rally. In the short term, at least, price direction is almost certainly lower. Technical support at current levels is unclear, but a test of US$1,500 per tonne for the LME 3-month price should not be ruled out.
Now that the July date has fallen out of the spread, nearby tightness has dissipated and the cash-to-3-month figure has widened to a US$27 contango, compared with US$13 a week ago. However, there are already signs that the spread is tightening again. There was significant borrowing of the August-September spread on July 20. If tightness returns, will LME stocks continue to rise? Almost certainly yes, since the market is in its seasonally quiet period anyway. What would really harm sentiment and hasten the price decline is if stocks continued to rise at their current rate, which is the fastest on record.
Prices at current levels underscore the issue of supply cuts. Phelps Dodge says it will not rule out production cuts despite having completed construction of a co-generation power plant serving its operations in the southwestern U.S. (as a result, it will be able to stop buying power in the spot market). WARN notices are still in place at the company’s Chino and Tyrone operations, both of which are marginal at current prices.
Aluminum prices revisited their lows for the current cycle, with the LME 3-month figure touching US$1,436 per tonne. Prices have moved down in stages over the past eight weeks, and forward buying is providing support at fairly regular US$15-to-$20-per-tonne intervals of between US$1,510 and $1,440 per tonne. If this pattern continues to hold, the move on July 20 to the bottom end of the recent range may signal a move to US$1,420-1,440 per tonne over the next few days. Given the weakness of market sentiment at present, a further move lower to US$1,400-1,420 per tonne should not be ruled out.
The continued downtrend in zinc prices was overshadowed by an announcement that Pasminco, the world’s largest zinc miner (representing 9% of all production), will be exiting the business. Up for sale are the Century mine (estimated production in 2001: 475,000 tonnes), Broken Hill (187,000 tonnes), Elura (85,000 tonnes) and Rosebery (69,000 tonnes). The decision to get out of zinc mining is not necessarily a verdict on the prospects of the sector. Pasminco is in debt to the tune of around $1.4 billion (Australian dollars), mainly as a result of currency hedging that has cost the company $867 million (same currency).
Nevertheless, with LME zinc prices at their lowest levels ever and with the zinc metal and concentrates markets heading for what would appear to be several years of surplus, the sector has rarely looked less attractive.
Will Pasminco benefit from focusing on smelting rather than mining? Its smelting capacity of 715,000 tonnes undoubtedly contains some major assets, but factors that currently favour smelting over mining (such as the oversupplied concentrates market and the strong U.S. dollar) will not last forever, and, over the course of the business cycle, zinc smelting has seldom proved a profitable activity in its own right.
Despite remaining in a broad US$5,900-to-$6,100-per-tonne trading area, nickel prices look vulnerable to a test of support at US$5,800 per tonne in the short term. The absence of follow-through buying on the back of the recent short covering rally only illustrates this point. With two consecutive closes late in the report period below the 10-day moving average, it would appear that the strong downtrend in base metals, which had passed nickel by since late June, may now be starting to exert itself.
As well as technical weakness, nickel’s fundamentals are poor. Falconbridge has revised its forecasts of the nickel market surplus in 2001. Its forecast of a market surplus of 30,000 tonnes represents an increase of 7,000 tonnes from forecasts made earlier this year. It is also roughly in line with expectations of a 35,000-tonne surplus made by the International Nickel Study Group in April.
This news coincided with figures released by Noril’sk Nickel in Russia showing its output rising strongly. Production of nickel at Noril’sk plants increased, on a year-over-year basis, by 6% during the first six months of the year. The increase comes despite a fall of 2.3% during the first quarter and suggests that output increased substantially in the second quarter.
Despite attempts to move above US$270 per oz. during the second half of the report period, movements in the price of gold remained lacklustre and continued to suffer from a lack of buying interest. Although prices were able to edge away from the narrow US$265-to-$268-per-oz. trading range, the move toward US$270 lacked momentum. Prices failed to steer their own course as the lack of buying left gold tracking movements in the foreign exchange markets. Weakness in the American greenback, on the back of market concerns about Fed commitment to the strong dollar policy, took the dollar down to its lowest level against the euro in two months.
It’s not surprising that gold prices reacted to a weaker U.S. dollar. Given other factors in the gold mark
et, however, it is perhaps equally unsurprising that prices were unable to build on the gains made once the yellow metal moved above US$270 per oz.
Given that prices made attempts to climb above US$272 per oz. on July 19, it is disappointing that, by the following day, they closed in London US$3 lower at below US$269 per oz. The failure to hold above US$270 partly reflects that fact that technical indicators moved from neutral territory into overbought. Even under normal circumstances, fresh fund interest in gold has been limited. With the relative strength indicators moving toward overbought, the chances of speculative interest moving in to take fresh longs were reduced.
Front-end lease rates also continued to trend lower. After moving down to around 1%, 1-month rates edged lower again, to around 0.6-8%. The further drop reflects the increasing levels of liquidity following the tightness and lease rate volatility that characterized the first half of the year. The consequence for spot prices in the gold market is that a significant source of nervousness and uncertainty has been removed, and with it, a source of potential support.
— The opinions presented are solely the author’s and do not necessarily represent those of the Barclays group.
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