The report period Jan. 15-19 was a strong one for base metals prices as tight nearby spreads in aluminum, copper and nickel supported the complex, pushing cash and 3-month quotes in several key markets to their highest levels of the year so far.
Cash prices for nickel (+4.5%) and aluminum (+2.3%) were the main gainers; copper (+1.2%) and zinc (+0.8%) were a little less impressive. Some consolidation now appears likely, but, with a combination of low LME stock levels and large-fund short positions still to be covered in aluminum, copper and nickel, further spread volatility is probable.
But will this buoyant mood last? The dramatic increase in London Metal Exchange (LME) aluminum stocks, a natural response to the growing backwardation, is seen as evidence of weakness in base metals fundamentals. In other words, the currently low LME stock levels may not be telling the whole story. We still expect the U.S. to achieve a soft landing, but the recent positive developments in the stock markets may be a little premature for metals. There is almost certainly more bad news to come out of the U.S., particularly as far as the basic metals-consuming parts of the economy are concerned. Meanwhile, a shrinking U.S. appetite for imports is causing Asian exporters to revise down their own growth expectations. The stronger euro has yet to inspire much European buying interest, which is not surprising given the slump in business confidence in some key markets (Germany’s Institute for Economic Research registered a seventh consecutive fall on Jan. 22). The current tightness in nearby spreads may persist for a few weeks yet, but once it dissipates, prices are likely to struggle to make further gains until fundamentals show distinct signs of improvement.
Copper price volatility picked up sharply during the report period. On Jan. 16, the LME 3-month price shed almost all of the previous week’s gains to trade at a low of US$1,760 per tonne but then rebounded very sharply two days later to hit almost US$1,840 per tonne — its highest level since before the Christmas break. The catalyst for the increase appears to have been a better-than-expected performance in U.S. housing starts, which were up 0.3% in December 2000 against expectations of a 3% decline. The upward move was helped along by a continued draw in LME stocks, a severe tightening in nearby spreads and a surge in the Nasdaq to a 5-week high.
The surge in price should not have come as a surprise, given that recent data from the Commodity Futures Trading Commission indicate that funds had built up sizable short positions again during copper’s slump at the end of 2000. Meanwhile, market longs have proved reluctant to lend material, their position strengthened by the low level of LME stocks.
It is not unusual for cash-to-3-month copper to move into backwardation at this level for the LME 3-month price, though, more often than not, the market has tended to be in backwardation. Most of the tightness in the current market is focused on the March-to-3-month spread, which, during the period under review, traded at a peak of US$32 per tonne. There was considerable borrowing for this period late in the week under review, and spreads then eased. But it appears likely there are still big fund shorts to be covered, so further spread volatility is quite likely.
It will be interesting to see if LME copper stocks rise, as aluminum inventory has recently done. Our perception is that there is probably less off-warrant copper around. We also think that the large single-day deliveries recently seen in aluminum are unlikely to be replicated, though steady increases are probable if the backwardation persists. Overall, copper stocks remain low. LME stocks have resumed their downward trend, and combined Comex and Shanghai stocks have been static, resulting in an overall decline in exchange stocks of about 10,000 tonnes.
There may also be some price weakness to come, particularly if spreads ease back. However, unless stocks rise more rapidly than we expect, prices could rise significantly if demand holds up.
Aluminum prices surged higher on Jan. 18, smashing through previous resistance at US$1,540-1,560 per tonne. The LME 3-month reached US$1,605 per tonne — its highest level since late December 2000. The tight power situation in California was a positive backdrop to the move, lending support to rumours that more production cuts are to come. The move higher also gained strength from a tightening in nearby spreads.
Has the mood turned in aluminum? There was certainly a lot of buying interest earlier in the report period, and significant volumes of upside call-buying for February, March and April suggests that some market participants are anticipating another leg higher in price later in the first quarter. However, the tightness in nearby spreads is narrowly focused between the end of January and early February, and it will be interesting to see what develops once this has dissipated. The 45,000-tonne increase in LME stocks that the backwardation stimulated during the report period supports suspicions that there are large off-warrant stocks of material available to market participants and that further large-scale deliveries are likely over the next week or so.
Nickel prices ended the period in a strong position, compared with the start of the year, when 3-month prices hit 6-month lows. At that time, several factors — the rapid deterioration in the global economic outlook, a weak steel sector, a badly performing base metals sector, and a technically insecure chart position — conspired to push nickel prices lower into a trading range of US$5,500-6,000 per tonne. Although the outlook for copper and aluminum prices in the year ahead is more positive than for nickel, nickel’s resilience against downward pressures is impressive, especially given the weakness in demand. To downgrade nickel’s trading prospects prematurely would be to disregard some positive fundamental indicators that have recently emerged.
The latest data to be released from the International Nickel Study Group (INSG) shows there was a fall in Western World production between October and November 2000. Output of primary nickel in October registered an increase of 66,300 tonnes, whereas, by the end of November, the figure had fallen to 63,500 tonnes. The outlook for nickel production remains firm (CRU International forecasts an increase this year of 8.8%, following an 8.1% jump in 2000). However, with much tighter conditions emerging in the scrap market, the market retains the potential to be physically tight.
Production increases are forecast to lead the nickel market into a surplus this year, following deficits in 1999 and 2000. However, stronger production and easing demand are not the only factors to be considered; equally important are low stock levels, production curtailments, and the still-uncertain output levels from the nickel laterite operations in Australia.
Although drawdowns are falling in size, LME stock levels remain significantly below the 10,000-tonne level. Stocks fell by 180 tonnes during the report period — a small figure in itself, but, given the size of nickel’s backwardation, it is surprising that stocks fell at all. Indeed, the situation serves as a good indication that tightness in supply exists. Holders of spare metal usually lend into a backwardation in order to earn the premium (as recently occurred in the aluminum sector). The result is rising stock levels that do not necessarily reflect demand, and the absence of this activity in nickel suggests that there is little spare material around.
The INSG confirms that stocks are dwindling, as world producer stock levels showed a year-over-year fall in November 2000 to 87,100 tonnes.
From a technical perspective,
The lack of investor interest in zinc is not surprising. The bear market that took hold toward the end of the year has dented price potential and restricted interest. We believe, however, that as the U.S. markets adjust to bearish economic indicators and the outlook for global economic prospects becomes less alarmist, the base metals complex will recover during the first half of the year.
Market backwardation has become a dominant feature of all the major base metals. Copper is the latest to have edged away from contango; the backwardation in nickel soared to beyond US$500 per tonne; while, in aluminum, cash prices peaked at a US$65 premium over futures price. The suspicion now is that zinc will be the next LME metal to move toward backwardation, and, with stock levels still well below 200,000 tonnes, the potential for tightness in nearby spreads is immediate.
Gold continues to perform poorly. After a week of being overshadowed by the meteoric rise of platinum group metals to record levels, gold was outshone by silver. The short-covering rally rocketed silver to the highest level since mid-October 2000, as funds, particularly on Comex, clambered to cover short positions. The yellow metal managed a rally of US$2 on Jan. 19 on a disappointing close below the 10-day moving average.
The outlook for
— The opinions presented are solely the author’s and do not necessarily represent those of the Barclays group.
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