The report period March 26-30 saw metal prices decline further. The copper market registered its disappointment at the scale of Phelps Dodge’s long-awaited production cuts by sending the London Metal Exchange (LME) 3-month price below US$1,700 per tonne to an 11-month low. Nickel and zinc prices continued their steady decline, falling to their lowest levels since mid-1999. Aluminum remains the healthiest of the base metals, thanks to massive production cuts, but unless there is a move to the upside soon, buyers may get tired of holding the well-tested 2-week support level of US$1,480-1,485 per tonne.
Is there a turning point in sight for metals prices? Judging from recent U.S. data, one is tempted to say yes. The period under review saw a healthy recovery in the Dow Jones Industrial Average and surprisingly strong consumer confidence. There is also evidence that steep increases in housing values are helping offset some of the negative wealth effect of lower stock prices in the U.S. Interest rate cuts have resulted in the widest differential between short- and long-term U.S. rates for five years, suggesting that an economic rebound and faster inflation may not be far off. Traditionally, the peak in differentials between short- and long-term rates has coincided with a trough for metals prices. But if the markets are now pricing-in a U.S. recovery, they are also in the process of adjusting for lower-than-expected growth elsewhere.
In Europe, the steady decline in the euro is evidence of the market’s impatience with the European Central Bank’s prevarication over interest rate cuts, and there are increasing concerns about Japan: a recent Tankan survey showed the first decline in business confidence in two years. Under these circumstances, any turning point in metals prices appears to be some way off.
Copper prices remained under downward pressure, reflecting several factors, including continued instability in global equity markets, disappointing Japanese data, and general disappointment with the scale of production cuts announced by Phelps Dodge. The persistent flow of metal into exchange warehouses (17,000 tonnes in total during the report period) is also helping to keep sentiment subdued. The LME 3-month price dipped to an 11-month low of US$1,678 per tonne on March 30, recovered briefly, but then fell back to end the week looking vulnerable at US$1,682 per tonne. One positive factor is that the Comex division of the New York Mercantile Exchange is running its largest fund net short position in two years in copper (almost 16,000 lots). This limits the scope for fresh short-selling to take place and raises the prospect of short-covering rallies over the next week or so. However, the upside is likely to be capped between US$1,720-1,740 per tonne, and our target for the LME 3-month price over the next month is the April 2000 low of US$1,634 per tonne.
Phelps Dodge’s announcement was much less than the market was hoping for or expecting — the 80,000-tonne-per-year cut in mine output has no impact on refined production, which will be kept at current levels using concentrate and other raw materials from alternative sources. However, the company did leave the door open for further cuts by extending warning notices to its employees of up to another 60 days. With power price exposure mitigated by its current arrangements, further production cuts will most likely be driven by copper price developments, and Phelps Dodge could put them back on the agenda if prices stay below US$1,700 per tonne for the next two months. There is also the prospect of cuts being made elsewhere in the American southwest, with Grupo Mexico’s 90,000-tonne-per-year Mission mine, in Arizona, thought to be the most vulnerable operation.
Meanwhile, prospects for copper consumption continue to deteriorate, notably in Japan, where consumption indicators have entered negative territory for the first time since February 1999. Less-than-stellar construction data from that country suggest further weaknesses to come.
Moreover, the local industry association’s forecast of a 6% fall in Japanese brass mill output in 2001-02 suggests that a contraction in Japanese copper demand during 2001 is highly likely.
Aluminum prices continue to find support at US$1,480-1,490 per tonne, but for how much longer? Buying at this level has supported the market since mid-March and has been tested successfully almost every day during this period, but, with the upside capped at US$1,520 per tonne, there is a real risk of a lurch lower. Aluminum market fundamentals are reasonably firm, and better premiums and falling stocks suggest that, despite weak demand, cuts in production are keeping the market fairly well- balanced. Further ahead is the prospect of a large market deficit emerging. However, the problem for aluminum is that elsewhere in the base metals complex, fundamentals are weaker and the outlook not nearly so positive. If global equities markets continue to shed value, and metals like copper adjust lower, aluminum price support is likely to give way. In the short term, US$1,480-1,490 per tonne is likely to continue to be tested, and if it gives way, a swift move lower to US$1,450 per tonne looks inevitable.
Unlike copper stocks, aluminum inventory on the LME has not risen in recent weeks, though the fact that it has yet to show any sign of declining is of concern, given the size of the production cuts that have taken place. Aluminum consumption usually peaks in the second quarter. Last year, LME stocks fell 106,000 tonnes in March, but this year they have shed only 6,000 tonnes. Last year, LME cancelled warrants soared in early March, whereas, this year, the increase was much smaller (and, subsequently, shipments out of warehouses have been offset by deliveries in). The current low level of cancelled warrants suggests that a gentle decline in LME inventory is the best that can be expected in the second quarter of the current year.
February’s Japanese aluminum product data was the first time shipments have turned negative, year-on-year, since May 1999. The combination of weak export demand and declining local construction activity suggests that the latest forecast from the Japan Aluminium Association of 0.5% growth in fiscal 2001-02 may turn out to be optimistic.
Zinc prices slipped to their lowest levels since June 1999, as the LME 3-month price fell below US$1,000 per tonne. On a technical basis, there appears little to prevent zinc prices from moving consistently below US$1,000 per tonne, and a test of support at US$960 per tonne (the low of May 1999) may not be far off.
Apart from fears about global stock markets and economies, plus falls in other metals markets, zinc is being undermined by disappointing data from Japan. Japan’s zinc stocks in February climbed almost 7,000 tonnes from their January levels, reaching 96,479 tonnes, their highest since June 1999. Japanese zinc shipments fell almost 14% in February, but production has continued to rise (+1.5%), and until it falls back or demand recovers, further stock increases are likely. Given the poor level of zinc de mand in Asia at present it is the former that looks more likely. Other regional producers, notably China, are also thought to be building stocks, and LME stocks in Singapore are also high, at more than 80,000 tonnes.
The weakness of the zinc market is illustrated by the total lack of a price response to Cominco’s announcement that it is extending its sales of electric power from the 290,000-tonne-per-year for Trail smelter, in British Columbia, to the cover the whole of the second quarter. Cominco says production will be slashed by 20,000 tonnes in the second quarter in Q2, and, in combination with the cuts already made in February and March plus a planned total shutdown in August and September, production in 2001 is likely to reach only 190,000 tonnes, or about 100,000 tonnes below capacity.
Nickel prices ended the week poorly, with the LME 3-month figure closing below US$5,800 per tonne yet again. The target on the downside for prices has moved lower, from US$6,000 to US$5,800 per tonne, as the steady downtrend continues for prices in place since early this year. However, volumes remain thin, and there is a distinct lack of willingness by participants to hold large short positions, which they believe could still be vulnerable to a price upswing. Since nickel is one of the few LME metals still in backwardation, forward prices continue to offer attractive buying opportunities for consumers. This should prevent any dramatic falls, though the gradual price decline looks set to continue.
The causes of nickel’s price weakness are evident in the March report of the International Nickel Study Group, which illustrates a growing surplus. The report also indicates a significant increase in producer stock levels of nickel. Throughout last year, the steady decline in levels of nickel inventories held in LME warehouses suggested a tight physical market. However, despite the steady stock falls and the fact that stock levels rarely climbed above the 10,000-tonne mark throughout the first quarter, producer stocks have remained consistently high.
The consequence for the nickel market, and ultimately for nickel prices throughout the rest of this year, is that when demand prospects do eventually improve, the impact this will have on nickel, in terms of higher levels of demand, will be muffled by the high producer stock levels. Making matters worse is the supply overhang that still exists in the stainless steel sector, particularly in Asia and the U.S. Given the combined effects of the excess that overhangs the market, we believe prices will behave in the second quarter in much the same way that they did in the first. In other words, prices will steadily weaken as prospects for price spikes become more remote.
Gold prices look vulnerable, as most market participants are maintaining a cautious distance. The early part of the report period was painfully quiet, as prices moved within a tight trading range, often by only a few cents per day. That the US$260-per-oz. support area came under pressure is not surprising, given the clear signals that upside potential has been exhausted. Given the events of recent weeks, it is not surprising that the US$260-per-oz. level was unable to provide support and prevent further price falls to the high US$250s.
The absence of investor activity and the renewed weakness in the gold market following the recent overreaction to the short-term liquidity crunch in the lending market are all the more poignant, given their timing. The headline-grabbing volatility on the U.S. and London stock markets has dented investor confidence in the stock market’s ability to shake off the problems caused by the slowing U.S. economy. Profit warnings from major tech companies and signs of company job losses have unnerved small and institutional investors alike and led to large-scale fund exits. Gold, however, has clearly not been the beneficiary of this change, and there has been little correlation between the price and the Dow Jones over the past two years.
— The opinions presented are solely the author’s and do not necessarily represent those of the Barclays group.
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