Despite fresh production cuts in zinc and copper (in byproduct form), base metals prices continued to trend lower during the report period Oct. 29-Nov. 2, dominated by poor economic data out of the U.S., Europe and Japan.
The falls were relatively minor, just a few dollars lower than the previous week’s averages for copper, aluminum and nickel, but ominously, both copper and aluminum registered fresh lows on Nov. 2, suggesting that more losses are likely in the weeks ahead.
It’s a fair bet at the moment that measures of business confidence coming out of any of the world’s major economies are likely to turn out much worse than expected. In October, the National Association of Purchasing Management index was almost six points below the market consensus of 45.5. Meanwhile, the Eurozone Purchasing Managers’ Index came in at 42.9, compared with a forecast of 45. So are economists lagging behind events in the real world, or have businessmen become too pessimistic? This quandary underlies one of the dilemmas affecting mining companies at present: whether to cut production now and see competitors gain as demand recovers, or suffer a long period of losses that might eventually threaten the viability of the whole company. This problem may help explain the apparent reluctance of copper companies to follow Phelps Dodge’s lead and make further production cuts (late in October, the company announced cuts of 220,000 tonnes per year at its high-cost operations in the southwestern U.S.). However, even if they do, the lesson from zinc is that prices are unlikely to improve much until demand shows signs of improvement.
After hitting their lowest level for 15 years, copper prices look vulnerable to further price falls as the market reacts with disappointment to the fact that no other producers are following Phelps Dodge’s lead. The major says its cuts are required to balance the market, because improved demand is not expected to rescue copper any time soon. Demand for the company’s wire and cable products is especially weak, with magnet wire down 15% this year and high-performance conductors down 30-35%. Phelps Dodge estimates that, by year-end, the global copper surplus will be around 500,000-600,000 tonnes.
With the market effectively in uncharted territory (Reuters price charts go back only as far as 1990), it’s difficult to guess where the next level of support might lie. For those with long memories, the 1986 low of US$1,330 per tonne may provide a benchmark. Below that, there’s a considerable gap to the early 1980s lows in the US$1,260-1,270-per-tonne region. After that, the target could be the 1977 low of US$1,163 per tonne.
There was anticipation early in the week that Grupo Mexico was about to announce a production cut of between 50,000 and 150,000 tonnes. However, the major then said it was only “seriously considering” cuts and that it has reduced its break-even price across all of its operations by more than 10 per lb. to 49.8 per lb. The cost of its operations in the southwestern U.S. is significantly higher than this. The problem for Grupo Mexico is that a closure of either the Ray mine, at 120,000 tonnes per year, or the Mission mine, at 90,000 tonnes per year, would leave the 210,000-tonne-per year Hayden smelter under-utilized and thus greatly raise its unit costs. While the major ponders this conundrum, the market will have to make good with the 35,000 tonnes of copper byproduct cuts at the Myra Falls and Ruttan zinc mines.
Aluminum prices continue to take a back seat to the rest of the base metals complex as the market remains focused on production cuts in copper and zinc. Prices continue to edge lower and are now not far from the May 1999 low of US$1,253 per tonne. With copper and zinc now trading below their 1999 lows, aluminum must have a chance of homing in on its equivalent at US$1,160 per tonne. The only thing preventing this is nervousness, on the part of funds, about going short in aluminum, given the massive loss of production that has taken place. One of the few positives in the aluminum market is a steady draw in London Metal Exchange stocks (down another 10,000 tonnes during the report period). Nevertheless, prices appear set to continue on a gradual downward trend until there is a clear sign that demand is improving.
The zinc market shrugged off the announcement of a substantial tranche of production cuts with little more than a blip in the steady price downtrend. The LME 3-month figure gained just over US$20 per tonne to hit a 12-day peak of US$792 per tonne on Nov. 2, immediately after Outokumpu announced it was suspending mining at its 200,000-tonne Tara operation. By the end of week, prices had fallen back and were trading back at their recent lows of just below US$770 per tonne. Prices are likely to continue heading lower this week, and we expect further tests of support at US$765 per tonne.
Outokumpu’s news brought the total amount of zinc production cuts announced in the report period to more than 350,000 tonnes — a number roughly on par with the global surplus expected this year (Barclays estimate: 363,000 tonnes). Why, then, the lack of price response?
– First, because no smelters have followed suit. Large stockpiles of zinc concentrate exist, and so the mine cuts will take some time to feed through to reduced metal output.
– Second, because stocks of zinc metal are also high, particularly off-warrant, where we estimate almost 400,000 tonnes have built up since early 1999.
– And third, because no recovery is likely in demand any time soon, and for the time being, supply cuts, though important in the medium term, can do little to address the poor demand side fundamentals that exist right now.
After finally breaking support at US$4,600 per tonne on Nov. 2, nickel prices look set to suffer further losses in the coming weeks, with initial support at US$4,200 per tonne. Since the start of the second half of 2001, nickel prices have already fallen by 25%; since mid-October alone, prices have fallen by 14%. Given the scale of this deterioration, it isn’t surprising that prices have consolidated at recent levels.
With the base metals complex still heading south and weak economic data emerging from every major economy, demand expectations alone are sufficient to weaken support in the short term. However, the supply-side situation for nickel is being harmed by mounting concerns surrounding inventories. There are signs that stable LME stocks may soon lose their ability to act as a drag on future price falls as stocks held off-warrant build to their highest levels in 10 years.
Reports that nickel stocks at the Noril’sk Kombinat in Russia have reached 50,000 tonnes confirm our own analysis that despite stable LME stocks, off-warrant inventories have been climbing strongly. Our figures suggest that, following a de-stocking process in the 1990s when Noril’sk adjusted to a market economy, stocks have climbed steadily by more than 60,000 tonnes over the past three years.
Although the risks of weakness in the U.S. dollar remain real, so do the risks of a stronger
— The opinions presented are solely the author’s and do not necessarily represent those of the Barclays group.
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