US indicators depress prices

Although some metals prices have started to show signs of nervous volatility as prices test new lows, the risks to the downside remain in place.

Economic expectations for the performance of the U.S. economy are being revised, and, accordingly, we have lowered our price forecasts in the belief that, although prices may be able to spike briefly off recent lows, they will be unable to launch a concerted recovery this year. The intense downside pressures on base metals may start to relent a little, but it seems unlikely that prices will be able to move against the tide of U.S. economic indicators, which are far worse than we had expected.

When, in mid-summer, Federal Reserve Chairman Alan Greenspan said “we are not free of the risk that economic weakness may be greater than we currently anticipate,” we did not know that this would be something of an understatement. As a winter of acute political and economic uncertainty approaches, the risk is not only that weakness will be greater than anticipated but that this statement will now be valid for much longer than anticipated.

Despite the current gloom, we continue to hold to our original forecasts that the U.S. economy and base metals prices are both capable of a strong recovery in 2002. Immediate risks of further lows in copper and aluminum remain real, especially following the release of our revised U.S. gross domestic product forecasts showing a fall of 0.5% in the third and fourth quarters of this year. On the upside, it is important to take into account the massive monetary and fiscal injections the U.S. economy has received — and continues to receive — in 2001. The U.S. housing market and construction sector have remained strong, and both will benefit from the continued policy of the Federal Reserve to relax monetary policy by cutting rates. Substantial inventory correction leaves the manufacturing and industrial sectors operating on a low-stocks basis, which will make the upturn in industrial production all the more aggressive when it ultimately gets under way.

For these reasons, our price forecasts for next year have been only slightly downgraded and still reflect our expectation of a strong recovery. However, before that occurs, markets will have to endure a winter of weak consumer and business confidence from the world’s three major economic zones, coupled with the growing threat of prolonged military hostilities involving most of the countries within those zones. Consequently, metals prices will likely remain depressed and short on upside potential.

As prices move closer toward the bottom of the current economic cycle’s forecast price curve, greater nervousness and volatility are taking hold, as was evident in the report period Sept. 17-21. Hence, in copper, the false start, on Sept. 21, of significant cuts in output was sufficient to trigger a buying rally of up to US$1,460 per tonne. The quick retracement below US$1,440 per tonne, once it was clear the cut was insignificant and had already been reported, followed by the late rally in London back to US$1,450 per tonne, reflects well the nervous sentiment in copper and suggests that further downside moves in the short term may be limited.

In a bearish end to the week on Sept. 21, prices moved again below our short-term target of US$1,360 per tonne to finish near this crucial area of technical support for the second consecutive day. Where does this leave prices in the days ahead? The last time this support line broke, in May 1999, aluminum lost US$100 per tonne in less than two weeks. The nervousness of the current market, the fact that there is already a large fund short bias, and the idled capacity in the U.S. all suggest that this move probably won’t be repeated, and yet the downside risks are quite real.

More than US$400 per tonne were wiped off nickel prices as low levels of consumer buying, additional downward pressure from the funds, and a soft base metals complex combined to erode support, first at US$5,200 per tonne and then at US$5,000. The next area of support lies at US$4,800 per tonne (for the first time since May 1999). With the speculative balance in the nickel market still net short and London Metal Exchange stocks remaining static (minus 24 tonnes during the report period), a test of lower areas of support is only likely if the lead is given by copper and aluminum.

In sympathy with the steep falls in nickel, zinc prices fell significantly. One reason for the fall is the low level of consumer buying. Forward buying is emerging, though in insufficient volumes to bring any credible support on the downside. With prices now below US$800 per tonne, expectations of mine production cutbacks will emerge again, particularly if the U.S. dollar weakens. Despite earlier reports of a combined producer cutback from China, we have no signs to suggest that this is forthcoming. As with nickel, after a week of heavy sales, further downside moves would have to be led by a weaker base-metals complex.

In nervous trading on Sept. 21, gold prices moved to US$295 per oz. before falling back on aggressive selling. Sharp falls in the Australian dollar on that date, resulting in a higher gold price, meant that, from the opening trades in London, the market remained jittery and uncertain and cautious of a possible spike above US$300 per oz. The looming weekend added to the nervousness, as did the developing military buildup by the U.S. In the short term, these developments will continue to be of key importance in determining the direction of gold prices. Taking all things into consideration, the chances of a break above US$300 per oz. increased during the report period. Although the failure of the rally on Sept. 21 was disappointing, the dire performance of the Dow Jones Industrial Average, the deterioration in short-term economic prospects, and the downside risks now associated with the U.S. dollar all count in gold’s favour. However, with the gold market operating under the same uncertainties as all financial markets, nervous caution still looks set to govern market activity in the days ahead.

— The opinions presented are solely the author’s and do not necessarily represent those of the Barclays group.