Weak consumer confidence blocks rally

After rallying in the first few weeks of August, the major base metals markets gave up a substantial portion of their gains in the period Aug. 27-31. Long liquidation, accompanied by some fresh commodity-trading-advisor short selling was sparked off by worse-than-expected U.S. consumer confidence data. The markets never recovered, and by the end of the week, what had been a promising technical picture, was deteriorating, with prices breaking below key moving averages.

With the summer holiday period not quite over, it is still difficult to gauge the state of the physical markets, and the direction of metal prices will probably remain sensitive to U.S. macro-economic indicators for some time. Although the August survey of the National Association of Purchasing Management is expected to show a modest drop in activity, most of the recent data from the industrial and manufacturing sectors continue to be consistent with a mild pickup in activity (factory orders and the Chicago Purchasing Managers’ Index exceeded expectations).

However, there are growing concerns about U.S. consumption levels, and these concerns were exacerbated by the recent big drop in consumer confidence data. With consumer spending likely to deteriorate further in Europe as the slowdown takes hold, and with no hope of any pickup in Japan, an awful lot rests on the U.S. consumer. Metals producers, along with the rest of the global economy, will be hoping they continue to spend.

Aluminum prices fell back sharply, giving up most of the gains that had been made since early August. The London Metal Exchange (LME) 3-month price crashed through both the 10- and 30-day moving averages on Sept. 30 after fresh fund-selling on the part of commodity trading advisors failed to meet the consumer buying interest that had been evident during previous dips. The strength of the euro and the return of consumers from holiday had boosted European buying interest earlier in the report period, but Thursday’s selling did not take off until after European trading hours. Some European buying came in to support the market on the morning of Sept. 31, but it was not enough to take LME 3-month prices back to previous highs, and the range for the short term now appears to be US$1,395-1,425 per tonne.

There are still few signs of any improvement in demand although there is growing evidence of the depth of destocking that has already taken place this year. Inventory of aluminum products held my members of the National Association of Aluminum Distributors is down 20% from year-ago levels. Shipments by members in June 2001 were 25.2% below levels recorded in June 2000, suggesting that further destocking has probably taken place in July and August. U.S. gross domestic product data for the second quarter also pointed to dramatic destocking, with inventory falling by US$38.4 billion, the fastest decline since the first quarter of 1983. These data lend support to the view that when the U.S. economy does begin to recover, there is scope for a rapid rebound in primary demand. Copper prices were left searching for support at US$1,500 per tonne late in the report period, after failing to break above US$1,540 per tonne in the first half. The deterioration came after broker liquidation sparked off fresh commodity-trading-advisor fund sales, suggesting that the fund net short position on the Comex division of the New York Mercantile Exchange, already large at more than 17,000 lots on Aug. 28, has grown again. Modest European buying interest suggests a fragile floor to the market at around US$1,495-1,500 per tonne in the short term, with the upside capped at around US$1,525 per tonne.

Global copper demand is still poor and suffering from persistent weakness in the electronics sector. Japanese wire and cable shipments fell 5.9%, year over year, in July, with shipments to the electrical sector especially weak, down by 11.9%. Wire and cable orders fell 7.4% — the sixth consecutive month of decline, suggesting that further falls in Japanese shipments of wire and cable are likely.

Production is also slowing. Chilean copper output rose by 1.2%, year over year, in July to 404,600 tonnes. Local mining groups expect production this year to grow to 4.7 million tonnes (an increase of 1.9%) and for growth to slow further next year to just 1.1%. These projections represent a significant slowing of growth in Chilean copper production, which grew by almost 25% between 1998 and 2000.

Zinc prices followed the rest of the base metals complex sharply lower, though the LME 3-month figure managed to keep just above its recent lows. Earlier in the report period, zinc had failed to break convincingly above either the 10- or 30-day moving averages, so the breakdown, when it came, was not a surprise. With both fundamental and technical indicators continuing to look weak, a test of the recent low for LME 3-month prices at US$831 per tonne looks inevitable unless the rest of the base metals complex starts to see some improvement.

Zinc market fundamentals are especially week at present. On the supply side, Peru, the world’s third-largest zinc producer, released data showing mine production had risen more than 8%, year over year, to 562,000 tonnes between January and July. The International Lead Zinc Study Group (ILZSG) also reported increases in production. Global mine production rose 4.2% in the first half of 2000, while refined output rose 6%. Meanwhile, global zinc demand is estimated to have fallen 1%. Also on the demand side, data from the Korea Trade Information Services (Kotis) showed that that country’s zinc exports fell almost 25%, year over year, in the January-to-July period. The weakness of the U.S. dollar, combined with the low zinc price, has helped reduce zinc mine profitability even further, yet there is still no sign of the cutbacks required to improve market fundamentals.

Nickel prices have been performing less impressively than other base metals. The LME 3-month price broke decisively below the 10- and 30-day moving averages during the second half of the report period and now look set to challenge support at US$5,400 per tonne. If this level gives way, a test of the recent low of US$5,250 per tonne looks likely. The negative sentiment that is currently pervading the nickel market was summed up by the almost total lack of reaction to the announcement that ferro-nickel production at Falconbridge’s 32,000-tonne-per-year Falcondo plant in the Dominican Republic is to be halted for three months, owing to poor nickel prices and high oil prices. Around 8,000 tonnes of nickel in ferro-nickel will be lost, but commitments to customers will not be affected.

Partially offsetting the Falcondo closure was PT Aneka Tambang’s announcement that it is restarting its ferronickel smelter in Sulawesi earlier than expected, and that full production is anticipated by October. Owing to an explosion in July, the plant was expected to remain closed for 3-4 months, resulting in an anticipated loss of 1,260 tonnes of nickel. Losses are now estimated at 1,086 tonnes.

An interesting dichotomy appears to have opened up in the gold market, between the bearish brokerage community and bullish speculators. A good measure of the way brokers view the current market is the GoldAvenue Gold Analysts Sentiment survey, a weekly poll of analysts and brokers who give a figure between 1 (very negative) and 10 (very positive) to indicate their view of short-term price direction. It recently returned its lowest-ever average: 3.69. Meanwhile, the funds continue to hold on to the largest net long position for many years. Given the low volumes of trade and the almost complete lack of producer or consumer activity at present, it is these two constituents that are making up most of the market, and given the US$270-276-per-oz. trading range during the report period, something of a stalemate appears to have developed.

Movements up and down within this range are being driven mainly by currency fluctuations, with gold’s direction in inverse relationship to the fortunes of the U.S. dollar. Recen
t data (particularly the much-weaker-than-expected U.S. consumer confidence figures for August) were greenback-negative and probably helped gold to defend its US$270-per-oz. floor. However, with some better U.S. data expected in the days ahead (the Chicago Purchasing Managers’ Index and July factory orders, in particular), plus the likelihood that there is further bad data to come out of Europe, the days of weakness in the U.S. dollar may be numbered.

For the time being, funds appear to be happy to hang on to their gold positions despite the inability of prices to move higher, but this is likely to change quickly if signs that the U.S. economy is recovering continue to emerge.

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