Base metals prices fell sharply during the report period July 15-19, erasing most of the gains made in aluminum and copper since the rally of late May and early June. However, the LME index of all base metals looks a little healthier. It has fallen back from its peak, but is still about 3.6% above its lows of late May. This is mainly a result of strength in some lower-volume contracts, notably nickel and zinc. However, gains in these two markets will also start to look fragile should weakness in U.S. equity markets begin holding back what has so far been an encouraging economic recovery.
Much appears to rest on the U.S. housing sector. The positive wealth effect of rising house prices is at least partially offsetting the decline in personal net worth stemming from falling share prices, thus lending support to consumer spending and overall U.S. growth. More directly, the U.S. construction sector is one of the world’s largest end-use markets for base metals. During the report period, slightly lower-than-expected housing starts were offset by an increase in building permits, suggesting that the sector remains robust. Our U.S. economists have argued that although the rate of house price appreciation in the U.S. is likely to slow over the next few years, it is not a bubble about to burst. If they are right, then continued growth in both U.S. house prices and construction activity should prove a key factor in supporting further recovery in metals prices over the next year.
Copper prices have hit our short-term technical target of US$1,580-1,600 per tonne, shedding almost US$60 per tonne in the week under review and taking LME 3-month prices back to levels last touched in late May. During that period, fund long interest on the Comex peaked at an all-time high of more than 32,000 lots as copper moved to its highest level for 14 months at US$1,706 per tonne.
The other main buyers during this period were Chinese merchants. However, the attractiveness of copper as an investment is waning as economic expectations are scaled down and the Shanghai/LME differential returns to below the level required for arbitrage to be profitable. Indeed, interest from these two camps may well be subdued for the next few weeks. If so, upside is likely to be limited until early September. In the short term, we expect recent lows from April at US$1,563 per tonne to be tested, though below this, the downside is likely to be limited as prices should begin to look attractive to non-U.S.-dollar-based consumers.
Farther ahead, we continue to believe that copper is well-placed to make strong gains, so long as physical demand picks up in early September. A key reason for this is the current tightness in raw material markets. This has shown up most clearly in China’s copper concentrate imports, which have contracted sharply in recent months. However, China’s refined copper production has yet to show any signs of contracting, having climbed 11% in the first half to reach 774,000 tonnes. China’s own mine production is unlikely to have accounted for more than 270,000 tonnes of this, imported concentrate, for perhaps another 240,000 tonnes. That leaves a gap of more than 250,000 tonnes, to be filled by local concentrate stock draws and use of scrap. Given that concentrate imports are likely to continue falling in the second half of 2002, this position appears unsustainable to us, and a sharp fall in Chinese copper production is likely soon.
Aluminum prices look vulnerable after recent sharp falls that took LME 3-month figures below the US$1,365-per-tonne level, which has been providing strong support on any downward moves. The catalyst for the move lower appears to have been a fall in copper prices, which in turn encouraged some light spill-over liquidation. Until July 19, low volumes of European consumer buying, encouraged by the weaker U.S. dollar, had placed a floor under the market. The likelihood, after the recent fall, is that consumers’ price targets will have been lowered a notch. Consequently, a test of US$1,340 per tonne looks possible in the short term.
There is little in aluminum market fundamentals to prevent prices sliding to the low US$1,300s. Alcoa’s recent announcement that it will guarantee some of the infrastructure costs associated with its proposed 295,000-tonne-per-year Icelandic aluminum smelter illustrates that producers are prepared to plan expansions even in the current environment of low prices and uncertain demand.
Quite how Alcan can forecast even tentatively that the aluminum market could move into deficit next year (as it did when it recently released its second-quarter results) we find difficult to fathom. Our current forecast is for a surplus of more than 300,000 tonnes. A balanced market would need demand growth of 8%, following on from the 5% growth we forecast in 2002.
Recent reports that Japanese port stocks in June had fallen to an all-time low of 188,200 tonnes need to be placed in context. The key point for us is that the increase in LME stocks is more than offsetting any falls in other reported stock levels.
After jumping above the key resistance area of US$7,500 per tonne during the previous report period (July 8-12), nickel prices traded at more realistic levels. The softer tone to the rest of the LME complex has acted as a cap on short-term price prospects for a start, while matters more peculiar to the nickel market have also combined to relieve some of the upward price pressure. These matters are part technical and part fundamental. Although prices moved above the US$7,700-per-tonne area, no consolidation had taken place before prices headed lower as a burst of producer-selling hit the market. Although LME inventory levels were down on the week, the stock draws have slowed, and they lack the scale to act as a reliable brake on any price slide.
Also, the reaction to news that talks had begun between Inco and labour unions regarding the renewal of contracts at the 145,000-tonne-per-year nickel plant in Thompson, Man., may have been overplayed. Current labour contracts do not expire until September, leaving the rest of the summer period for negotiations to take place. Although no details have been released indicating the pace of progress, the market clearly feels that stumbling blocks will be met. Given the importance of the plant to global supply levels (10% of total) in a market that remains tight and is notoriously volatile, the market will continue to monitor the situation carefully. The deadline for the current labour contract is approaching, so if the talks have not reached a satisfactory conclusion, it seems inevitable that nickel prices will experience renewed upward pressure. Improved supply-demand fundamentals show that consumption is beginning to outstrip production, meaning that future price strength will not all be based on labour-related speculative buying alone.
After falling back from their recent peak of almost US$850 per tonne, zinc prices found good support at around US$830 per tonne, suggesting that, in the short term at least, the rally from mid-June lows of around US$770 per tonne remains intact. In the short term, we do not rule out another test of US$850 per tonne, nor even a move back up to the March high of US$870 per tonne.
The zinc market certainly appears much tighter than it did just a few weeks ago. Demand from the galvanized steel sheet sector is still patchy, but overall the picture is one of gradual, if rather fragile, improvement. Coupled with temporary smelter cutbacks and the substantial drop in both Chinese zinc production (minus 12.2% in June, year over year, and minus 8.7% in the first half of 2002) and exports, the market has moved into a small, though probably temporary, deficit.
Against this backdrop, regional premiums have picked up substantially. In Europe, spot premiums are at US$60-70 per tonne from US$45-55 in late May; in Singapore, they are at US$20-25 per tonne (from US$7-12), and in the U.S., they are up to US4.3 per lb., compared with 3.9 per lb. Because producer shipments have been reduced, demand for LM
E metal has picked up and LME stocks levelled off at around 600,000 tonnes. A steep rise in cancelled warrants, spread regionally among warehouses in the U.S., Europe and Asia, confirms that the falls are supported by fundamental developments and that there are more to come.
So, have LME stocks peaked? We doubt it. Outokumpu’s recent purchase of the Bula deposit, neighbouring its Tara mine in Ireland, makes a restart even more likely, and as smelters return from summer maintenance, we expect a swing back into market surplus and further increases in LME stocks.
The rally in gold prices on July 19 appears to have been triggered by carefully executed buying by a major U.S. hedge fund soon after the opening of the market in New York. Worse-than-expected U.S. trade figures (with the deficit reaching a record US$37.64 billion), further erosion of equity market values, and a new high in the eurodollar all provided a positive backdrop to the move. Whether or not it signals fresh upward momentum remains to be seen. It’s worth noting, though, that gold has failed to establish fresh highs since its recent peak in early June, and if it does not do so soon, fund longs will lose patience.
Although weakness in equities and in the U.S.-dollar has not pushed gold prices significantly higher, could a return of confidence to these markets pressure gold lower? Our view is that it could. Although we have always maintained that gold’s price rally was fuelled by internal means (in particular, the process of consolidation within the gold industry and the re-assessment towards gold hedging by producers), that does not mean that the influences of a weaker greenback and poor investor confidence in other U.S.-dollar-denominated assets have no bearing on possible gold price moves.
But in a market that is being driven more by sentiment and less by fundamentals, the bearing that these macro-economic and “external” factors could have on gold prices should not be understated. A strong recovery in equity markets may not be necessary for price weakness to creep into the gold market. If equity markets begin to bottom out, funds may swiftly be moved out of gold. What has kept speculative longs from liquidating so far is the belief that gold prices are capable of returning to, and climbing above, the US$330-per-oz. level. Part of this belief was built on expectations of gold price volatility on the back of stock market falls. With prices failing to behave in this fashion, these strong beliefs may soon turn into weak sentiment, and the consequences for the gold market would be renewed weakness and a return to US$310-312 per oz.
— The opinions presented are the author’s and do not necessarily represent those of the Barclays group. For access to all of Barclays’ economic, foreign-exchange and fixed-income research, go to the web site at barclayscapital.com
The Week at a Glance
– Copper prices look set to test April lows of around US$1,560 per tonne after their steep fall at the end of the report period July 15-19. However, concentrate tightness suggests better fundamentals so long as demand continues to improve.
– Aluminum prices followed copper lower in the latter half of the report period, though buying by European consumers helped slow the descent. If consumers lower their price targets, a test of US$1,340 per tonne is next.
– Nickel was knocked off its lofty perch by a small volume of producer selling, but a lack of follow-through selling betrays market nervousness surrounding labour negotiations at Inco’s operations in Ontario.
– Zinc prices look capable of further gains, supported by healthy increases in regional spot premiums. However, we expect the increase in London Metal Exchange zinc stocks to resume once summer maintenance at smelters comes to an end.
– Gold prices spiked sharply higher on July 19 after strong buying by a major hedge fund. However, unless fresh upward momentum is established, fund longs are in danger of being liquidated.
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