Higher prices offset low volumes

The report period Nov. 27-Dec. 1 saw most London Metal Exchange (LME) metals hold on to gains made late in the previous week. Nickel, aluminum and copper were the main climbers, with weekly average prices up by 3.9%, 2.6% and 2.3%, respectively. However, despite the improved performance, volumes are low and prices do not look entirely convincing at these new, higher levels. Furthermore, upside potential seems limited, and a period of quiet range-trading is looking increasingly likely between now and the year-end.

Markets continue to be concerned about oil, the euro and the state of the U.S. economy. Oil prices remain volatile, and in the short-term there is still potential for a sharp upward hike in crude prices. However, there is a growing consensus that once the Northern Hemisphere cold weather has run its course, the price of crude will return to the range of US$22-28 per barrel, which is the target of the Organization of Petroleum Exporting Countries. This would calm fears that oil prices are contributing to inflation and slower growth. The stronger euro (up 5% over the past two weeks) should also benefit metals markets, though this, in itself, is indicative of a faster-than-expected slowdown in the U.S. economy. In the U.S., metals-consuming parts of the economy, such as manufacturing and transport, are slowing much more rapidly than other sectors, raising the fear that a soft landing for the general economy could still be a hard one for metals demand.

Despite having climbed to a 4-week high of US$1,863 per tonne in the middle of the report period, copper prices never looked convincing at these levels, and it was not surprising to see them fall back a little by the end of the week. The large fund net short-position on Comex at the start of the report period failed to provide enough fuel for anything but a modest rally, and funds are probably neutral now. Nor has a weaker U.S. dollar leant much support. Instead, the market has continued to focus on a deteriorating U.S. economy, with recent stock market jitters proving particularly damaging. Unless fund short-covering becomes a factor, a range of US$1,780-1,880 per tonne looks like a pretty good bet for the rest of the year.

One positive feature of the market is the continued drawdown in global exchange stocks. The fall in combined LME, Comex and Shanghai inventory accelerated again in November, dropping 40,000 tonnes, compared with minus 23,000 tonnes in October and an average monthly decline of 40,000 tonnes for the year so far. This stock fall has not helped prices, owing to the widespread perception that it represents an addition to non-exchange inventory rather than consumption.

Since the beginning of the third quarter, when global consumption started to slow down, non-exchange stocks have risen by an estimated 300,000 tonnes. But just how serious is this? If we add this amount to total exchange stocks at 494,000 tonnes plus other reported consumer, merchant and producer stocks at around 1.1 million tonnes, we get a global copper inventory figure of 1.9 million tonnes, or around 6.6 weeks of global consumption. This is significantly above industry comfort levels, even if a substantial portion of off-warrant material is located in inaccessible locations such as China.

Current copper price levels are therefore probably a pretty fair reflection of fundamentals. We still expect copper prices to rise early next year, but this will depend heavily on whether good consumption growth leads to further declines in global inventory levels.

Like copper, aluminum prices were unable to build on early gains in the report period. After reaching a peak of US$1,538 per tonne on Nov. 29, the LME 3-month price fell back to support at US$1,500 before recovering a little on Dec. 1. The fact that positive technical signals for aluminum (notably the crossing of the 10- and 30-day moving averages) failed to prompt much buying signals a lack of upside potential at present. In the short term, there is support provided by the 30-day moving average at US$1,493 per tonne, but if this gives way, it will likely lead to a re-test of recent lows of US$1,440-1,450 per tonne for the LME 3-month price. On the upside, aluminum looks unlikely to make much headway above US$1,550 per tonne.

U.S. demand remains the main area of concern. Closely watched U.S. aluminum shipment data released by the Aluminum Association shows that shipments fell by more than 6% in September.

Evidence from manufacturers of fabricated product suggests there is worse to come in the U.S. Mill stock levels are high and CRU International now forecasts a 6.2% decline in consumption of flat-rolled product in the first quarter of 2001, following an estimated decline of 8% in the fourth quarter of this year. Extruded products shipments are forecast to suffer an even larger decline in the first quarter, minus 15%. Given the dramatic weakening expected in semi-fabricated products markets, it seems likely that consumption of primary aluminum in the U.S. could fall sharply over the next six months.

With a hard landing for U.S. aluminum demand looking increasingly likely, we are downgrading our LME cash price forecast for aluminum next year to US$1,650 per tonne from US$1,750.

Nickel prices trended gradually downward for most of the report period but found good support from the 10- and 30-day moving averages at just above US$7,000 per tonne. Unless the rest of the base metals complex weakens significantly, prices are unlikely to dip below this level Few market participants are willing to go short at a time when LME stocks are low, the cash-to-3-month backwardation is in place, and the strike at Falconbridge’s operations in Sudbury, Ont., is dragging on.

Despite the fact that the base metals complex moved away from recent lows, zinc prices managed only a weak recovery. Prices moved up from their lows on the back of the previous Friday’s (Nov. 24) rally above the 10-day moving average. But by the end of the recent report period, the gains had been given up and, once again, the US$1,060-per-tonne support level was tested. Nonetheless, this support level is looking increasingly secure.

Although zinc prices were not as buoyant as copper and aluminum, it would have been naive to have expected any greater shift higher. The mild copper and aluminum rally aided sentiment by showing that the September downturn had come to an end. It did not, however, signal that a bull run was about to begin. It was liquidation of short positions amassed during September and October that fuelled the rally. However, zinc attracted little short-selling during the period, as prices were already low.

Although long-term supply side issues have not benefited zinc prices this past year, recent trends suggest that any move to the downside is unlikely in the short term.

For one thing, LME stocks have been steadily declining throughout recent months. Stock levels shed 5,074 tonnes during the report period, bringing the total stock decline this quarter already to more than 20,000 tonnes. This steady decline has also brought total zinc stocks to within just 2,200 tonnes of falling through the 200,000-tonne level.

Also, news of reduced mine and smelter production has reached the market at the same time that a spate of closures, strikes and temporary cuts in production were announced. The strike at Outokumpu’s 157,000-tonne-per-year Tara mine in Ireland continues, and there are no indications as to how long it might last. In addition, Tennessee-based Pasminco Zinc has closed its 240,000-tonne-per-year smelter in Hobart, Tasmania, following a fire that damaged the conveyer system. The shutdown is expected to last a couple of weeks. As well, Toronto-based Breakwater Resources announced that rising treatment charges and low zinc prices had forced the closure of its Langlois mine, near Val d’Or, Que. The 28,000-tonne-per-year mine will remain closed until the second quarter of 2002. Finally, Toronto-based Inmet Mining, which owns 49% of Turkish miner Cayeli Bakir Isletmeleri, has received notification that the union representing workers at Cayeli’s mine can legally go on strike beginning Dec. 7.

In the face of these supply-side announcements and the possibility that stock levels will slip below 200,000 tonnes, it is unlikely that zinc prices will fall US$1,060 per tonne, and we believe support will hold. The extent of zinc’s potential on the upside is not so clear. Despite signs that economic prospects are looking more gloomy, zinc consumption remains healthy. And though we do not forecast a general uptrend in zinc prices, there would seem to be potential for something of a step-up. However, if zinc fails to fulfil this potential, prices are likely to trend sideways and, in doing so, set the tone of paralysis.

Gold has a tendency to rally on weakness in the U.S. dollar, which is what happened during the report period, when prices climbed to a 6-week high of US$272.30 per oz. as the dollar weakened against all major currencies. The release of data from the U.S. Commerce Department, including a revision downwards of provisional gross domestic product growth to 2.4% from 2.7%, has damaged confidence in the invincibility of the dollar, and this is the reason for its current weakness. However, we still forecast a soft landing for the U.S. economy and a resurgence in strength for the greenback.

As the U.S. economy enters a period of some volatility, the strength of the U.S. dollar will be tested further. For short-term gold prices, this implies a stronger band of support around the US$260-270-per-oz. level, as the appetite of speculators to go further into short territory is restrained by the threat of sudden moves higher.

The longer-term perspective is a different matter. Presuming our outlook on the U.S. economy is correct, confidence and stability can be expected to return to the U.S. dollar early next year. The long-term consequence for gold is that prices will then adopt a more bearish outlook as investor confidence returns to U.S.-based assets. In the short term, however, we believe gold prices will remain supported on the downside by volatility in the U.S. dollar and the stock market, while vulnerable to short-lived spikes to the upside.

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