Strength returns to base metals

During the report period Dec. 4-8, base metals markets put in their best performance since late August, as funds rushed to cover short positions. The market was invigorated early in the week by hints from Alan Greenspan that the phase of rising U.S. interest rates may be at an end, and then later on by a series of power-related cutbacks in aluminum. Not surprisingly, aluminum was the week’s major gainer, ending on Dec. 8 at an 11-week high of US$1,593 per tonne. Meanwhile, copper hit a 7-week high of US$1,912 per tonne, while zinc touched US$1,113 per tonne, its highest level since mid-October. Nickel, lead and tin, with much smaller fund positions to leverage off, remained subdued.

Copper prices continued their steady upturn, supported by Greenspan’s remarks. Another fall in global exchange stocks of the red metal, combined with a positive report on copper market fundamentals from the International Copper Study Group (ICSG), had the effect of sending the London Metal Exchange (LME) 3-month price to an 8-week high of US$1,918 per tonne.

The ICSG estimates that the copper market deficit for the first nine months of the year was a massive 393,000 tonnes, with the preliminary monthly balance for September moving back into a deficit of 29,000 tonnes after a surplus of 71,000 tonnes in August. This estimate of the copper market deficit is at the high end of the range. We estimate a figure of 320,000 tonnes; Brook Hunt estimates 400,000 tonnes; and CRU International, 309,000 tonnes. However, by any standards, copper market fundamentals have been exceptionally strong this year.

The copper price rally of recent weeks has taken place on relatively thin volume and is mainly the result of fund short-covering. However, the low level of visible stocks and sluggish outlook for supply growth next year may now be tempting some funds to build long positions. This process will probably be gradual, and we do not expect any further dramatic further appreciation in copper prices over the next several weeks. However, we are becoming increasingly confident about copper’s price prospects for next year.

Readers who have followed our comments on the aluminum market will know that we’ve been warning that the risk of large-scale power-related cutbacks in the U.S. has not been fully priced in by the market. The 191,000 tonnes of production cuts recently announced brings the total amount of U.S. power-related cuts to more than 700,000 tonnes since early summer and suggests that, even with a slower pace of demand growth, the aluminum market could be in deficit by almost 500,000 tonnes in 2001. Furthermore, we estimate that around 150-200,000 tonnes of capacity in the northwestern U.S. is still vulnerable to closure. Higher aluminum prices have already pushed other base metals up, and the immediate short term should continue to be volatile for the whole complex as the market adapts itself to the probability of a tight market for aluminum next year.

Aluminum prices spiked higher during the report period, mainly in response to a spate of announcements about production cuts at U.S. smelters that resulted from high power prices. Other factors contributed: LME stocks fell by 11,550 tonnes; funds were rumoured to be big buyers of upside calls for early 2001; and nearby tightness intensified, with the January 3-month spread moving to a US$7 backwardation.

A total of 191,000 tonnes of production cuts were announced at three smelters: Columbia Falls (minus 51,000 tonnes per year); Alcan’s Kittimat (minus 50,000 tonnes); and Kaiser’s Mead (minus 90,000 tonnes) smelters. Also, the 115,000-tonne-per-year Vanalco smelter has now ceased all operations. The new Bonneville Power Association contracts, which cut power supply to smelters in the northwestern U.S. by 25%, do not take effect until October, but there is evidence that aluminum companies are cutting back output before that date in order to take advantage of high power prices by selling power back into the grid. For example, Columbia Falls announced it would be able to sell 100 MW of power as a result of its production cut.

The slow, steady uptrend in nickel prices continued during the period under review, with the LME 3-month price closing at US$7,345 per tonne, almost US$800 above the mid-October low of US$6,600 per tonne. Further gains appear to be in store if the rest of the base metals complex can sustain its overall recovery, but nickel’s price rebound is not only attributable to improvements in other metals markets.

There is growing talk that the de-stocking cycle in stainless steel is now drawing to a close, particularly in Europe where producers negotiating contracts with consumers have been encouraged by healthy levels of demand for early next year. However, we are skeptical that the de-stocking in Europe is over, given the high levels of stainless stocks recorded just a few weeks ago. Nonetheless, there is little evidence of weak fundamentals in key nickel market indicators, such as LME stocks, where no clear upward trend has yet developed. The report period was a case in point: although stocks rose 174 tonnes overall, a 534-tonne delivery on Dec. 7 was more or less offset by a 486-tonne withdrawal on the following day.

With visible nickel inventory remaining low (helped by a decision by Noril’sk to build up stock in Russia rather than ship metal to Europe), the pressure on LME shorts continues, as is illustrated by the tightening of nearby spreads again. The cash-to-3-month backwardation flared out to more than US$340 per tonne late in the report period.

The general price upturn in the base metals complex took some time to influence zinc‘s fortunes, and, until Dec. 7, it appeared that paralysis was setting in. However, the prices on Dec. 7-8 suggest that a buoyant performance is ahead.

The major source of strength was supply-based: LME stock levels fell below 200,000 tonnes for the first time since February 1992. Having shed 3,650 tonnes, stock levels now stand at 198,550 tonnes, and, with cancelled warrant figures doubling, the drawdown in stocks is likely to continue.

Cominco’s decision to cut refined zinc production by 20,000 tonnes between now and next month provided a further fillip to prices. The move allows Cominco to sell power back to a U.S. energy company and take advantage of strong power prices at a time when zinc prices are weak. It also comes shortly after output at Pasminco’s smelter, in Hobart, Tasmania, was cut by 8,000 tonnes following a fire.

From the downturn that began in early September, zinc has formed a firm base in the range of US$1,060-1,090 per tonne. With short-term supply issues turning in zinc’s favour, prices may establish a higher trading range in the short term.

Gold prices again proved their susceptibility to sharp swings higher. Though prices look stronger (earlier in the report period, they were able to hold on to previous gains and, by Dec. 7, had jumped to a near-2-month high of US$275.65 per oz.), we believe there has been no any change in gold’s fundamental position, nor in its medium-to-long-term prospects.

The increase in price is not due to one isolated change. Rather, a host of ingredients has combined to fuel the increase and prevent further weakness on the downside.

The economic climate remains one of gold’s key driving forces. Although the U.S. ended the report period with its economy looking more robust than in the previous week (largely thanks to positive productivity figures and upbeat words from the Fed), the U.S. dollar continues to look weak. The euro remains at a 6-week high against the greenback, though, with Eurozone data not supporting the recent rise, these gains are unlikely to be sustained.

In part, technical factors drove the recent price spike. A clear trend line exists from gold’s peaks following the Washington Accord in September 1999 and announcements from major producers in February that hedging programs were to be restricted. Once prices broke through this trend line, on Dec. 6, funds still holding significant short positions interpreted the break as a signal to cover their positions.

Finally, the fund short position on Comex at the beginning of the report period was still large, at almost 27,000 lots, down from 36,000 lots in the week. This provided ample fuel for a short-covering rally.

Key data expected from the U.S. and the Eurozone regarding inflation and gross domestic product (GDP) growth, respectively, should give an indication of future currency movements. Given that the Eurozone’s GDP in the third quarter has been slow, prospects for the euro, and therefore gold prices, appear less than robust.

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