Looming slowdown triggers liquidation

The report period Dec. 11-15 saw a bout of liquidation in metals markets, inspired by worse-than-expected U.S. economic data. As a result, prices fell back — nickel, by 2.9%; tin, by 1.7%; and lead, by 0.4%. These were the weakest performers in markets that are trading in increasingly thin volumes ahead of Christmas holidays.

Although most analysts estimate that base metals markets have mostly moved into surplus in the fourth quarter, the rate of decline in London Metal Exchange (LME) stocks is only just beginning to show signs of slowing down. All the major LME metals have so far recorded steep falls in inventory in the fourth quarter (copper, down 71,000 tonnes; aluminum, down 61,000 tonnes; zinc, down 27,000 tonnes; and nickel, down 800 tonnes), taking stocks to their lowest levels in many years. Metal inventories may be building up off-warrant, but this is likely to be of little comfort to those short on the LME. The tightening in nearby spreads that occurred during the report period, as copper and aluminum prices rallied, illustrates the vulnerability of base metals markets to squeezes. If LME stocks remain at their current levels, volatility in nearby spreads could be an uncomfortable feature of the market early in 2001.

Copper prices picked up steam again on the morning of Dec. 15, regaining most of the ground lost earlier in the week as the LME 3-month price reached a high of just over US$1,930 per tonne. However, resistance at this level was reinforced by a spate of worse-than-expected U.S. economic data that hit the market in the early afternoon, and prices fell back sharply, ending the week back below US$1,900 per tonne. After its recent gains, copper now looks set for a test of the downside, though this is likely to be limited while a volatile aluminum market could still move up, taking copper higher with it. Technical support is provided by the 30- and 200-day moving averages at US$1,840-1,850 per tonne, and resistance, by 10- and 100-day moving averages at US$1,895-1,900 per tonne.

Stock movements suggest that the physical market is now easing, but it is too early tell if this is just due to seasonal factors or if it reflects an underlying slowdown in demand. LME and Comex stocks together shed almost 13,000 tonnes during the report period, but this was partly offset by a big increase in Comex and Shanghai stocks, giving a net fall in global exchange stocks of only 2,000 tonnes. The rise in Shanghai stocks is not surprising, given the massive increase in Chinese net imports of cathode this year and recent data showing domestic refined copper production ahead of year-ago levels by 25%. The Chinese economy has shown some signs of slowing in the past month, when retail sales slowed, but activity is still at a high level. Contributing to the stock rise is a slowing down of activity ahead of the Chinese New Year holidays which fall earlier than usual this year, beginning Jan. 23.

The recent settlement between Freeport and the Japanese for a treatment charge of US$80 per tonne and a refining charge of US8 per lb. (covering 2001 concentrate deliveries) appeared, at first sight, to be above market expectations. But after adjusting for such factors as the US$6-per-oz. gold refining charge (Freeport concentrate is unusually high in gold), the terms turned out to be closer to US$75 per tonne and US7.5 per lb., in line with market expectations. The settlement is a little below mid-year terms but above those of a year ago, suggesting that concentrate availability is increasing gradually and will not be a constraint on refined production growth in 2001.

After the previous report period’s dramatic gains, aluminum price action was relatively subdued. Downside support at the US$1,590-1,600-per-tonne level was tested early on, before prices bounced back strongly to challenge resistance just above US$1,630 per tonne. Meanwhile, forward-selling by producers put heavy pressure on the back end of the forward price curve.

The aluminum market has good reason to remain nervous about the U.S. power situation. Spot power prices in the Pacific Northwest are extremely volatile and recently have been running at highs of US$3,000-5,000 per MW-hour. The Bonneville Power Administration (BPA) was forced to alert aluminum smelters and other industrial customers to prepare for cuts in electricity because cold weather had raised demand from other consumers. The BPA revealed it has a contract with Alcoa whereby, for a price, it will reduce the voltage at its smelters, enabling the BPA to increase voltage over the remainder of the grid.

In thin volume, nickel prices fell sharply, testing support just below US$6,800 per tonne for the LME 3-month price before rebounding a little. The catalyst for the selloff appears to have been a big increase in LME nickel stocks on Dec. 13 (plus 420 tonnes), but withdrawals earlier in the week and large falls on Dec. 14 and 15 (totalling more than 400 tonnes) meant that, overall, the stock change on the week was still negative.

Nickel prices have lacked direction since early October, meandering in a range of US$6,600-7,400 per tonne. Negative factors such as weaker demand from stainless steel producers and good availability of stainless steel scrap means there are few buyers at the top end of this range. Likewise, three factors — the Falconbridge strike in Sudbury, Ont., low visible stocks, and the continued tightness in nearby spreads — mean that taking a large short position is risky. While this uneasy impasse continues, nickel market volumes are likely to remain low, and price action, subdued.

Zinc prices, unlike copper and aluminum, remain on course to end the year below the average price set during 2000. Prices gained support during the report period, but there was no upward momentum from recent supply constraints and declining LME stocks. A firm support level is being established at US$1,090 per tonne; however, given the lack of fund interest in zinc, price upside depends very much on fundamentals. Moving into 2001, the question for zinc therefore is: What are the fundamentals and what are the prospects for a recovery?

One key reason for zinc’s weakness is illustrated by figures showing that world supply is moving into surplus in the fourth quarter. Consumption is estimated to have fallen for the third consecutive quarter, to 2.3 million tonnes, while supply is forecast to rise to 2.2 million tonnes. This latest view of the zinc market pushes supply growth in 2001 up by 5.8% and demand by 5%, edging the market into a balance, which we believe will turn into a 105,000-tonne surplus next year.

Throughout this year, declining LME stock levels have failed to encourage bullish sentiment. At 195,750 tonnes (stocks fell 2,800 tonnes during the report period), LME stocks are at their lowest level in almost nine years, while prices remain at the bottom of an 18-month range. What remains the guiding force of zinc prices, apart from the increases in supply, is the perception that:

– following large increases in galvanized steel production, excess stocks exist;

– the economic climate is looking increasingly negative for industrial production; and

– despite fewer exports in the fourth quarter, China’s capacity to depress prices through higher exports remains potent.

In all of these perceptions, an element of truth exists. The release, on Dec. 15, of disappointing U.S. industrial production data and the recent downward revision in its third-quarter gross-domestic-product growth rate indicate that the tighter fiscal policy this year is taking its course. In terms of demand for galvanized sheet, all the major U.S. auto producers have announced cutbacks in production in an attempt to bring stock levels under control. Also, preliminary data from the China’s State Statistical Bureau have confirmed that that country’s capacity to saturate the market remains large: zinc production in the year to November increased to 1.8 million tonnes, up 17.3% over the comparable period in 1999.

The key variable in this bearish outlook for zinc prices remains the progress of the world economy, or, more particularly, the direction and fortunes of the U.S. economy. It is not surprising that commentators have become merchants of gloom as each set of data has confirmed that the boom that hit a peak in the second quarter is unwinding. What is more surprising is that six months ago this was widely expected to take place; the key concern was whether the Federal Reserve Board had gone far enough in its attempts to curtail the rampant growth levels. The controlled downturn we are now seeing is therefore part of a preconceived plan and, relying on track record, Federal Reserve Board Chairman Alan Greenspan is capable of achieving it without turning the massive supply-side gains of the past decade into a recession.

The implication for zinc prices is apparent. If the current climate over the U.S. economy clears during the first half of next year and the prospects for industrial demand growth are resurrected, consumers will face depleted stock levels at a time when economic fundamentals are strengthening and turning in zinc’s favour. With increased supply levels forecast to come on-stream through 2001, this scenario is dependent on a question of timing. It is still possible, however, that zinc may have the last laugh.

Gold will end this year following the trading patterns it has set throughout the past 12 months. Again, gold prices proved their lack of resilience against the wider picture of weak fundamentals, central bank sales and a powerful, psychologically bearish sentiment barrier against achieving even mild gains.

The rally during the previous week proved to be short-lived and was, in part, a function of Comex short-covering as funds reduced a net short position that had been steadily increasing since gold fell through its US$270-per-oz. support level. Figures released on Dec. 15 show the trend continued in the week to Nov. 12.

A further reason given for the previous week’s rally was the strengthening euro against the U.S. dollar. Following additional data that confirmed the slowdown in U.S. economic activity (November industrial production fell by 0.2%), the greenback was unable to claw back losses incurred during the past three weeks, when investor confidence in the U.S. began turning sour.

The year 2001 offers little by way of bullish influences for gold prices. Central bank sales will continue, and, with the pace of world growth forecast to decline, demand figures, already weakened this year, look set to fall further. The longer-term outlook for gold, as the industry absorbs structural changes is more complex, and we shall be looking at this further throughout the coming months. For the shorter-term, however, we do not expect 2001 to be a happier new year for gold prices.

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