Metals give back August gains

After another poor week, base metals markets ended back at their recent lows and have now given back almost all of the gains made in August’s second half rally.

Nickel has fared worst of all, cementing its position as the poorest performer of the major London Metal Exchange (LME) traded metals, by registering fresh 25-month lows. The price fall sparked small amounts of forward buying on Thursday and Friday, but interest appears to be much less than when prices were last at these levels three weeks ago. If more selling emerges it may not take much to push prices down to fresh lows in the current cycle.

Forward-looking indicators are continuing to improve but are doing little to lift the bearish mood in base metals markets. Last week’s figures from the National Association of Purchasing Managers (NAPM) exceeded even the most optimistic forecasts by a large margin, confirming that the U.S. manufacturing sector is stabilizing. But there is not yet any sign of any pick-up in base metals demand there, or in any of the other of the world’s major economies.

LME stocks are continuing to trickle upwards and physical premiums are depressed. In the absence of a physical pick-up, prices look set to move lower in the short-term, making production cuts more likely. Last week’s news suggests that Chinese zinc producers are already hurting and an announcement concerning zinc production cuts is expected from China soon.

Copper production cuts could also be on the horizon if prices move much lower. Copper prices came under heavy selling pressure last week as a combination of poor data releases, weak stock markets and LME stock increases brought forth fresh shorting of the market. LME 3-months ended the week back at its low for the year so far at just above US$1,440 per tonne.

Paradoxically the market appeared to lend more weight last week to the poorer-than-expected NAPM non-manufacturing index and some weak U.S. jobs data than the much stronger-than-expected and more relevant NAPM manufacturing index (+47.9 vs. 43.8).

Light volume Far East and trade buying helped to slow the price fall on Friday and fund profit-taking should provide another layer of support for copper at $1,400-1,440 per tonne.

However if the market is to move higher, signs of a pick up in demand are desperately needed. Despite the improvement in some leading indicators there is little sign of this yet.

Demand for cathode from U.S. brass mills is one of the few sectors where there has been some mild improvement recently but this probably reflects a lack of scrap availability in the U.S. rather than any pick up in orders for brass mill products.

Emphasizing the slackness of the physical market some large deliveries into LME warehouses in Europe and the U.S. in the second half of last week meant a net increase in LME stocks of 6,775 tonnes.

Aluminum prices also fell sharply last week, with LME 3-months returning to mid-August lows of just above $1,370 per tonne. A key factor in the price decline was the liquidation of part of a large options trade on Thursday. Official LME data showed that almost 24,000 lots were traded, though this was almost certainly exaggerated by the original business flowing through several different market makers. It is thought to have resulted in around 2,000 lots of actual forward selling.

Small amounts of forward buying emerged to support the market on Friday morning but this will have to pick up if prices are not to move below their previous lows.

Alcoa announced last week that it had cut production at its 90,000-tonne-per-year Pocos de Caldas aluminum smelter by a further 22,500 tonnes annually to 45,000 tonnes per year. The company also cut production at its 370,000-tonne-per-year Alumar smelter by a further 29,500 tonnes to 280,000 tonnes per year.

These cuts move Alcoa’s smelters in line with those made by other Brazilian smelters in response to the country’s power crisis. We estimate that Brazilian smelters are now operating at around 72% of capacity and that around 133,000 tonnes per year of production will be lost in 2001 relative to total production in 2000 of 1.279 million tonnes. If the smelters continue to operate at current rates for the whole of 2002, we estimate that around 350,000 tonnes of production will be lost.

Zinc prices fell back toward the bottom end of their recent trading range last week on weakness in the rest of the base metals complex. News that China may be on the verge of announcing major production cuts failed to move the market higher but is likely to prevent prices moving below recent support in the low US$830s.

There were distinct signs last week that the supply side of the industry is starting to respond to the current low level of prices. Early in the week China’s largest zinc smelter, Huludao, announced the closure of its 130,000 tonne-per-year no. 3 smelter though its additional smelting capacity of 200,000 tonnes per year will remain in operation. Before the closure, Huludao had been expected to produce 290,000 tonnes of zinc this year; therefore lost output on an annual basis is estimated at around 90,000 tonnes, equating to around 30,000 tonnes over the rest of this year. Market impact is judged fairly minimal since according to our forecasts, the zinc market was due for a surplus of 300,000 tonnes this year and 385,000 tonnes in 2002 anyway.

However, reports are emerging that China’s 20 leading zinc smelters met last week to plan production cuts. The China Nonferrous Metals Industry Association is expected to announce an agreement soon and it is thought that each smelter will be required to cut output by an agreed percentage. For the time being the market is not getting too excited until a firm announcement is made but given the fact that China is the world’s largest zinc producer at over 2 million tonnes per year, any co-ordinated cut could be quite significant.

Nickel prices fell sharply last week, extending nickel’s position as the worst performing major metal traded on the LME. Prices are now trading at 25% below the level at which they started the year. With the market now heavily oversold and consumer buying interest emerging late last week it looks likely that support at US$5,100 per tonne will hold for the time being, but if this gives way, a test of the 1999 low at US$4,660 per tonne may be on the horizon.

Russian nickel exports registered a large decline in the January-July period, falling by 11% to 96,900 tonnes. Exports for the year so far are around 12,000 tonnes less than in 2000, suggesting that Noril’sk is slightly behind in its plan to cut exports by around 40,000 tonnes this year to 155,000 tonnes, announced in April 2001.

The figures imply that Russian exports in the second half of 2001 are likely to be around 20-30,000 tonnes less than year-ago levels if the target is to be met.

Given the tightness in stainless-steel scrap that still persists, as well as recent production problems at Aneka Tambang and Falconbridge’s Falcondo plant and intermittent interruptions still occurring to Australian laterite output, nickel supply is rising less quickly than previously thought.

Whether or not this provides much help to prices will depend on an improvement in demand over the rest of this year and at present there appears to be little sign of this.

Gold prices held up surprisingly well last week finding firm support at just above US$270 per oz. despite a sharp fall in the euro which fell to below US89 before recovering a little toward the end of the week.

Given the euro’s weakness, with which gold-price movements have been quite closely correlated for most of the year, and the apparent lack of upside potential for gold prices at present, it is very surprising that funds have liquidated only a small portion of their large net long position.

It is just plausible that funds are hanging on to long positions as a hedge against further U.S. dollar weakness or a deterioration in the U.S. economic outlook.

However, a more likely reason is last week’s announcement of an A$3.2 billion bid for Normandy Mining by
AngloGold. In the wake of the bid Anglo restated its hedge policy, reiterating that it aims to hedge up to 50% of 5-year forecast production over a 10-year period in order to secure stable revenue flow, irrespective of market volatility.

Although Normandy has reduced the size of its hedge book recently, it still hedges a larger portion of its output than Anglo. Could the funds be waiting for hedge book restructuring resulting from the merger to boost prices? If they are they may have to wait a long time.

On this specific element of the merger Anglo’s official comment was that it may run down the Normandy hedge book a “little bit.” The most likely way for this to be done is for Anglo to deliver gold into short positions without rolling them forward, rather than instituting a buy-back, in which case market impact is likely to be limited.

With the U.K. gold auction taking place on Wednesday, price movements early this week are unlikely to move out of the recent US$270-275-per-oz. range. After that, we continue to favour the downside and a test of support is likely if euro weakness resumes.

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