During the report period Aug. 13-17, the base metals complex put in its strongest performance since late May, which suggests that the long downtrend in prices may be turning at last.
Because the bulk of the rally came toward the end of the week, average price gains were fairly unimpressive (tin was the biggest gainer, at +2.1%, whereas aluminum gained only 0.3%). Of more significance were breaks above key technical price levels. After the rally on Aug. 17. aluminum, copper and nickel are all trading above the 30-day moving averages for the first time since late May/early June, pointing toward the likelihood of fresh fund short-covering in the short term.
Whether or not these developments really do mark an end to the downtrend or are just another technical correction in a thin holiday market remains to be seen. The upward move appears to have been sparked by fund profit-taking that then spilled over into broker short-covering. As yet, there has been no change in underlying fundamentals. Indeed, the poor August Philadelphia Fed Index (minus 23.5, from 12.2) suggests that we can expect further contraction in the U.S. manufacturing sector. Also, the soon-to-be-released business climate index from Germany’s Institute for Economic Research (IFO) is expected to confirm worsening economic conditions in Europe. Despite the weaker U.S. dollar, consumers (many of them still on holiday) are showing little interest in buying, while producers appear just as reluctant to cut production. In the absence of real physical interest to sustain the price rise, markets are likely to drift back to support levels again by the end of the week.
Copper halted its long downtrend late in the report period, rallying strongly on Aug. 16-17 to push the London Metal Exchange (LME) 3-month price to its highest close since late July at US$1,516 per tonne. The move higher was sparked by the aluminum price rally and helped by better-than-expected U.S. housing, consumer price index and initial claims data that prompted some broker short-covering. Funds were not heavily involved at first but began to cover shorts as LME 3-month prices approached US$1,500 per tonne. Some borrowing of the September/October spread was evident during the report period, and September, for a day, continues to trade in a small backwardation. However, there are, as yet, no signs that the spread will balloon as it did in July. With 80,000-100,000 tonnes of metal rumoured to be ready for rapid delivery to LME warehouses in the U.S., any further tightness that does develop seems unlikely to last for long.
Exchange stocks of copper rose a fairly modest 6,000 tonnes during the report period, while cancelled warrants continued to climb, suggesting that a modest rise in physical offtake may be ahead. After hitting almost 31,000 tonnes on Aug. 15, their highest level for a year, stocks fell back to just below 26,000 tonnes — still relatively high. Meanwhile, despite a downward revision of copper price forecasts to US78-82 per lb. for 2002, Corporacion Nacional Cobre de Chile said it would not consider closing its 40,000-tonne-per-year El Salvador mine, where cash costs are now above current price levels.
Aluminum prices registered their biggest 1-day upward move since mid-May, gaining US$31 per tonne on Aug. 16 before reaching a peak of US$1,433 on Aug. 17 — an 18-day high for the LME 3-month figure. The rally was fuelled by fund short-covering against the background of a stronger euro, though without fresh consumer interest, it is unlikely to be sustained. On Aug. 17, prices closed US$11 per tonne below their high for the day, suggesting short-covering may be losing momentum. If so, another test of support at US$1,400 per tonne looks likely in the short term.
In a perverse week for the zinc market, prices rallied strongly, ending at US$876 per tonne, their highest level since mid-July, despite a massive 34,000-tonne increase in LME stocks. As with other base metals, the upward move appears to have been fuelled by fund profit-taking in a thin market, which then brought in some dealer short-covering. At the beginning of the week, zinc prices had also rallied, but then, after closing at the bottom of their trading range for three consecutive days, they began to look decidedly vulnerable; of course, that was prior to the big move on Aug. 17. Given the large increase in zinc stocks during the 5-day period and the continued absense of any cutbacks on the mining side, it is difficult to view the late-in-the-week improvement as anything more than a rally in a bear market. Consequently, a return to test support at US$864 per tonne, the 30-day moving average, looks likely before too long.
The vulnerability of the nickel market to short-covering price rallies was clearly highlighted during a flurry which took prices to beyond US$5,800 per tonne from lows earlier in the week of around US$5,250. The move higher was in clear sympathy with the other industrial metals, which were themselves subject to a surprising degree of short covering and profit-taking. The increase in prices has taken place despite the lack of a clear signal that the downturn in the U.S. or global manufacturing sector is over (the U.S. dollar fell to its lowest level against the euro since May) and without any signal to indicate a turnaround in the pessimism over the U.S. economy, which has been growing throughout the summer.
Although we believe the rally will be short-lived, it may act to caution commodity trading advisors against aggressive short-selling. This, together with a firmer base metals complex, may help to slow the move back down to US$5,600 per tonne in the days ahead.
On initial face value, the gold price had a good week; a hold of support at US$275 per oz. was followed on Aug. 17 by the highest closing price in London since late May. Against the backdrop of the lowest euro/greenback level since March and a significant deterioration in U.S. economic confidence, it is debatable whether the gold market was really able to take full advantage of its supportive background. A late fund-buying surge in thin conditions on a Friday has happened on a number of occasions this year and has failed to take the pressure away from downside risks. In the short term, a move above higher resistance will depend largely on the commitment of fresh buying by the funds that have already dramatically increased their net long position in recent weeks (the fund net long position on the Comex division of the New York Mercantile Exchange now stands at 33,000 lots, its highest since late May).
Given that we expect this week’s data to be more U.S.-dollar-friendly and that gold prices and the euro look equally overbought from a technical perspective, the chances of a significant break above US$280 still look limited.
From a fund perspective the evidence may appear less persuasive. The first break above US$268 per oz., earlier in August, failed to attract speculative buying straight away, and it was not until prices exceeded US$272 per oz. that open interest figures on Comex showed the presence of fund-buying. Also, two sets of data at the start of the week painted a less-than-encouraging outlook for investment activity. Turnover data from the London Bullion Market Association showed both fresh lows for daily average ounces transferred and for the daily average value of gold transferred; the former fell to 16.1 million oz., down 21% month-over-month and 21.5% year-over-year, whiile the latter fell to US$4.3 billion. World Gold Council figures also showed investment demand for gold falling 14% year-over-year in the second quarter of 2001 and 8% year-over-year in the first half of 2001. During a time of massive equity weakness, these are not encouraging figures. Indeed, they provide a reminder that there are fundamental limits to gold price strength.
— The opinions presented are solely the author’s and do not necessarily represent those of the Barclays group.
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