Base metals prices put in a mixed performance during the report period Nov. 26-30, driven by further production cuts and by differing responses to Enron’s troubles (see editorial, page 4). Copper, which saw an increase of 3.5% in its average cash price, and aluminum, which rose 3.2%, were the main gainers. Lead, at 1.4%, and nickel, at 1.1%, rose more modestly, while zinc prices actually fell, by 1.3%.
It’s hard to escape the conclusion that copper and aluminum prices are heading for a sharp fall. We had expected the focus to return to the downside, but nervousness over the demise of Enron resulted in short-covering that drove prices to their highest levels in many months. Meanwhile, the global economy was taking yet another turn for the worse. With recent optimism about the U.S. economic outlook fading, cuts in American interest rates are back on the agenda and being priced back in by the markets. Recent data has confirmed there is little sign yet of the long-awaited recovery. The Chicago Purchasing Managers’ Index, which dropped more than five points in November to 41.1 (the 14th consecutive month of contraction), suggests that the U.S. manufacturing sector, and hence metals demand, is still falling and will continue to do so for some time. Meanwhile, the eurozone continues to deteriorate, and we now forecast it will be in technical recession until at least the second quarter of next year. The report period saw the biggest increases in exchange stocks of copper and aluminum in several months, and if, as we suspect, Enron’s problems result in further deliveries into London Metal Exchange (LME) warehouses of some its large off-warrant holdings of metal, this trend could be with us for some time. Once fundamentals reassert themselves, metals prices may fall back as quickly as the Enron share price.
Copper prices held up much better than we had expected, as jitters over Enron, short-covering by the company itself and smelter-refinery output cuts pushed the LME 3-month price to an 18-week high of US$1,595 per tonne on Nov. 30. The Enron factor renders the short-term price outlook difficult to predict. Current prices are not supported by fundamentals, but market participants are likely to be wary of going short if Enron has more buying to do. In the medium term, the outlook is bearish if the company is forced to deliver its off-warrant holdings of copper to LME warehouses. There are signs that this is already happening, with LME stocks rising almost 14,000 tonnes in the last two days of the week under review. In the short term, a range of US$1,540-1,600 per tonne looks likely, but if the lower end is broken, a swift move down to US$1,500 is probable.
At last, late on Nov. 30, the market got the production cuts from Asarco that it had been anticipating. At face value, they appeared to be in the right ballpark, with a headline figure of a 95,000-tonne reduction in output at the Amarillo refinery (taking production to 232,000 from 327,000 tonnes per year). On closer inspection, however, the cuts are much less than the 100,000 tonnes hoped for. The Mission mine, in Arizona, which had been operating at a rate of around 70,000 tonnes per year, will be cut by just 23% (16,000 tonnes per year). The rest of the cut, at the Amarillo plant in Texas, will come from reduced blister refining after the loss of Asarco’s 75,000-tonne-per-year supply from the Chemetco smelter, the closure of which, about a month ago, should already be reflected in the price. Meanwhile, Nippon Mining’s 40,000-tonne smelter cut is not surprising given the dramatic dip in Japan’s demand for copper.
Aluminum prices too were buoyed by the events surrounding Enron, with the LME 3-month figure hitting a peak of US$1,470 per tonne on Nov. 29, its highest since early July. The strength in aluminum prices appears even less justified than in copper, but Enron was a large buyer on Nov. 29 (estimated at around 4,000 lots), bringing fund-related purchases in as well. Like copper, aluminum stocks are now climbing rapidly, up 16,400 tonnes in the early days of December, with further deliveries likely. One side effect of Enron’s problems could be an easing in the tightness that had started to build in forward spreads early next year. Currently, that tightness remains mild, with February trading in a US$1 backwardation, but in previous years, this has usually widened sharply.
Despite the rapid appreciation in aluminum prices since the lows of early November, there has been little forward selling by producers. The forward curve has moved up almost as quickly as cash and 3-month quotes, suggesting that most producers are expecting prices to be even healthier in 2002.
The rally in copper and aluminum prices has not helped
The usual culprits for a weak performance can be found: stocks up by more than 5,000 tonnes on the week; lack of production cuts; and reports of bearish views held by producers and consultants. Moreover, the lack of response in zinc prices exposes the highly technical nature of the current rally in base metals. Price direction is being steered by fund activity in copper and aluminum. With funds largely turning their backs on the zinc market, prices have been left to wither on the sideline, and they now look poised for further falls. The poor state of fundamentals was outlined by the Doe Run chief executive officer, who forecast prices remaining depressed for several years. Adding to the pessimism, AME, the Australian-based consulting firm, also painted a gloomy outlook for the market, with consumption remaining negative until 2003. The technical picture, too, leaves zinc poised for a fall: the weekly chart shows the Nov. 30 copper-aluminum rally lifting prices back above the 10-day moving average. This should simply be a postponement of a fall, however, and we predict a drift below this moving average and below US$800 in the immediate term.
During the start of the report period, nickel prices became distorted by false stories that Noril’sk in Russia was to cut nickel production by 10% next year. Market nervousness (generated largely by fund-covering in copper and aluminum) was acute and a price reaction was inevitable. The initial move back above US$5,600 per tonne was brief, however, and confirms our view that nickel prices above US$5,200 per tonne are still unsustainable. With production news still dwarfed by developments in copper, the supply side fundamentals in nickel remain comparatively unchanged. Our price target in the short term consequently remains US$5,000 per tonne.
Behind the headline news, however, there were some subtle supply-side changes in the nickel market. The daily cancelled warrant data released by the LME suddenly showed a sharp jump over the past few days, increasing to the highest levels since May 2001. Given that such data indicate how much material is being taken off warrant and out of LME warehouses, the increase is viewed by some as a sign of future stock movements. Nickel stocks already fell by 132 tonnes during the report period, while copper and aluminum registered large increases. The implication of high cancelled warrant data is that if large deliveries into warehouses do not take place in the next few weeks, stocks will continue to fall. The last time cancelled warrants rose to these levels, nickel prices increased to beyond US$7,400 per tonne.
Gold prices were exposed to numerous influences in the Nov. 26-30 period — some positive, some negative. The overall result, however, was that the former were cancelled out by the latter, leaving prices to operate in narrow ranges and failing to show signs of clear direction. Although prices have so far shown a reluctance to claim back lost ground above US$275 per o
z., the risks to prices look to have moved away from a test of US$270-per-oz. support taking place in the immediate future.
With market attention in commodities firmly focused on the base metal and energy markets in the aftermath of Enron’s sudden demise, gold has operated somewhat in the shadows. Notwithstanding low volumes, however, the yellow metal has managed to reinforce support at US$270 per oz. once again — this despite the emergence of several bearish influences on prices.
Chief among these was a very neutral Bank of England gold auction earlier in the week, which had denied prices potential support from strong levels of buying interest. Judged on the cover ratio figure, this was one of the poorest-ever auction results. Also, the week opened in London with U.S. speculative funds on Comex holding a net short position for the first time since August. Exposing prices to potential short covering, this could be bullish, but the broader implication is bearish, showing, as it does, that funds have altered their opinions on gold and returned to previously held negative views.
These two downside developments aside, there has also been significant weakness in the U.S. dollar. Downbeat economic news from the U.S. together with negative sentiment resulting from what looks likely to be the biggest corporate failure in that country’s history have pushed the U.S. dollar/euro to three week lows after a week of deterioration. This pro-gold weakness in the U.S. dollar has so far been able to offset the potentially negative developments of fund short selling and the ongoing issues of central bank sales.
— The opinions presented are solely the author’s and do not necessarily represent those of the Barclays group.
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