Base metals steady as summer approaches

The major base metals continued to trade steadily to slightly lower during the report period May 20-24. The fillip of much-better-than-expected U.S. durable goods orders helped push prices to a fairly encouraging close on May 24, though recent trading ranges remain intact. With the summer slowdown approaching and inventory levels on the London Metal Exchange (LME) more than comfortable, there is little sign of a break to the upside.

Looking ahead, there is mounting evidence that the conditions are falling into place for a much stronger performance in prices over the latter part of this year. The best evidence for this comes from the U.S. New orders for shipments of durable goods have climbed sharply higher in recent months. This is supplemented by anecdotal evidence that demand for semi-fabricated products, particularly aluminum flat-rolled product in the construction and distributor sectors, is strong indeed, and lead times are lengthening.

Chinese metals consumption and demand from some other parts of the Far East are also healthy, though Europe is lagging behind. Reports from European metals companies indicate that sluggish demand could last for some time as both Umicore (copper and zinc producer) and Draka (supplier of copper cable) reported little sign of any upturn in their sectors. A distinct lack of European consumer buying interest despite lower metals prices and a stronger eurodollar bears out these reports. Nevertheless, as long as the U.S. continues to drive a global recovery, European demand prospects should steadily improve. Indeed, by early in the fourth quarter, the conditions could be in place for a strong rebound in base metals prices.

Copper‘s strong close to the report period pushed LME 3-month prices to the top of their recent range on May 24, boosted by better-than-expected U.S. durable goods orders. The durable goods orders series is notoriously volatile, but the 3-month trend is up, and the improvement in copper’s demand conditions in the U.S. is born out by other indicators as well. The U.S. Geological Survey leading index surged 0.9% in March, signalling that improvement in the U.S. copper industry is on the way. The component covering hours worked in copper-fabricating plants made the largest positive contribution.

Strong Chinese buying of copper and steady withdrawals from visible stockpiles (down by 13,000 tonnes during the report period, though from levels still close to 1.5 million tonnes) are also providing a positive backdrop to the market. Japanese copper demand looks healthier now as well but is unlikely to be sustained, given that country’s ongoing economic problems. A better bet is Korea, where growth has recently turned out stronger than expected and is less dependent on export markets. With speculative interest in copper at well below its recent highs, there is scope for another run-up in prices.

However, if copper is to break above its recent high at US$1,677 per tonne, then an upturn in European demand is required, of which there is no sign yet. Both Umicore and Draka Cable have issued profits warnings amid downbeat projections for the copper parts of their business.

After a half-hearted attempt to break out of its recent downtrend, aluminum continues to stagnate, and a test of the December low at US$1,325 per tonne now looks likely. The performances of aluminum and copper have diverged sharply since late April, the spread climbing almost US$50 per tonne to US$270 per tonne over the same period. Any investor seeking leverage to the global economic recovery is unlikely to be attracted to aluminum, where LME stocks continue to climb, China is exporting large amounts of metal, and substantial spare capacity overhangs the market. These factors are all absent in copper and help to explain its much better recent performance.

Higher inventory levels in LME warehouses have undermined support in nickel prices, as has the perception that stocks levels are set to climb higher still. The brief dip toward US$6,400 per tonne was certainly sharper than expected, but the quick recovery has led prices to our target of US$6,600 per tonne. The week began with rumours of imminent stock increases to the tune of 10,000 tonnes. In the event, stocks rose by 3,150 tonnes, still sufficient to dent confidence, but well short of rumours. However, with large export volumes having left Russia early in the second quarter, there is a risk that further material has yet to show up in LME inventory data. We therefore regard a return to US$6,800-7,000 per tonne as unlikely in the near term.

Zinc‘s firm end to the report period after hitting a 6-month low on June 10 is unlikely to be the precursor of a sustained recovery. Although there are signs of some improvement in demand from the steel galvanizing sectors in both North America and Europe, the outlook continues to be darkened by oversupply. The May 20-24 period was, on the whole, a poor one for zinc. The restructuring of Pasminco appears to be taking place without any loss of production, and the Clarksville smelter in the U.S. is on the selling block, as are some mines in Tennessee and the Elura mine in Australia. Although none of these is a particularly attractive asset, they will all be kept in operation while the company searches for buyers. Pasminco’s three Australian smelters and the Budel smelter in the Netherlands will be retained and presumably operate as close to full capacity as possible in order to keep down unit costs. Meanwhile, the company has sold its Broken Hill mine, and forward-selling associated with this deal (plus hedging from Kagara Zinc’s Mt. Garnet project) looks likely to overhang the zinc market for some time.

With Antamina’s zinc production climbing in the first quarter and the reopening of the Tara zinc mine looking more and more likely (Outokumpu will announce a decision on June 7), smelters are unlikely to close as a result of tightness in zinc concentrate. To encourage the scale of production cuts that are required to rebalance the market, a sustained period at sub-US$750 for zinc prices is now required.

There is a problem with much of the comment on the current rally in the price of gold. It is that it misleadingly suggests that a broad base of sophisticated investment funds has been spooked into becoming gold-friendly because of political or economic fears. However, the factors that have pushed gold to its highest level since October 1999 are still a little more everyday than heightened fears of an economic or political meltdown against the backdrop of nuclear hostilities. Does this mean gold is no longer a “safe haven”? It would be interesting to know exactly how gold has earned itself this rather curious, almost mythical, title; more interesting still to know how it has managed to retain it over the past two decades of unprecedented economic and technological expansion. As a term, it is in danger of becoming a piece of verbal Polyfilla, used to explain a phenomenon that doesn’t really exist, by commentators who have a few holes in their knowledge of how the contemporary gold market operates.

But so what, so long as the herd mentality dominates and enough funds continue to buy into the self-fulfilling story? As with the emperor’s new clothes, if sufficient numbers believe the hype, does it matter if unimpressive fundamentals are clothed in nothing but their own speculation? With gold prices piercing through US$320 per oz. during the report period, it would seem not. However, claims that investment flows are undertaking a volte-face and reversing their long-term flows away from bullion toward other assets are certainly not correct. The source of the current strength in gold prices would seem to lie in the laps of small speculative funds rather than in the fears of broad-based investment flows.

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