Modest recovery projected for base metals in 2003

This article is the second of two instalments devoted to base metals and was culled from Barclays Capital’s monthly report The Commodity Refiner. Part 1 appeared in our Dec. 2-8 issue, and a separate report on aluminum and tin markets will appear in our Dec. 16-22 issue.

As discussed in last week’s column, we think further attempts on the upside in base metals markets will be capped until leading demand indicators turn around. As a result, we have kept our previous price forecasts for the period 2003-06 unchanged, and continue to expect only a modest recovery next year. We have upwardly revised fourth-quarter prices for all base metals, bar tin, to capture recent rallies. This revision, in turn, has resulted in an aggregate rise to our fourth-quarter estimate of 6.8%.

Copper

The copper market is relatively well-placed to take advantage of an eventual recovery in demand. Supply-side factors together with external market developments (related to equities and currencies) have enabled higher prices recently. Funds (primarily commodity trading advisors) covered short positions aggressively over the past month, allowing the large net short on the Comex to reverse to a net long. This occurred despite a deteriorating outlook for demand, with signs of restocking coming to an end in the absence of improvements in underlying demand.

Producer discipline remains a key topic, while strike actions and financial constraints have also been significant features of late, providing price support. Grupo Mexico is considering shutting its high-cost Mission mine in Arizona before year-end. Even though the mine currently produces only 46,000 tonnes per year of copper-in-concentrates (following cutbacks in 1999 and 2001), a shutdown could have an important impact on the company’s smelting operations (200,000 tonnes per year at the Hayden plant) and refining operations (220,000 tonnes per year at the Amarillo plant), as Mission accounts for almost 25% of feed to its smelter. Over the past month, Grupo Mexico faced a strike (which has ended) at the 180,000-tonne-per-year Toquepala mine in Peru, as well as strikes at the 160,000-tonne-per-year Cuajone mine and the 300,000-tonne-per-year Ilo refinery. Meanwhile, it appears that its U.S. subsidiary, Asarco, would receive short-term financial respite by extending its short-term debt of US$450 million until the beginning of 2003.

In South America, Corporacion Nacional del Cobre de Chile (Codelco) has decided to prolong curtailed output at its Chuquicamata mine (of 50,000 tonnes per year) through 2003. However, the company will still produce 100,000 tonnes more copper this year (total: 1.6 million tonnes) than it did in 2001. Although this was in line with our expectations, it is disturbing that the company made its decision in spite of its forecast of continued weak market conditions. BHP Billiton (which played an important role in introducing producer discipline a year ago in response to weak demand and low prices) will announce the future of its idled output (170,000 tonnes per year) by year-end. Both BHP Billiton and Rio Tinto reported declines in output for the third quarter (-9% and -4%, year over year, respectively), and we expect BHP Billiton will maintain idled capacity at least in the first half of 2003.

In finely balanced market conditions and in light of positive price performance of late, recent supply-side developments highlight this market’s sensitivity to any production disturbances. Although we do not believe supply-side factors alone will enable a long-term trend reversal, at least they help provide a floor under the market.

On the demand side, the latest statistics from the International Copper Study Group (ICSG) suggest world copper usage fell by 4%, month over month, in August, despite a sharp rise in imports to China. However, during the first eight months of this year, usage rose 1.5%, year over year. As a result, the global copper market registered a 13,000-tonne deficit in August, but a 74,000-tonne surplus in the January-to-August period. We expect the Western World market will move into deficit next year.

q Prices — Trading statistics from the Commodity Futures Trading Commission (CFTC) show the speculative net long on the Comex increased further to 17,500 lots as of mid-November on the back of a combination of fresh longs and short-covering.

Fund exposure to copper is still below recent peaks, suggesting that there is potential for fund positions to be extended, supporting a continuation of the recent trends that have seen prices rise. However, we think there is good reason why fund exposure may be approaching its limits now.

The relationship between open interest and prices suggests that the establishment of fresh long positions supported the price rise in the first quarter, whereas declines in the second quarter were the result of a combination of long liquidation and fresh short selling.

In October, total futures open interest for copper stood at 202,000 lots, down marginally by 0.5%, month over month, but up by 10.8%, year over year. Lately, however, open interest and prices have risen simultaneously, reflecting renewed buying of fresh long positions on the London Metal Exchange (LME).

Trading volumes of LME copper futures have been in an overall modest downward trend since 2001, though they picked up during September and October after a quiet August. However, in October, volumes rose sharply to 1.6 million lots, up by 30.9%, month over month, and by 12.7% compared with the corresponding month of 2001.

Copper was the second-heaviest-traded LME metal after aluminum in October.

The shape of the copper curve has remained remarkably steady over the past month, though price levels for all future contracts are higher than in previous months. While there has been evidence of nearby tightness, all future dates are trading in contango, reflecting good metal availability over the next 63 months. Contracts for 27-63 months forward started trading on Oct. 1.

European contract premiums were set at US$38 per tonne for 2003. Although unchanged over 2002, consumers are reluctant to agree in the face of slack demand.

Still, spot premiums in Europe have risen. Although total LME stocks are not far from all-time highs (at 860,000 tonnes), material is either tied up in warehouse rent deals or held tightly by various market participants. Asian spot premiums have continued to rise, in light of continued strong demand, primarily from China, Taiwan and South Korea.

In the U.S., scrap tightness has enabled spot premiums to remain relatively firm, with premia trading from US2.75 to 3.5 per lb., depending on location.

Spot treatment and refining charges (TC/RCs) remain low, enhanced by recent shipment disruptions at Ok Tedi. A recent mud slide at the Antamina mine in Peru could help keep TC/RCs under pressure.

On a contract basis, miners have gained a reduction of more than US2 per lb. on TC/RCs for next year, with Escondida and Freeport settling with the Japanese at around US$58 per tonne and US5.8 per lb. This is the lowest level since 1988. We believe, however, that with the Escondida Phase IV expansion and increased output at Grasberg, TC/RCs are close to their lows at present.

q Inventories — LME copper inventories have continued to decline modestly since their August peak, falling another 9,000 tonnes during October.

Drawdowns have been evident in most regions, especially at warehouses in Baltimore, Md., which have fallen by about 20,000 tonnes since the beginning of October. Reductions have occurred also at the Shanghai Futures Exchange, with inventories registered at 119,000 tonnes in mid-November, down from more than 200,000 tonnes only a couple of months ago. Comex stocks, on the other hand, have remained stable at around 345,000 tonnes in recent months, having climbed above the 300,000-tonne mark in May this year.

Cancelled LME copper warrants have been in a modest uptrend since July, though they rose sharply by 23,700 tonnes in a single day (Nov. 11), amounting to about 50,000 tonnes in mid-November. However, this is still well below the peak of 92,000 tonnes in May, when LME copper stocks started to decline.

With still about 50,000 tonnes awaiting outward shipment, we think LME stocks are likely to continue to fall modestly in the near term, despite poor demand conditions.

Total commercial inventories amounted to 2.2 million tonnes at the end of August, according to the latest available statistics from the ICSG. This represents a decline from the previous month of about 20,000 tonnes, primarily as a result of declines in LME inventories, which represent the major share of total reported stocks (41%).

Copper stockpiles held at producers (including estimates of Chilean producer inventories) were reported at 470,000 tonnes for the end of August. Although total reported copper stocks have been reduced in recent times, they remain near all-time highs. The stock-to-consumption ratio rose to an estimated 10.4 weeks in the third quarter, also representing an all-time high.

Lead

While benefiting from more positive sentiment on the LME, supply developments in China, related to the lack of concentrates and poor prices, have been supportive. Nonetheless, we believe the lead market will enjoy only modest demand growth even with a pick-up in economic activity.

On a brighter note, the winter battery season could have a near-term positive impact. The latest statistics from the Battery Council International showed replacement battery shipments to North America for January to July rose to 49.3 million units, up 5.9%, year over year. However, longer (lead-acid) battery lives are contributing to both depressed lead demand and tight scrap availability.

The raw material market for lead remains tight, with spot TCs having fallen further, to below US$100 per tonne for deliveries into Antwerp. As a result, Chinese refined output is falling, which has been an almost unseen trend in the past.

Domestic production fell to 96,000 tonnes in September, following production of 105,000 tonnes in August, 109,000 tonnes in July and 117,000 tonnes in June. This has kept net exports to the Western World subdued, at 13,500 tonnes in October. During the first 10 months of this year, net exports were 321,200 tonnes (with exports down by 4%, year over year) and third-quarter export volumes represented the lowest levels for four years. Chinese producer premiums remained high in October, suggesting exports are likely to remain subdued and keep imports attractive.

Also on the supply side, Doe Run (the world’s largest lead producer, at 280,000 tonnes of lead per year) avoided moving to Chapter 11, as it managed to restructure its debt, whereas the future of M.I.M.’s Avonmouth smelter (producing 35,000 tonnes of lead per year) is still uncertain. We think closure is likely, though this would have only minimal impact on the global market.

The latest data from the International Lead and Zinc Study Group (ILZSG) show total Western World refined lead consumption fell to 439,900 tonnes in August, which was 0.8% lower over the month. During the first eight months of this year, consumption was 1.9% lower, year over year (at 3.5 million tonnes).

Demand growth trends were similar on a global basis. With global production amounting to 530,100 tonnes in August and 4.3 million tonnes in the January-to-August period, the global market registered balanced market conditions in August, but a 65,000-tonne surplus for the January-to-August period.

Global mine output declined sharply, according to the ILZSG, to 1.8 million tonnes during the first eight months (-10.4%, year over year) and to 226,800 tonnes in August (-1.3%, month over month). We have reduced our near-term demand growth assumptions and expect another year of surplus market conditions before the market moves into deficit.

q Prices — Spot lead treatment charges have fallen to their lowest since mid-1995, at just below US$100 per tonne in October. This reflects the tight concentrates market for lead. Australia is the largest exporter of lead concentrates (454,000 tonnes in 2001). For the first nine months of this year, exports were 26% lower at 92,500 tonnes. Chinese imports of lead concentrates, meanwhile, fell 13.2% over the same period to 234,000 tonnes.

The relationship between open interest and prices during most of this year suggests speculators have been shorting lead aggressively. In recent times, however, data from the LME suggests that a combination of short-covering activity and the establishment of long positions have supported higher prices.

In October, total futures open interest for lead amounted to 48,000 lots, compared with 52,000 lots in the previous month, but higher than the 43,000 lots in October last year.

Trading volumes of LME lead futures have been relatively stable in recent months, at around 275,000 lots. In fact, current trading volumes are well above the 250,000-lot average for the period January 1998 to October 2002.

In October, volumes rose sharply to 450,000 lots, up sharply by 65%, month over month, and by 55% from the corresponding month of 2001. As a result, lead ranked number four in terms of trading volumes on the LME in October, with nickel and tin behind. (On average, lead and nickel volumes tend to be similar.)

The current lead forward curve shows that nearby prices have risen at a faster rate than forward prices recently. The curve’s shape suggests that forward prices will remain below US$500 per tonne, but we also expect spot prices to remain below this level over the next year.

The nearby cash-to-3-month spread suggested good metal availability for spot delivery through October. However, in mid-November the nearby spread narrowed quickly to a small contango of only US$3 per tonne, compared with an average of US$10.7 per tonne in October.

Apart from Singapore, physical spot premiums for lead have been falling over the past month. This is especially true in Europe and the U.S. Demand remains weak, and warehouses contain plenty of material still. Chinese producer premiums remained high in October, which should keep exports subdued.

q Inventories — Recent trends in LME lead inventories have persisted over the past month. Inventories held at U.S. warehouses have continued to rise rapidly, while other major warehouse locations have continued to report net drawdowns over the same period. We believe this is due to Far Eastern metal being redirected from Europe to the U.S. The net change over the month was small, with the total having fallen by only 800 tonnes.

Like the trend in LME lead inventories, cancelled warrants have also been volatile. In mid-November, cancelled warrants amounted to about 10,000 tonnes (or about 6% of the total remaining). Given the prevailing weak demand environment, we think the level of LME lead stockpiles will remain firm in the near future.

According to the latest statistics from the ILZSG, producer inventories (representing the largest share of total reported lead stockpiles) fell by 3,300 tonnes in August to 197,600 tonnes. Consumer stocks were steady at 140,500 tonnes over the same period. As a result, total reported lead inventories amounted to 533,200 tonnes in August, representing a reduction of 6,200 tonnes over the month. Compared with the same month last year, however, total reported lead stocks are still 103,000 tonnes higher.

The stock-to-consumption ratio fell from its second-quarter peak of 5.4 weeks to an estimated 5.1 weeks in the third quarter. However, this still represents the highest levels since 1995.

Nickel

Three-month nickel prices reached their highest level since mid-July by the end of October. Although speculators have been the main force behind firmer prices, a rising price trend has been fundamentally justifiable in our view (in contrast to some of the other metals), primarily because of strong demand for primary nickel from the stainless steel industry.

However, as the economic outlook is uncertain and most leading indicators are pointing at below-trend growth, we think prices are vulnerable in the near term, especially if stainless steel mills revert to de-stocking in the absence of underlying demand improvements. While stainless steel prices remain firm in Asia and Europe, U.S. stainless steel prices have shown signs of weakness. In addition, demand from end-uses other than stainless steel is slow. We have adjusted our demand growth projections to incorporate this development and expect a slowdown in Western demand growth next year.

This year, tight scrap supplies have given an additional boost to nickel demand, and we expect the absence of secondary material to remain, over all, a positive factor. History suggests that scrap supplies emerge to the market with nickel prices above US$3 per lb. on a sustainable basis, and normally with a lag of one to two quarters.

Recent statistics suggest U.S. stainless melt output remained strong still in August, having risen by 28%, year over year (to 207,000 tonnes). According to data released by the Specialty Steel Industry of North America, total stainless steel consumption in the U.S. rose to more than 1.5 million tonnes in the January-to-August period, up by 6%, year over year. Japanese production of stainless steel has also been notably buoyant (boosted by Chinese demand), posting a rise in August after a 7% drop in the first half. However, Chinese consumers are cutting back on purchases as the end of the year approaches, which should lead to another decline in Japanese production in the fourth quarter. In Europe, attention is focused on production cuts, with some producers planning longer-than-usual Christmas shutdowns.

The latest statistics from the International Nickel Study Group (INSG) show that the Western World nickel market registered a reduced deficit in August at 9,500 tonnes, compared with a 16,600-tonne deficit in July. This was the result of a 2.5% fall, month over month, in Western consumption to 80,300 tonnes in August, and a 7.6% rise in refined production to 70,800 tonnes.

Meanwhile, Inco said the third quarter showed remarkable strength in a traditionally slow period for nickel demand, which helped push the company’s inventories to 7-year lows. A large proportion of the company’s sales went to Asia. Furthermore, Inco said work on the Voisey’s Bay mine in Labrador is on schedule, with startup planned for 2006.

q Prices — Stainless steel prices have remained firm in Asia and Europe, whereas there have been signs of an easing in U.S. prices. Meanwhile, ferrous scrap prices have fallen sharply recently, suggesting steel-makers may have started to de-stock in light of an apparent weakening in demand.

Open interest and prices for nickel continue to move in a similar pattern. This suggests that rising LME nickel prices in the first quarter and lately have been supported by the establishment of speculative fresh longs, whereas long liquidation has been the prime reason behind falling prices. As a result, it seems that this market has not been a victim of aggressive short selling, like most other LME metals.

In October, total nickel futures open interest amounted to 39,000 lots, compared with 45,000 lots in the previous month and 41,000 lots in October last year. In mid-November, however, open interest had risen to 43,000 lots.

Trading volumes of LME nickel futures have been relatively modest during 2001-02, compared with rising trading volumes when prices moved above US$10,000 per tonne. However, trading volumes have started to pick up recently, in line with rising prices. In October, volumes rose to 345,000 lots, up by 15.5%, month over month, and by 1.1% from the corresponding month a year earlier. Still, nickel trading volumes represented the lowest share of the LME traded metals after tin in October.

The nickel forward curve remained in a full backwardation for all forward-traded dates in October, with prices for all future trades trading at higher levels than the previous month. In early November, however, nearby tightness eased, and the cash-to-3-month spread eased to a small contango. During October, the cash-to-3-month spread tightened to a US$100-per-tonne backwardation. However, while generally easing by the end of October and in early November, the nearby spread was trading in a US$20-per-tonne backwardation again by mid-November.

Physical spot premiums for nickel have eased in Singapore and Europe, according to data from Brook Hunt. However, U.S. premiums have remained relatively firm still.

q Inventories — LME nickel stockpiles have remained subdued over the past month, falling by a modest 300,000 in October to 20,900 tonnes. However, this is still significantly higher (+17.4%) than at the same time last year.

Volatility in inventory levels at Rotterdam warehouses (a convenient location for Russian material) has eased during the Autumn, though this still accounts for the largest share (51.4% of the total).

Stockpiles at other major locations (Singapore and Baltimore) remain in downtrends for most of this year.

While the total LME nickel inventory stockpile has been largely flat over the past four months, cancelled nickel warrants have been declining. Cancelled warrants amounted to only 1,000 tonnes in mid-November, suggesting little metal is awaiting outward shipments. If physical demand starts to slow down in light of possible de-stocking at stainless steel mills, LME inventory levels might start to rise again in the medium term.

Nickel inventories, on a total reported basis, are also at relatively low historical levels.

Inventories held at producers represent the largest share of the total (80%). According to the latest available data from the INSG, producer stocks fell by almost 3,000 tonnes in August (to 89,700 tonnes), while the total commercial stockpile stood at 117,300 tonnes at the end of August (down by 5,400 tonnes over the month).

The stock-to-consumption ratio for the third quarter remained firm at an estimated six weeks, albeit below the recent peak of 6.6 weeks a year ago.

Zinc

While the other base metals were enjoying price rallies in October, zinc was hit by another wave of speculative selling on disappointment that follow-through buying activity failed to emerge in this market. In light of current poor demand conditions and the absence of smelting capacity closures, we regard fundamentals as relatively weak still.

Market attention has been on the possibility of reduction in smelting capacity. However, one of the smelters up for sale, M.I.M.’s Duisburg plant, was acquired by U.S.-based private equity fund Safeguard International. Even though the plant will be converted to secondary feed only, there seems to be little chance of additional concentrates to the otherwise tight market as the source, McArthur River, will switch to direct leach and will no longer produce a bulk concentrate to sell.

Pasminco plans to shut its 80,000-tonne-per-year Cockle Creek zinc-lead smelter in Australia, but not until some time between 2006 and 2008. Elsewhere, uncertainty remains over Glencore’s 85,000-tonne-per-year Porto Vesme zinc smelter in Sardinia, owing to relatively unfavourable power rates. In Mexico, disruptions to Grupo Mexico’s 100,000-tonne-per-year San Luis Potosi zinc refinery, resulting from a workers’ strike, were temporary and had no lasting effect on production.

Concentrates tightness remains a key feature for this market, which continues to have an impact on Chinese output and exports to the West. Official data for September suggest Chinese refined output in September amounted to 178,500 tonnes, bringing the total so far this year to 1.5 million tonnes. Chinese net exports of zinc continue to slow, amounting to 350,300 tonnes in the January-October period. Exports fell 10.4%, year over year, during this period to 396,500 tonnes. In October alone, 37,400 tonnes of refined zinc was exported, compared with a monthly average of 39,300 tonnes so far this year. We expect net exports to decline to 445,000 tonnes this year and to 390,000 tonnes next year, owing to concentrate shortage, which, in turn, reduces domestic refined output. However, as soon as concentrates are available, we expect Chinese operating rates (currently below 80%) to resume.

The latest statistics from the ILZSG show world demand for zinc fell by 1.9%, month over month, in August (to 747,100 tonnes). However, during the first eight months of this year, demand was 2.4% higher, year over year (at 6 million tonnes).

Global refined zinc output, meanwhile, was 1.7% higher, month over month, in August (at 772,000 tonnes), and 2.1% higher, year over year, in the January-to-August period (at 6.3 million tonnes). As a result, the global market registered a 25,000-tonne surplus in August (compared with balanced market conditions in July) and a 248,000-tonne surplus during in the January-to-August period (compared with a 260,000-tonne surplus in the same period last year). Global mine output fell 3.3%, month over month, in August (to 745,000 tonnes) and by 0.5%, year over year, in the January-to-August period.

q Prices — We believe the sharp rise in galvanized steel prices this year has been supported by restocking, but also boosted by higher steel prices.

Given the historical correlation and in light of continuous weak demand conditions, we think galvanized steel prices are likely to ease, rather than zinc prices rising substantially.

The relationship between open interest and prices for zinc suggest speculators have been short-selling this market aggressively since early 2001. During October, however, open interest started to fall at the same time as prices rose, suggesting some of those short positions were covered during this period.

In October, total zinc futures open interest had fallen to 132,000 lots (and further to 125,000 lots in early November), compared with the peak of 142,000 lots in August, but still significantly higher than the 86,000 lots in October last year. Monthly trading volumes of LME zinc futures have averaged about 575,000 lots since 1998. In October, volumes rose to 754,000 lots, up by 31.3%, month over month, and 46.6% higher from the same month a year earlier.

Zinc is the heaviest-traded LME metal after aluminum and copper.

The zinc forward curve remains in a full contango, having flattened marginally recently compared with recent months. The tightening of forward spreads gave some price support in mid-November. The contango reflects good metal availability over the coming 26 months.

Zinc spot treatment charges have fallen to their lowest levels since mid-1994 at just below US$150 per tonne.

Annual TC negotiations between the European smelters and their suppliers are unlikely to be concluded until early next year. An early conclusion is unlikely because of production uncertainties related to the Avonmouth and Porto Vesme smelters.

Despite weakening demand, European physical spot premiums have remained firm. We believe this suggests lack of availability of stockpiled material at LME warehouses.

U.S. premiums have been largely flat, and warehouse stockpiles have been built up in that region. However, sharply rising premiums in Singapore reflect continuous strong demand from the galvanized steel industry, in China in particular. Taiwanese galvanized steel output, on the other hand, has started to slow, as evident from output figures for September.

q Inventories — We believe recent trends in LME zinc inventories reflect Far Eastern shipments redirected from Europe to the U.S.

The warehouse in New Orleans remains the major location of stockpiled zinc, accounting for about 35% of the total (or 230,000 tonnes), even though the stockpile held in Singapore has risen rapidly (to 205,000 tonnes in mid-November). Inventories at Trieste, on the other hand, have continued to fall sharply. We believe this is due to a combination of recent re-stocking by galvanizers and reduced shipments from Asia.

As a result, the rising trend in total LME zinc stocks has flattened out, with inventories rising a modest 1.4% during October (+8,800 tonnes). However, compared with the corresponding month in 2001, stocks are still sharply higher (+61% or 246,000 tonnes).Although cancelled warrants have come down over the past month, they remain at relatively high levels, possibly preventing a further buildup in LME zinc stocks in the near term. In mid-November, another 25,000 tonnes (or 4% of the remaining total) was awaiting outward shipment.Statistics from the ILZSG suggest producer inventories have fallen in four consecutive months, based on data up to the end of August. However, in contrast, consumer inventories rose sharply in August, to 155,500 tonnes from 115,700 tonnes in July. As a result, total reported zinc stocks reached their highest level since April 1996 in August, at 1.1 million tonnes.The stock-to-consumption ratio rose to an estimated 8.3 weeks in the third quarter, compared with eight weeks in the previous quarter and 6.2 weeks in the third quarter of 2001.– The opinions presented are the author’s and do not necessarily represent those of the Barclays group. For access to all of Barclays’ economic, foreign-exchange and fixed-income research, go to the web site at barclayscapital.com. Queries may be submitted to the author at kevin.norrish@barcap.com