Broadly speaking, metals markets slipped during the Feb. 19-23 report period as market-watchers saw an end to the quiet, range-bound trading that prevailed during the previous two weeks.
The cause of the slide was long liquidation as participants, disappointed at the lack of direction, decided to cause some of their own and bailed out. The exit pushed aluminum prices down by 2.7%, copper by 1%, and nickel by 3.6%. Three consecutive days of constant selling put support levels under considerable pressure.
The backdrop of the price falls continued to be the economic situation in the U.S. and Asia. Markets were selective, however, over what data were used to assess the economic developments. The unexpectedly large increase in the U.S. January leading indicator kept what has become a key signal of American economic activity well above the levels reached during the years of recession in the 1980s and 1990s. Little was read into this set of data, however, and it failed to provide cheer to pessimistic markets. On the other hand, the slightly higher-than-expected figures for the U.S. Consumer Price Index (CPI) caused a wave of mild panic.
What did the markets read into these data? The interpretation was that any threat of inflationary pressures reduced the Federal Reserve Board’s ability to lower interest rates this year. The concern is perfectly valid; in fact we reduced our forecasts for U.S. rate cuts the day after the CPI data were released. The point worth noting, however, is this: for some considerable time, even through to the second half of 2001, market sensitivities over U.S. data are set to remain acute. Even positive data will provide little relief so long as the constant stream of negative data continues. The market finds it easier to listen — and react — to bearish news and will therefore continue to be selective in its reading of economic data throughout this year.
Copper prices continued the gentle downtrend established in late January. Prices shed almost US$60 per tonne from their early-week highs, testing support at US$1,740 per tonne and falling on Feb. 23 to a low of US$1,733 per tonne. In the short term, we expect support at US$1,740 per tonne to continue to hold.
Another notable feature of the report period was a large increase in London Metal Exchange (LME) cancelled warrants on Feb. 22 (+6,000 tonnes), taking the total to 50,000 tonnes. This suggests that the steady rate of LME stock withdrawals, mainly in Europe, is set to continue, though there are rumours that a significant tonnage of Chilean copper is about to be delivered into LME warehouses.
On Feb. 22, the U.S. leading indicator rebounded by 0.8% month-over-month — the first increase in four months. It is well above the level that indicated recession in the early 1980s and 1990s. However, the rebound may not necessarily signal higher copper prices to come. There is an intuitively surprising inverse correlation between movements in the leading indicator and copper prices. Part of the explanation for this may be that copper is a “late-cycle” metal, insulated from the early impact of economic slowdown by its high level of use in construction, where copper products such as wiring and tube tend to be installed as buildings near completion. Recent U.S. construction data have been surprisingly good, but, if activity in the sector lags the downturn seen in other areas (such as transport), U.S. copper demand may not be at its lowest point yet.
Mixed data from Asia showed Japanese brass mill production holding up well, up 5% in January year-over-year, though Chinese refined copper imports fell 28%.
Aluminum prices fell sharply, with LME 3-months testing support at US$1,540 per tonne, the lowest level since early January. The Consumer Price Index figures, combined with the collapse of the backwardation, caused long liquidation, which carried through into fund short selling. On Feb. 23, prices managed a close above support despite having fallen, at one point, to a low of US$1,527 per tonne. If prices are able to stabilize in the region of US$1,540-1,545, a recovery to US$1,560-1,580 per tonne is possible, though, with bearish news continuing to emerge from Japan and South Korea, upside resistances may be tough to overcome.
With the backwardation out of the way for the time being, the rate of increase in LME stocks is likely to slow considerably. Since December 2000, when nearby tightness first appeared, LME stocks have climbed by 175,000 tonnes. However, a 30,000-tonne increase in LME cancelled warrants on Feb. 23 to 51,000 tonnes suggests that LME stocks may be about to start falling again. This would be supportive for LME 3-month prices, and, in the short term, we expect support at US$1,540 per tonne to hold.
Data for January reveal the first year-on-year decline in aluminum production for several years, falling 0.7%. The biggest contributor to the fall came from North America, where production was down 13% year-over-year, owing to the impact of production cuts in the northwestern U.S. We expect further production shortfalls over the next few months, since the full impact of cuts announced in late December 2000 through to February 2001 have yet to show up in figures. By the second half of the year, North American production is likely to begin rising again thanks to the startup at Alcan’s Alma smelter, in Quebec. Alcan expects Alma to reach its full 400,000-tonne-per-year production level by September.
However, the impact of declining output in the U.S. is certain to trim global output growth this year. We forecast only a 1.5% increase in primary aluminum production for this year.
With copper and aluminum prices subdued at the start of the report period, nickel quickly became the focus of attention. The failure of prices during the previous week to hold support at US$6,400 per tonne, followed by the move below US$6,200 per tonne, considerably weakened nickel’s technical position and resulted in prices testing support lower down at US$6,100 per tonne.
Apart from the bearish combination of poor demand and a collapse in the backwardation, it was ultimately the end of the Falconbridge strike in Sudbury, Ont., that undermined sentiment. The successful ratification of new labour agreements focused concerns on increased supply levels, while, at the same time, reinforcing fears over nickel’s forecast surplus in 2001. As the seasonally tight supply flow of material from Russia eases and production increases come on-stream, the risks will turn increasingly to the downside.
Stock increases helped to undermine sentiment. On Feb. 20, an increase of 1,000 tonnes helped push LME stock levels back above 10,000 tonnes for the first time in a month while the week-over-week fall of 24 tonnes in cancelled warrants suggests that limited scope exists for any major stock reductions.
The stock increases coincided with the end of the Falconbridge strike, which occurred a little sooner than expected. For this reason, predictions, earlier in the week, of a sudden collapse in nickel prices looked exaggerated. We are not surprised by nickel’s ability to retain its position above US$6,000 per tonne, given that an end to the strike had already been factored into prices.
Supply constraints in the current nickel market are still sufficient to contain price falls. While the reduced supply from Sudbury and Nikkelverk (in Norway) were important, they were by no means the only factors causing supply tightness. Stocks still remain low, Russian supplies are seasonally thin, and the backwardation (although, at US$120 per tonne, substantially reduced in comparison with a few weeks ago) remains in place. Nonetheless, we believe the scope for considerable price deterioration during the first half of 2001 remains limited.
This view is substantiated by the fact that prices stayed above US$6,000 per tonne in the report period — despite growing stock levels, the decision of workers at one of the world’s principle suppliers to return to work and the sharp falls in aluminum and copper prices.
Beyond the first half of 2001, however, the outlook is poor. Not only will improvements at Australian laterite plants add to absolute Western World output levels; they raise concerns over the potential for adding further supply to a growing surplus. Australia’s Anaconda Nickel announced that its Murrin Murrin plant will complete the ramp-up in production within a year, while December 2000 production levels reached a record high of 1,715 tonnes — all of which is a reminder of the potential of laterite technology to affect nickel production significantly.
Zinc prices ended in a technically vulnerable position, and, despite recent price declines, zinc still looks to be the weakest-performing base metal. Although prices were able to hold on at the US$1,020-per-tonne support level, Feb. 23 saw the third consecutive close below support, leaving prices precariously close to the psychologically important US$1,000-per-tonne level.
Trading remained subdued and interest levels low as a result of lethargy in copper and aluminum markets. Aside from the listless price movements, however, a raft of data emerged which provides an indication of zinc’s prospects this year — unfortunately, for zinc bulls, an indication of the struggle prices will face to retain ground above US$1,000 per tonne.
Much of the news was associated with the supply side of the market. LME stock levels increased further (by 4,650 tonnes on the week) bringing the gain in stock levels since the start of the year to almost 43,000 tonnes. Although planned production increases have been in the pipeline for several months and the stock increases come as no surprise, the historically low level of LME stocks has been one of the few bullish indicators for the zinc market. With stocks now rising on a regular basis and the other weak fundamentals still firmly in place (rising production levels, subdued demand, weakening U.S. and Asian economies, indications of large Chinese exports), the risk for prices is clearly on the downside.
Poor data from Japan and South Korea served to emphasize the struggle zinc prices face in the current economic environment. Figures showing the first fall in South Korean power consumption in more than two years, largely due to a 7.6% fall in consumption from the automotive sector, preceded the release of unemployment statistics showing an increase to 4.1% in January. Two factors — the 15.4% fall in the number of construction jobs and the decision by Japanese auto producer Mitsubishi to cut its workforce by 9.5% and close one of its four production plants — illustrate the weakened state of industrial activity in the region. One consequence is poor demand for zinc.
Reports of poor demand from South Korea for Chinese zinc are now reaching us. Figures released by the Japan Iron & Steel federation showed a fall in steel exports to South Korea of 8.3% and clearly indicate that zinc exports can be expected to suffer similar falls this year.
Meanwhile, the potential for Chinese zinc exports to depress prices further remains potent. Although recent data show exports at near 2-year lows in January (27,000 tonnes), recent smelter expansions in China and high levels of concentrate imports suggest that exports of refined zinc will remain high throughout the rest of this year. Meanwhile, reports that China may abolish its zinc quota system by 2002 indicate that zinc exports will remain a dominant feature of the market.
Gold prices staged a recovery to close above US$260 per oz., following the previous week’s test of the low US$250-per-oz. area. The result of the recovery is to strengthen downside support levels and establish US$258 per oz. as a credible line of support and mark the area to US$260 per oz. as a trading range. With no fundamental news to buoy prices and signs of further producer selling reaching the market, prices remain vulnerable to downside moves.
The central banks are rumoured to be planning a second Washington-Accord-style agreement aimed at limiting, or at least controlling, the sale of gold stocks. Were such an announcement to be made, the impact on gold prices is not difficult to imagine. Following the gold price fall to the low US$250s during the previous week, prices during the report period returned to stability and established a range-support area of around US$258-260 per oz. These and other developments have strengthened prices to above US$260 per oz. with more ease than might have been expected.
One further positive note remains the large speculative short position on the Comex division of the New York Mercantile Exchange, which leaves gold prices exposed to higher spikes as holders of shorts cover their positions against sudden price rises. Figures available on the afternoon of Feb. 23 showed a further extension in the net speculative short position, which now stands at the largest level since July 1999. With such a heavily short market and lease rates moving sharply upwards, holders of short positions will be keeping a close watch on every price move.
On the downside, the climb in lease rates indicates that short-term borrowing remains a feature of the current market and suggests that (contrary to the latest rumours) bank selling is taking — or is about to take — place. With gold prices still hyper-sensitive to the impact of central bank activity, any suggestion or evidence of renewed off-loading of bullion stocks would bring the US$250-per-oz. area under further pressure. With the pattern of gold selling this year incorporating both producer-hedging and central-bank selling, upside resistances will become increasingly more difficult to overcome and rallies more difficult to sustain.
— The opinions presented are solely the author’s and do not necessarily represent those of the Barclays group.
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