Base metals prices pushed back

Base metals markets saw a promising mini-rally snuffed out in the second half of the report period April 10-14. Volatility in equity markets prevented follow-through buying, and, by the end of the week, fresh short- selling by opportunistic technical traders had pushed prices back to the bottom end of recent trading ranges. Both copper and aluminum are at 6-month lows, and nickel and zinc, which currently have the strongest fundamentals, could be in trouble if stock markets continue their slide.

The catalyst for the recent equity sell-off was the release of stronger-than-expected U.S. consumer price data: prices were up 0.7% in March, compared with market expectations of a 0.5% increase. These data underscore what we have been maintaining for some time now, namely that the risk of higher interest rates poses a threat to metals markets this year. This risk is negative for metals markets on two fronts: first, it makes speculators reluctant to buy metals because of concerns over future demand prospects; second, it means consumers will continue with the hand-to-mouth buying practices they have followed so far this year. In the short term, at least, these trends almost certainly mean lower prices across the board.

A mini-rally in copper prices was snuffed out in the second half of the report period as another round of fund short-selling emerged, dragging down the London Metal Exchange (LME) 3-month price to a fresh 6-month low of US$1,660 per tonne. Earlier in the week light short-covering had lifted the 3-month price to a peak of US$1,726 per tonne, but the tentative nature of the rally, combined with a slowdown in the rate of LME stock withdrawal, caused the market to shift its focus back to the downside. With consumers still content to wait on the sidelines, there is a real chance that 3-month copper could soon be trading in the US$1,650-per-tonne region, not seen since mid-1999.

During a recent visit to a major European producer, we were reminded of just how good consumption is at present. Order volumes were up more than 30% on 1999 levels and the company’s rod mill was working weekends, whereas the schedule a year ago was five days.

However, strong consumption is not feeding through to market sentiment, which remains poor. LME stocks have now fallen 122,000 tonnes from their peak of 843,000 tonnes in mid-March, but, for the following reasons, this is having little impact on prices:

Arbitrage plays between different exchanges (notably Shanghai and the LME) mean that the physical outflow of material from LME warehouses is not an accurate barometer of copper consumption.

Cancelled LME warrants are concentrated in a small number of warehouse locations, heightening suspicion that withdrawals are being manipulated by a small group of trading companies for reasons other than physical demand.

The cash-to-3-months contango enables material to be profitably financed off-warrant, and there are said to be significant volumes of unreported stocks.

One positive outcome of the recent price fall has been a tightening in scrap availability. Scrap merchants are hoarding metal in the hope of a price recovery. On a 30-day moving average basis, the U.S. bare bright discount to primary metal has been halved, from a peak of US$120 per tonne in early March.

Aluminum, not unlike copper, saw a brief move to the upside early in the report period, only to give way to a test of support at US$1,480 to US$1,490 per tonne for the LME 3-month price as funds turned sellers once again. In a week of technical trading, yet another sizeable LME stock fall (minus 26,000 tonnes) was ignored. Prices are now back at the level where the late 1999 rally began, and the chance of another spike in prices occurring before the seasonally slow third quarter looks increasingly unlikely. Although buying is emerging on price dips, consumers are well-covered and feel little need to chase prices higher. Indeed, as prices weaken, they are steadily ratcheting down the levels at which they want to do business, and, whilst this continues, further price weakness is probably in store.

The week’s major news was the final withdrawal of Pechiney from the proposed 3-way merger between it, Alcan and Algroup. The stumbling block proved to be Alcan’s refusal not to divest its 50% stake in the Norf rolling mill, Europe’s largest. The European Commission had asked the firms to take steps to ensure they would not have too-dominant a position in the European market for rolled aluminum. The decision is probably market-neutral in the short term since no major changes to the group’s primary smelting capacity had been planned. The move leaves open a possible merger between Alcan and Algroup (already approved by the European Union), or perhaps Pechiney will now make its own bid for the Swiss group.

In a week of volatile trading, nickel prices regained almost all of the ground that they had lost in the previous report period, as the LME 3-month price climbed from US$9,060 per tonne to a peak of US$9,800 before falling back to close at US$9,445 on April 14. Nickel’s volatility reflects a growing uncertainty among market participants over the current state of market fundamentals. There is growing speculation that off-warrant stocks are being held in Rotterdam, and developments in the stainless steel sector suggest that scrap availability has soared and prices fallen relative to nickel prices. Perhaps wary of this uncertainty, funds are thought to have squared off their positions and now, for the first time in many months, are fairly neutral toward nickel. Nonetheless, nickel remains finely balanced, and we would not be surprised to see prices rally again while the labour situation at Sudbury, Ont., remains undecided.

As far as the two main areas of uncertainty are concerned, the issue of off-warrant stocks in Rotterdam has become something of a red herring. If there are 30,000 tonnes of Russian uncut cathode in Rotterdam, as rumour has it, this is the equivalent to little more than seven week’s worth of production from Noril’sk. As working stock, this may seem a little above the normal level for a Western producer, but it is not excessive considering the seasonal variations that occur to Russian exports as a result of having to ship out of the port of Dudinka all year round. The reason this material has not been stored in LME warehouses is probably because Russian uncut cathode currently trades on the LME at a discount of US$100 per tonne yet can be sold at a premium of US$5 per tonne to LME cash in the spot market.

Rumours that stainless steel scrap is becoming more available hold more weight. Discounts have widened in recent weeks, and there are reasons to believe that the supply of stainless steel will grow. High rates of stainless steel production and consumption usually result in higher levels of scrap generation, and stainless output has been growing strongly for more than a year now. Also, current high nickel prices could be drawing more scrap out of Russia and Eastern Europe, where supply has been quite sensitive to price.

A healthy rise in zinc prices at the start of the report period gave way to an anticlimax by April 14, when prices in London closed at US$1,115 per tonne. News that production had ceased at Union Minire’s Belgian Balen plant caused prices to jump strongly and move away from their recent support level of US$1,100 per tonne. The Belgian producer is one of the world’s largest, and news of the halt sent prices to a high of US$1,157 per tonne on April 11. Cash prices rose even faster.

It is disappointing that, despite strong fundamentals in terms of supply and demand, zinc prices have failed to drift upwards. On the other hand, given that prices are operating in a base metals complex that is far from rosy, zinc would appear to be holding up reasonably well. We believe prices should be able to keep their current trading range and create a higher level of support at around the level of US$1,140 per tonne.

Gold traded quietl
y during most of the report period, keeping prices in a narrow range of US$280-to-US$283-per-oz. Interest in gold picked up late on April 14 in response to equity market volatility, and it will be interesting to see whether the yellow metal benefits as a safe haven if this volatility persists. Data on futures and options, released by the Commodity Exchange of New York, showed speculators going net short for the first time in many months, though, if equity markets continue to slide, this nascent trend could be rapidly reversed.

Market participants are waiting to hear what method the Swiss will use to sell their bullion stocks. It seems unlikely that the announcement, due in early May, will include plans for open market auctions in the rigid style of the Bank of England. The Swiss are more likely to adopt the more flexible, Dutch approach. This can result in lower levels of price volatility, as, when prices are higher, sellers enter the market and place a cap on increases.

The Swiss sales are already factored into market conditions and prices, so we do not expect the commencement of the sales to upset the market seriously. For the short-to-medium term, we see prices settling in a range near the US$275-per-oz. level, though equity market volatility could provide some short-term support. By the end of 2000, up to four Western national banks could be actively selling gold (in England, Holland, Switzerland and Austria). So far this year, physical demand has supported prices well, but, in the face of concerted bank selling and declining investor activity, we believe all support levels will come under increasing pressure.

— The opinions presented are solely those of the author and do not necessarily represent those of the Barclays Group.