Data point to turnaround

The decline over the Jan. 14-18 period in base metals has highlighted the extent to which markets heralded the new year with over-optimistic expectations akin to a false dawn.

Large price increases and nervous fund activity belied markets, which operated with minimal consumer activity and only few signs that buying was set to increase. The selling of prematurely taken fresh long positions by funds is not surprising given the dose of economic realism markets received during the report period, particularly from the eurozone and Japan.

In Germany there were reports that the government is about to receive warnings from the European Commission that key budget targets will be missed, and in Japan the 13% year-over-year drop in industrial production put down solid foundations for another quarter of negative growth in the final three months of 2001.

For another week, eyes were on the U.S. economy for any signs of a turnaround. Optimists were not disappointed after the initial claims data showing a healthier labour market by registering a fall and, more notably, the large increase in the Philadelphia Fed survey. The Philly Fed data (which are well-correlated with the National Association of Purchasing Management) was particularly welcome given the broad-based nature of the improvements. For example, new orders, shipments, and business activity were all up strongly, and inventories were aggressively drawn down. True, this augurs well for demand prospects and paints a brighter outlook for the metals markets over the medium term, but the euphoria with which funds greeted 2002 looks incongruous against these still-nascent signs of growth, and we expect to see prices retrace their steps on the downside over the shorter term.

Copper effectively remained range-bound over the report period as prices carved a trading area between US$1,530 and US$1,555 per tonne. A break of this range was never seriously threatened as markets operated, for the most part, on low volumes and continued to be exposed to technical trading funds and commodity trading advisors, while consumers remained absent. Prices on Jan. 18. weakened but were able to ride the large stock increase in both London Metal Exchange and Shanghai warehouses, though we expect to see greater pressure on support in the short term.

After threatening to break support levels a number of times, aluminum prices were able to hold support on the afternoon of Jan. 18 to earn themselves another reprieve. Markets were, on the whole, characterized by thin volumes, resulting in skittish, disproportionate price moves. As with copper, the only real activity was provided by the technical funds and commodity trading advisors. Demand fundamentals still look set to remain poor through the first quarter, and we expect prices to retrace their steps lower in the immediate term.

It could be argued that nickel, which began recovering in mid-December 2001, has led the base metals complex to higher ground during the first weeks of the new year. This is somewhat surprising. Nickel’s price movements during the report period may well be a foretaste of what it is to come in copper and aluminum. However, after moving sideways for two weeks between US$5,800 and 6,000 per tonne, support broke and prices weakened further on Jan. 18. The cash-to-3-month backwardation came off heavily after spiking to more than US$330 per tonne, and stocks rose steadily. We expect further price weakness ahead.

Zinc ended the week looking considerably weaker. As with nickel, zinc has, to some extent, been leading the base metals complex higher. The price strength began around mid-December and was able to last until the report period, when prices at one stage threatened to test resistance at the 200-day moving average for the first time since September 2000. Unsupported by continued fund buying in the rest of the complex and weakened by nickel’s sell-off, prices soon moved out of the established US$820-to-$840-per-tonne range and returned to more normal behaviour (a test of support). The price target is US$780 per tonne.

In the gold market, the report period saw more questions being asked than answered. Much of the bullish sentiment seen earlier in the week had, by Jan. 18, dissipated following three developments: the dismal results of the Bank of England’s penultimate gold auction; a lack of short covering ahead of the U.S. public holidays; and the failure of funds to respond positively to the withdrawal of AngloGold from the race for Normandy Mining.

Our view of these events is roughly as follows: The turnout for the auction raises questions about the extent to which consumers of gold are willing to make purchases when prices are perceived to be at the higher end of trading ranges (on the eve of the auction, prices peaked at more than US$290 per oz. in Australia). If Newmont Mining succeeds in taking over AngloGold, the gold market would benefit insofar as the non-hedger camp would become reinforced.

Despite all this, prices look set to remain volatile as the market digests the latest developments. Upside potential does exist, but as the gold market often proves, price action has a tendency to disappoint. Initial support lies at US$282 per oz., and stiff resistance is likely to be met at US$285 per oz.

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