Discouraging data dampen metals prices

– Copper — Chinese production rises, but net imports remain strong.

– Aluminum — Company share-price declines highlight poor demand, while primary production rises.

– Nickel — The 200-day moving average provides strong support, which should hold.

– Zinc — Price performance was poor, despite positive supply signals from China.

– Gold — The precious metals complex trended higher over the past week, despite poor demand data.

The report period Sept. 16-20 saw base metals suffer again, reflected by poor economic data, rising primary output and weak demand conditions. Weaker-than-expected U.S. industrial production (though flagged in our previous weekly report, when we looked at leading indicators of IP) attracted renewed speculative selling, further encouraged by sharp falls in equity markets.

Moreover, 10-year bond yields falling to fresh lows (the lowest since 1962) and the risk of further reductions in interest rates are not helping to create a favourable environment for base metal markets.

While most recent economic data (including U.S. housing starts, employment data and European industrial production figures) have been discouraging, the latest Philadelphia Fed Index offered at least some cause for some optimism. The index signalled that manufacturing activity in the mid-Atlantic region of the U.S. has been growing modestly, which could be an early positive indicator of nationwide manufacturing activity.

Also, data on U.S. business inventories suggest that heavier-than-expected restocking took place in July. However, while this is positive for base metal demand growth, the fact remains that economic activity has stalled since July, and inventory management could have a negative impact on demand in coming months.

While recent trading activity on the London Metal Exchange (LME) suggests prices are vulnerable on the downside, we believe any downside risk is currently restricted to the lows reached at the end of last year, assuming a prolonged economic slowdown can be avoided. Currently, The Economist’s base metal index is 8.5% above key support, having been tested three times during the 1990s (Nov 1993, March 1999 and November 2001).

Despite the fact that speculators already are heavily short, copper prices fell back approximately 2.8% during the week on renewed speculative selling. The large net short should help restrict downside risk and also enable a rapid positive reaction in the event of any positive news. Even if the Western World supply-side is fairly well maintained, the copper price trend will depend considerably on macroeconomic developments.

Early October will see the release of key U.S. data, including the Conference Board leading indicator, consumer confidence, Federal Open Market Committee interest rate decision, durable goods orders, and gross domestic product.

Evidence of much-needed producer discipline was reflected in the latest production data from Chile, with the Escondida mine (partly owned by BHP-Billiton) reporting it produced 15.5% less copper-in-concentrates in August, compared with the corresponding period of 2001. During the first eight months of 2002, it produced 10.7% less, or 488,000 tonnes, than in the year-earlier period.

Meanwhile, however, data from the Chinese State Statistical Bureau showed Chinese output of refined copper rose by 12.7%, year over year, in the January-August period to more than 1 million tonnes. The rise in Chinese production occurred despite the prevailing tightness of raw-material feed, suggesting drawdowns of stockpiled concentrates and possibly increased use of scrap. Production in August alone also accelerated (probably faster than expected), rising by 19.2%, year over year.

However, in light of strong domestic demand, China remains a significant net importer of refined copper. Preliminary trade data shows that net imports in August stayed very strong at around 150,000 tonnes.

Aluminum prices have retraced about 2.5% over the past week on speculative selling as economics (both macro and market specific), have shown no clear signs of improving.

In addition, selling pressure has remained severe on the world’s largest aluminum companies, with their share prices having been reduced by double-digit numbers since the beginning of the year. Mining equities often lead base metal prices, and the fact that the selling pressure has been caused by demand concerns is not an encouraging sign for the underlying aluminum market.

Fundamental aluminum news over the report period included production figures from key operating regions. The latest statistics from the Chinese State Statistical Bureau showed that production of primary aluminum rose by 26.9%, year over year, to 2.8 million tonnes during the first eight months this year. Alumina output rose by 13.9% to 3.6 million tonnes over the same period. Alumina availability are key to China’s aggressive expansion plans for primary production and to that country’s plans for exporting large quantities of primary aluminum to the West.

The International Aluminum Institute also released its latest production figures, showing that total production of 1.8 million tonnes (excluding China and Russia) was 8.4% higher than a year ago, and 3.6% higher last month). The largest increases were registered by Latin America and in North America (plus 26.5% to 191,000 tonnes and 7.6% to 466,000 tonnes, respectively), following a period of power-related production curtailments. The daily operating rate rose to 60,300 tonnes per day, compared with 58,200 tonnes in July and 55,6000 tonnes in August last year.

The area between US$6,400 and US$6,600 per tonne has acted as the key area of technical support for nickel for most of the second half of the year. However, in line with the rest of the base metals complex, this area of key technical support is meeting renewed pressure as fears of further or prolonged weakness in demand continue to hang over the commodity markets.

In nickel, the technical importance of the $6,400-6,600-per-tonne area is heightened by the 200-day moving average line. This now sits at $6,544 per tonne, just below the Sept. 20 close on the daily chart. On the weekly chart, prices have registered their first clear close below this line since March 2002 while daily prices have not traded below this key level of support since last year. A fresh slide below the 200-day moving average now would therefore deliver a bearish signal to the market at a time when fundamental demand concerns remain dominant.

With prices now so close to this key support line, the question arises, what are the chances of a move below it? Out of all the other base metals, nickel has clearly had the “best” downturn. Stocks have remained consistently low, and the improvements in the stainless steel sector have provided a source of demand in an otherwise weak consumption environment. Price falls have therefore been mild compared to the rest of the LME complex. This suggests that a degree of catch-up may be about to take place in nickel.

The physical market, where conditions remain tight, may still put the breaks on a fresh price slide. The backwardation remains in place (though the nearby spread briefly turned into a contango during the period under review), and stainless steel prices are continuing to recover. Furthermore, the latest price fall has been the result of speculative liquidation following the agreement reached between Inco and labour unions in Canada, rather than a reflection of fundamentally driven price reassessment. On balance, in the short-term at least, conditions in the nickel market suggest that support above the 200-day moving average should hold.

Zinc was among the worst-performing base metals during the Sept. 16-20 period, falling 3.6%.

Production data from China, the world’s largest producer of refined zinc (22.5% of the world total), were generally supportive. The statistics showed the country produced 1.3 million tonnes of refined zinc during the first eight months of this year, which was 6.2% lower than in the corresponding period of 2001. Tight availability of concentrates, following mine closures earlier in the year, caused by weak prices, has led to reductions in refined output, which, in turn, have had positive implications on exports to the West. In the past, large quantities of Chinese exports were a major negative factor depressing prices. So far this year, Chinese exports of refined zinc have been about 10% lower than a year ago, which may result in net exports for the full year of 500,000 tonnes at most, compared with 550,000 tonnes in 2001.

If the concentrates market remains tight in a low-price environment, there will likely be further curtailment of smelter capacity. In combination with lower production and exports from China, the outlook for zinc prices would then turn positive, especially in conjunction with improving demand.

The outlook for the galvanized steel industry has improved this year. European galvanized steel prices have risen by 50% since the beginning of the year (compared with only a 4.9% gain in zinc prices), and traditionally, galvanized steel and zinc prices are well-correlated.

Although some selling on Sept. 20 interrupted the trend, the precious metals complex trended higher over the report period. The exception was palladium, though even here, price action has been resilient and able to shake off the impact of General Motor’s statement that it hopes to cut the use of platinum group metals use by up to 17% by 2006.

Overshadowing most of the complex, however, was the rally in platinum. Spot prices rose to the highest level since June 2001, owing to tighter borrowing conditions, and higher lease rates prompted the purchase of spot material by short-covering Nymex-based funds. While demand-side fundamentals in platinum are sound, consumer buying interest is not strong enough to follow prices up to the highs of US$580 per oz., limiting the platinum’s prospects of sustaining such a sharp move. Furthermore, the fact that Johnson Matthey has set its target price ceiling for the year at this level is sufficient to build in resistance and trigger producer selling, capping any additional moves above US$580 per oz. in the short term.

As for gold, the key event has been the World Gold Council’s release of demand data that provided clear details of consumption not only for the second quarter but for the second half of 2002.

The weakness of demand largely met market expectations. The higher gold price environment had been expected to erode levels of demand, and the 18.3%, year over year, drop in first-half jewelry demand (led by a 46%, year over year, fall in year-to-date Indian gold consumption) did not fail to provide a clear message.

However, basing gold’s short-to-medium-term price expectations on demand developments is misleading. The gold price direction since the start of the year has been influenced more by the industry’s internal developments and less by fundamentals, whether on the demand or the supply side.

Weak consumer demand data have failed to dent price sentiment, as have supply-side developments, such as comments from the Bundesbank regarding possible future sales.

Meanwhile, key price supports have remained in place:

– U.S. equities are sliding back toward their July lows;

– the downgrading of JP Morgan has been a reminder of the problems associated the U.S. corporate sector and debt burden;

– the U.S. dollar has shown that it remains vulnerable to continued weakness against the euro;

– and on the producer side, announcements by Barrick of hedge reductions have kept the issue of accelerated supply cuts in the headlines.

Still, associating the gold price strength with renewed investor interest still requires caution. The WGC data also showed that investor interest remains poor. Net investor demand fell by 12%, year over year, in the second quarter to 57 tonnes, leaving producers and speculative funds as the main price determinants.

— 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