Markets anticipating Chinese trends

The recent fund-led selloff has left the base metals markets heavily dependent on fundamental support. Over the next few weeks, movements in London Metal Exchange (LME) stocks and physical premium levels will be watched closely for evidence that the recent spate of strong economic data in the U.S. and Europe is affecting demand for metals. Nickel and zinc stocks have been trending downward for some time now. An increase in cancelled LME warrants for aluminum and an upturn in Chinese copper buying suggest that similar trends may be about to emerge in the two major LME-traded metals.

We believe the prospects are good for higher prices across the whole of the base metals complex as the market enters the peak season for demand. In order of fundamental strength, we rank the main traded metals in the following order: nickel, zinc, aluminum and copper.

Precious metals prices also fell sharply during the period under review (Feb. 28-March 3), as markets responded to news that Russian export licences have been granted for palladium and that the U.K. Treasury is to press ahead with its program of gold sales.

The recent sharp fall in copper prices has taken the market back to levels that are a closer reflection of market fundamentals. The market looks as if it is establishing a new trading range for the LME 3-month price in the region of US$1,740 to US$1,780 per tonne, and there will likely be firm resistance in the US$1,780-to-US$1,800-per-tonne.

Speculative interest in copper is lower than it has been for many months, and the market is heavily dependent on an upturn in consumption if prices are to regain higher levels.

The market is pinning its hopes on China in the short term. A rise in the Shanghai-LME copper price differential in recent weeks has encouraged a substantial amount of arbitrage buying by Chinese merchants. Local merchants are likely to take delivery against their open arbitrage positions, and this could result in a surge in imports of up to 100,000 tonnes into China in May and June.

LME stocks climbed by 16,950 tonnes during the report period, and total exchange stocks (LME, the Commodity Exchange of New York, and Shanghai) now stand only a shade below 1 million tonnes. However, there is uncertainty as to how much of the visible stock overhang is available to the market in the short term. As much as 500,000 tonnes could be tied up in financing deals. The LME warrant market in Singapore has tightened a little. We note also that the cash-to-three-months contango has narrowed at one stage to US$25-27 per tonne, compared with US$34 per tonne in the previous report period. Most of this tightness is concentrated in the April-May spread. If demand for LME warrants really does take off as shipments to China rise, we might see nearby spreads continue to tighten over the next few weeks.

Announcements that could lead to the reopening of two more copper mines were made during the report period. Namibia’s 30,000-tonne-per-year Tsumeb mine and smelter, closed in April 1998, was acquired by Ongopolo Mining from Gold Fields of Namibia. As part of the deal, the government has dropped an environmental suit against the operation, and Ongopolo says Tsumeb could be back in production by early next month. Also, Leader Mining and Imperial Metals have purchased Similco Mines’ Canadian copper-gold-silver operation, which was shut down in 1996. Similco is expected to produce, on an annual basis, 40,000 tonnes of the red metal, beginning in late 2000.

Aluminum prices fell sharply during the period under review, as funds withdrew from the market, accelerating the downtrend that has seen the LME 3-month price shed almost US$130 per tonne since its peak of US$1,750 per tonne in late January. During that time, LME stocks have climbed by more than 100,000 tonnes — a key factor in helping to weaken market sentiment. However, a good portion of the aluminum stocks that has been delivered to LME warehouses is material already committed to by merchants for later in the year. LME stocks fell by a little less than 10,000 tonnes in the report period, and cancelled warrants have risen as well, suggesting that this outflow could continue. The level of withdrawal could conceivably average 10,000-11,000 tonnes over the next few weeks, which would indicate that the market is moving into deficit. A further rally in prices in the second quarter could follow.

The recent selloff in aluminum reflects growing nervousness on the part of hedge funds concerning the outlook for consumption growth in Asia this year. Funds had been banking on a continuation of high growth rates in Asian demand following last year’s 11% expansion in the region, but recent data suggest that the eventual improvement could be less than expected, particularly in Japan.

Japanese industrial production growth in January was 0.9%, month-on-month, significantly below consensus forecasts of 3%. Although housing starts were up 25% in January, this appears to have been a one-off event related to last-minute applications for loans in October, before the lending rate rose. Applications for mortgages in January dropped 47% from year-earlier levels.

In addition, Japanese aluminum mill product data show that both output and shipment growth moderated in January. As far as primary aluminum demand is concerned, restructuring in the Japanese financial sector is forcing trading houses to cut back on stock levels, and this trend may also be putting some downward pressure on physical demand.

Meanwhile, premiums for second-quarter aluminum shipments in Asia are being settled. Demand in Taiwan is strong. Second-quarter aluminum premiums have been settled at US$80 per tonne, compared with US$75-77 per tonne in the first quarter. Japanese premiums have settled at US$74-72 per tonne, and premium negotiations in Korea are still under way with talk that large stocks left over from last year could prevent premiums rising from first-quarter levels of US$75-$77 per tonne.

Volatility has returned to nickel. After a period of narrow range trading, the LME 3-month price fell to a 2-week low of US$9,380 per tonne, though prices quickly rebounded to a new high of US$10,340 per tonne. During the second half of the report period, the market traded nervously in thin volume with the focus on nearby spreads. At one stage, the cash-to-three-months spread widened out to US$340 per tonne.

Nickel prices remain firmly supported by fundamentals (as they have been since January), and short-term prospects will continue to be dominated by the possibility of strikes at Inco’s and Falconbridge’s operations in Sudbury, Ont. In addition, some market-watchers are speculating that the Noril’sk Mining and Metallurgical Kombinat in Russia may soon announce a production shortfall. We, however, are skeptical of these rumours: shipments from Noril’sk are low at present for the usual seasonal reasons, and, although Russian exports in the fourth quarter of 1999 were a little below expectations (55,000 tonnes, compared with 58,500 tonnes in the comparable period of 1998), there is no compelling reason to suspect that there are problems. Indeed, with prices for both nickel and platinum group metals at such high levels, it would make sense to do everything possible to increase output levels.

Workers at Eramet’s smelter in Doniambo, New Caledonia, have voted to continue their labour dispute, and Eramet says it will maintain production at its current 70% level, implying that the 33% cut in shipments of ferronickel to Japanese and Korean customers will remain in place.

After underperforming for most of the year to date (despite relatively good fundamentals), zinc prices partially turned the tables. The LME 3-month price recovered much more quickly than either copper or aluminum prices, following the selloff that hit base metals in general during the report period. However, it is too early to get carried away just yet. The recovery in prices has done little more than return zinc to the upper end of its US$1,100-to-$1,135-per-tonne trading
range, and concerns about rising Chinese exports and unreported stocks will probably continue to hamper progress. Prices need to break convincingly through the US$1,140-per-tonne region to signal the start of a new upward trend.

Efforts by miners to better the terms agreed to by Japanese and Korean smelters with Pasminco appear to have failed, judging by reports of contract treatment charges for zinc settling at around the US$189-per-tonne level (basis: US$1,000 per tonne LME). The new level is much higher than last year’s level of US$169 per tonne. The deterioration in treatment charges for the miners reflects an abundant supply of zinc concentrates (zinc mine output is rising much more quickly than smelting capacity); it also raises the prospect of further increases in Chinese zinc exports as higher treatment charges improve the economics of importing concentrate and exporting metal for Chinese zinc smelters.

Following a static and rage-bound start to the report period, gold prices dipped sharply on March 2. The heavy drop followed a sudden U.S. selloff on March 1, which, in turn, prompted sell-stops on the Commodity Exchange of New York towards the end of trading that day. Adding to the downward pressure is the fact that the Australian market saw strong selling as a weakened dollar cued producers to go short. The increased U.S. and Australian selling saw London prices drop to a low on March 2 of US$285 per oz. following a morning Fix of US$289. Good physical demand helped cushion the fall.

Gold’s failure to hold at US$290 per oz. has pushed the next real level of support back down to US$280 per oz. Some resistance may be met at US$285, but, given recent falls and the bearishness of current market sentiment, it is likely that the next trading range will be lower than this.

The U.K. Treasury’s announcement that it will press ahead with its sales of gold was not unexpected, and it served to draw attention once again to the steady trickle of central bank gold into the market. The selling of 5.5 tonnes by the Dutch Central Bank brings to an end its gold sales, until September. Last September, the bank said it would sell 300 tonnes of gold over the next five years and that the first 100 tonnes would be sold before September 2000. The fact that all of its 100-tonne quota has been sold well in advance is probably due to the peak in demand that occurs at this time of year; it may also reflect some profit-taking by the bank before prices drop to their previous levels prior to the hedging spike.

The rapid sale may also bring forward the sales of gold by the Swiss Central Bank, which plans to begin selling once constitutional matters are ironed out (probably before the summer). The market clearly has had little difficulty absorbing the Dutch gold — a fact that will give confidence to the Swiss.

Other precious metals, such as silver, platinum and palladium, traded significantly lower during the report period. After an attempt earlier in the week to move up to a higher trading range of US$5.10-$5.20, prices fell back in accordance with the falling price of gold. On March 2, news from Russia’s Ghokran, which holds the country’s precious metals reserves, that it had achieved its export quotas acted to depress prices, particularly in the palladium market, where prices are threatening to test the US$650-per-oz. level.