METALS COMMENTARY (January 17, 2000)

Metals markets have been demonstrating resilience in global financial markets, which began the new millennium in a nervous mood.

Like the high-tech stocks, base metals prices enjoyed a rapid rise toward the year-end but did not suffer the same new year’s hangover in their first week of trading. Nor were they hit by the unwinding of millennium bug hedges, which contributed to lower oil and gold prices in the week ended Jan. 7. While the Nasdaq composite index lost around 11% of its value and stock markets world-wide suffered new-year jitters, base metals wobbled early on, but then recovered strongly, with aluminum hitting a 25-month high.

Economic data from North America and Europe have been bullish, and many analysts have revised upward their growth forecasts for the first half of this year. A strong recovery in Dow Jones Industrials in the second half of the week also bolstered confidence. However, consumers were largely absent from the market during the run-up in the fourth quarter, and the investment funds that were the main buyers will be watching closely for a pick-up in physical demand over the next few weeks (in the form perhaps of falling London Metal Exchange stocks or rising physical premiums). If this is not forthcoming, metals markets may be due for some jitters of their own.

Copper prices have adjusted slightly lower following a very strong end to 1999, but a sharp recovery from Wednesday’s low of $1,836, and a strong close on Jan. 7 at $1,876, shows that funds are maintaining their interest on the long side. Funds are keeping faith with the strong demand story for the time being, despite fears of interest rate hikes in Europe and the U.S. and evidence that some important demand sectors are weakening (U.S. new home sales fell a larger than consensus 7.1% last week).

After climbing strongly in the run-up to the holiday break, LME stocks fell by 2,000 tonnes in the first week of trading, but there is little significance in this. With copper in healthy contango, it is easy enough to finance excess inventory off-warrant. Indeed the shape of the copper forward price curve makes copper prices extremely vulnerable to forward sales by producers, which as a group are underhedged. In the short-term however, the uptrend in prices is likely to remain intact. Over the next week a range of $1,840-1,890 per tonne looks likely and, if this is broken on the upside, $1,940 is the next target.

Aluminum prices reached a fresh 25-month high on Jan. 7, with the LME 3-month quote hitting a peak of $1,673 per tonne. Falling LME stocks, rumours that a major Russian aluminum smelter may be short of alumina, and continued tightness in forward spreads were all supportive background factors. Although aluminum price risk remains on the upside, it may be difficult for aluminum to maintain the pace of its recent upward momentum since it is now approaching a level (just above $1,700 per tonne) where historically there has been heavy technical resistance.

The week’s major news involved a change to the tax regulations governing alumina-tolling in Russia. There are still some grey areas, but, as we understand it, the exemption from value-added tax (VAT) of 20% on internally tolled alumina has now ended, and imported alumina for tolling will also be subject to the 20% VAT from now on. Smelters will pay the VAT and payments can be reclaimed when the metal is exported. In order to soften the blow, the 5% export tax on primary aluminum has been suspended for six months. In our view, these changes will have little impact on the flow of alumina into Russia or the export of primary metal.

Nickel prices fell from their recent highs early in the week ended Jan. 7, following a run up to a fresh peak of $8,510 per tonne at the end of December. Stale long liquidation and profit-taking pushed prices down before trade buying, and some commission house/CTA buying came in to support the market.

LME stocks continued their downtrend over the holiday period, falling 876 tonnes in the past two weeks. The decline in stocks could slow down over the next few weeks, with Inco expected to reach full capacity at its Manitoba operations this week. However, if demand accelerates over the next few weeks, this may not be the case, and stocks could continue to fall. Despite the sharp rise in nickel prices over the past few months, there is still plenty of scope for further upward moves before long-term technical resistance dating back to the mid-1995-to-mid-1996 period at $9,200-9,400 per tonne is reached. Looking farther ahead, Outokumpu’s restart of its Hitura mine (though small) raises the question of whether other closed mine capacity will be restarted soon.

Like the rest of the base metals market, zinc prices fell early in the week ended Jan. 7 on equity market jitters. However, by the end of the week, zinc had recovered to around $1,226 per tonne — just $20 per tonne below the end-of-1999 peak of $1,244 per tonne. Despite last week’s increase in LME zinc stocks, global inventory levels remain low and price risk is still on the upside.

LME zinc stocks climbed 3,575 tonnes over the course of the first week’s trading, with the bulk of the rise accounted for by Chinese deliveries into the Singapore warehouse. Stocks in the Singapore warehouse now stand at 70,025 tonnes, compared with their mid-November 1999 low point of around 55,000 tonnes. Chinese exports of zinc were at a high level in the fourth quarter of last year but are likely to dip in January and February as a result of Chinese New Year holidays. If this does happen, the rate of increase in Singapore zinc stocks is likely to slow once again, which could provide a further boost to prices.

Spot gold prices ended the first week of 2000 steadier in Europe at around $282 per oz. Earlier in the week, they had fallen dramatically, from around $290 per oz., before support was found at the level of $280 per oz. Weak equities markets then sparked some buying, notably from Asia, and this helped to keep gold in a $279-to-283-per-oz. range for the rest of the week. However, sentiment is poor and the market is nervous in anticipation of the next U.K. gold auction, scheduled for Jan. 25. If gold breaks through support at the $279-to-280-per-oz. region, a test of the early December 1999 low of $274 per oz. is likely.