After looking at estimated relative metal price performances for 2004, copper looks to be the strongest, and we believe there are strong fundamental reasons for an aggressive annual average cash price forecast of US$2,238 per tonne (US101.5 per lb.) for 2004.
The restocking phase of this price cycle started only recently (late in 2003), and the bulk of consumer business is still to come. At the same time, investors now have a large appetite for metals, and copper is in a good position to receive a lot of attention, partly because of its Comex and Shanghai contracts.
While fundamentals have now fallen into a strong situation after years of depressed demand and prices, exchange-rate developments are enhancing the positive fundamental aspects of the copper market. Based on the negative correlation between the U.S. dollar and copper prices, we have calculated that copper remains undervalued by approximately US$250 per tonne; and the weak U.S. dollar environment is likely to continue.
We have also calculated that even though London Metal Exchange (LME) copper prices are already trading around the previous cycle’s peak levels (and at 6-year highs), a significant share (40%) of global copper smelters are loss-making. Part of the reason is the extreme tightness in the concentrates market, enhanced by production problems at
As well, several strike threats kept prices supported during the fourth quarter of 2003, but we suspect mine owners will be keen to avoid strike action when market conditions are this favourable.
About 325,000 tonnes of previously idled capacity is set to restart in 2004, and together with new mine capacity (for example,
As total exchange copper stocks approach 800,000 tonnes,
A healthy reduction in the fund net long copper position on the Comex was confirmed by data from the Commodity Futures Trading Commission. The cut of the net long to 25,800 contracts at the end of November 2003 was primarily the result of technically driven Commodity Trading Advisors fund long liquidation. Market participants, believing the cycle peak has now been reached, also sold a few shorts. We do not share their belief; rather, we’re of the opinion that in spite of recent aggressive long liquidation, the limited price correction is constructive, for it shows that buyers, such as consumers and fundamentally driven macro funds, have absorbed selling activity well.
In the early part of the fourth quarter of 2003, the copper price and open interest moved in a close positive correlation. However, the most recent observations show that the same relationship that is evident in aluminum is beginning to develop: the copper price is accelerating at precisely the same time that open interest is falling away. This could highlight fund long liquidation being absorbed by strong consumer buying interest — a development we see as positive for the copper price.
Copper replaced aluminum as the most actively traded metal on the LME in November 2003, with a turnover of 1.8 million contracts in the month. While this reflects the general month-over-month pattern across the LME metals, with a reduction of 12%, in year-over-year terms, copper has been far more resilient than the other metals, showing an increase of some 57%. This reflects the increased flow of speculative money into copper, mirroring the experience on both the New York and Shanghai exchanges.
The whole forward copper price curve has shifted sharply higher over the past couple of months, in line with our forecasts of higher prices next year. However, trading in a full backwardation, the forward curve is now steepening fast as producers take advantage of attractive forwards to lock in future sales. Cash prices in early December 2003 were almost 20% higher than two months previously, while far forwards are only 10% higher over the same period.
Still, current forward prices for the fourth quarter of 2004 are trading at a large discount to our estimated prices for that period (which we expect will represent the peak in the current cycle) of about US$300 per tonne. As a result, current forward prices would represent a good opportunity for consumers to hedge their requirements.
The latest available official data show that physical copper premiums in Shanghai have remained steady at around US$85-90 per tonne. While large quantities of copper are being shipped to the region, there are indications that premiums are on the rise again, even though business might slow a little ahead of the Chinese New Year.
In any event, spreads in physical premiums between different geographical regions appear to be narrowing. Because of shortages in Europe, premiums have risen sharply in that region during the second half of this year and are now not far below those in the U.S. and Asia.
While in line with sharply rising contract premiums for next year (also in response to high freight rates), we believe the level of premiums reflects a strong copper market from a fundamental point of view.
The copper concentrates market remains extremely tight, as evidenced by low treatment and refining charges (TC/RCs). Meanwhile, annual contract negotiations for 2004 are under way, though they appear to have stalled in the current uncertain environment after the accident at the Grasberg mine in the fourth quarter and following recent strike threats.
Despite announced capacity restarts for 2004, we expect the copper concentrates market to remain tight for at least another six months, which will keep TCs low and maintain financial pressures at smelters, especially outside the U.S.-dollar region.
LME copper stocks have fallen in all major warehouse locations over the past year, most notably in the U.S. Given the extremely low LME copper stocks in Asia, where copper demand growth has been greatest, we believe metal has been withdrawn from U.S. warehouses and shipped to China, where premiums are also strong. The downward trend in copper stocks accelerated during the second half of the year, coinciding with improving macroeconomic data in the U.S. and improving order books for copper.
As a result, the LME copper stockpile is almost 400,000 tonnes lower since the beginning of the year (or down 45%). LME cancelled copper warrants have been volatile in relation to the heavy outflow of metal. However, the rise in cancelled warrants at the beginning of December 2003 will almost certainly ensure that the firm downward inventory trend remains intact, with about 65,000 tonnes still awaiting outward delivery. Total exchange stocks (including Comex and Shanghai) had fallen to 840,000 tonnes in the third quarter of 2003, only 40,000 tonnes above the level Codelco is awaiting before considering the release of its 200,000-tonne stockpile accumulated during the year.
Total reported copper stockpiles (including inventories at exchanges, producers, consumers and merchants) have fallen rapidly from all-time highs in 2003, and stood at 1.8 million tonnes at the end of the third quarter. The decline has primarily been the result of falling inventories at Exchanges, but consumer and merchant stocks are also lower. Data indicate that the declining inventory trend is price-supportive.
In line with falling inventories and improved demand conditions, the historically high stock-to-consumption ratio is also declining. Data for October suggest total stocks measured as weeks of consumption stood at about 8.6 weeks at the end of the third quarter. These data do not include China (now the world’s largest copper consumer), but as U.S. consumption growth moves out of negative territory, the Western World stock-to-consumption ratio should also improve rapidly.
Official customs statistics show that Chinese net imports of refined copper slowed somewhat in October 2003, amounting to 103,000 tonnes, which was the lowest monthly level since April of the same year, while net imports rose above 1 million tonnes in the first 10 months of the year (+8.2% year over year). Domestic refined copper production rose to 1.5 million tonnes during this period (+10.5% year over year), which attracted imports of 2.3 million tonnes of concentrates (+42.6%), and 2.6 million tonnes of copper scrap (+3.8%). The high level of concentrates and scrap imports is impressive, given tightness in both markets, and it highlights Chinese producers’ relative competitiveness when TC/RCs are at historic lows, which is causing restricted smelting production elsewhere, especially in non-U.S.-dollar regions.
Data from the International Copper Study Group (ICSG) show that the apparent refined copper balance for the first eight months of 2003 indicated a production deficit of 256,000 tonnes, compared with a production surplus of 127,000 tonnes in the corresponding period of 2002. The refined market balance for August 2003 showed a surplus of 67,000 tonnes — mainly a reflection of the seasonal weak demand in the U.S. and Europe. The data also show that world refined copper usage grew 1.7%, year over year, in the first eight months of 2003. Only Asia contributed considerably to the increase, while Europe and the U.S. showed a decline.
Nickel
As nickel prices have reached 14-year highs and as demand from the stainless steel sector continues to increase, attention is turning to the prospects for new supplies.
The market is also focusing on opportunities to substitute nickel in end-use applications. However, none of these aspects seems seriously to threaten the strong upward price trend over the nearer term. Instead, we think the nickel price has more room on the upside, despite a 70% price gain in 2003, and together with copper, we think nickel will be among the best performers on the LME in 2004. The attractive thing about nickel is that even if demand growth were to disappoint, the market would still be in deficit, for there is no spare capacity available to restart, and the start dates for major new projects are still a long way off.
Because of the strong price environment, companies are putting a lot of effort into exploration and project planning, and there are regular new capacity announcements. The problem is that once the new operations are ready to begin life (in many cases beyond 2006), it will be too late to capture strong prices, and they will only help to exaggerate the downward move while the market turns to oversupply. By 2006-2007, major new projects, such as
Nickel is not easy to substitute for cheaper materials. About 70% of all nickel consumed goes to the stainless steel sector, and it is a crucial ingredient to maintain the desired quality of end-use products, such as kitchenware, cutlery, and other household appliances and machinery. However, in response to strong nickel prices, several major stainless steel producers in Asia (China and Taiwan, especially) have changed their production processes to lower-content nickel (200-series containing 4% nickel) from the 304-series containing about 8% nickel. We believe that European stainless steel producers slowed austenitic stainless steel production during the fourth quarter in response to strong nickel prices. This might improve the outlook for the nickel market further (provided healthy end-use demand), while stainless steel inventories become leaner. At the same time, Japanese stainless steel production is strong, and refined nickel consumption is enhanced by continuous scrap shortages.
What else could threaten the outlook for nickel? Reported refined inventories rose in the aftermath of the release of
Stainless steel prices have failed to advance at the same phase as nickel prices. This is most likely an indication that the rally in nickel is partly supply-driven, while it might also be difficult for stainless steel producers to pass on higher prices down the supply chain.
The continued reduction of total LME open interest has failed to temper nickel’s strong price gains over the course of the fourth quarter. Given heavy fund length in nickel, we find it somewhat hard to explain the fall in open interest. However, it may suggest that some long liquidation has occurred and that prices have received support from genuine consumer business. In any case, we believe the drop in open interest is encouraging as it leaves plenty of room for fresh longs to be established, which will keep the price in its firm upward trend.
Nickel turnover on the LME was 311,000 contracts in November 2003, meaning that it was the least traded metal on the LME after tin. More important, however, is the 42% year-over-year increase in turnover volume — the second largest increase after copper, which suggests that money has not been scared off from nickel by the rapidly increasing prices.
The whole nickel forward curve remains in a steep backwardation, and there have been signs of spreads tightening further over the past months, as some producer selling activity has emerged. In fact, far forward prices (27 months) are practically unchanged compared with a month ago, while cash prices have advanced a further 21% over the same period. Similar to most other base metals, current forward prices for nickel are trading at a discount to our estimated price levels for the same period. For example, current prices are trading at US$11,700 per tonne for the fourth quarter of 2004, compared with our average cash estimate of US$13,000 per tonne for that period. Consumers with hedging requirements should consider this opportunity. The nearby (cash-to-3-month) spread returned to a backwardation toward the end of the first half of 2003 and persisted throughout the second half. With fresh strike fears looming amid wage talks at Falconbridge in an already tight market, the nearby backwardation is likely to persist for now.
Physical spot premiums in the U.S. eased a little after the 3-month-long Inco strike was resolved but remain high in a historical context, given the emergence of new strike fears amid labour negotiations at Falconbridge. European premiums have been stable in recent months, owing to the dual effects of somewhat reduced consumption in response to high prices and decent inventory levels at LME warehouses.
LME nickel inventories rose sharply during the second half of 2003, reflecting inflows at Dutch warehouses. Given strong demand for nickel from the stainless steel industry, the inventory rise most likely reflects material being shifted from Norilsk Nickel’s consignment stock. Total LME nickel inventories stood at 34,000 tonnes at the beginning of December 2003.
LME cancelled warrants have fluctuated between 500 and 3,000 tonnes, or about 2.5-4.5% of the total remaining LME nickel stockpile, for most of the second half of 2003. In December, cancelled warrants were only 1,000 tonnes, suggesting that only a small amount is awaiting outward delivery.
Despite the rise in LME nickel stocks this year, total reported inventories (exchange, producer, consumer) are low in a historical context. In fact, total stocks are only half the level (or about 136,000 tonnes), compared with the mid-1990s, when the price also reached multi-year highs.
As total reported nickel inventories are historically low, and refined nickel consumption generally strong, the stock-to-consumption ratio has fallen to only 6.4 weeks. With the exception of the fourth quarter of 2000, this represents the lowest level we have on record, and suggests prices will remain supported from a favourable fundamental situation.
Official statistics confirm that there is still strong import demand for refined nickel into China. Net refined nickel imports to China in October 2003, at 8,400 tonnes (+121% year over year), were the highest since January 2003 (when a record 10,500 tonnes were imported), and were well above the 5,500-tonne monthly average for 2003.
The latest statistics from the International Nickel Study Group include no surprises, and the monthly deficit remained firm at 10,800 tonnes in August 2003, or at 25,600 tonnes for the January-August period. The data show a sharp drop in global production in August (due to the strike at Inco), with refined output down 5.2%, year over year, at 101,700 tonnes, but still 1.6% higher, year over year, in January-August at 792,000 tonnes. Mine output was 3.9% higher in January-August (at 847,000 tonnes), but down 3.2%, year over year, in August alone (at 101,700 tonnes). Global refined nickel consumption growth remains stable at around +4%, helped by even stronger growth in China, while growth rates in the Western World have eased a little.
— The opinions presented are the authors’ 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 authors at kevin.norrish@barcap.com and ingrid.sternby@barcap.com
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