Slumping copper typical of base metals complex

The report period March 19-23 was a mixed one for base metals, as markets were dominated by collapsing global equities values. Copper prices continued in the steep downtrend established in early March, hitting a 10-month low of US$1,707 per tonne. Despite regaining some ground later on, the average London Metal Exchange (LME) cash quote shed 2.6%. Aluminum found consistent support at US$1,480-1,490 per tonne for the LME 3-month price but still saw a decline of 1.5% in cash prices. Nickel and zinc saw brief short-covering rallies, though the trend in both would appear still to be downward.

There are signs that the de-stocking cycle in the U.S. that has been hampering metals demand is coming to an end. Aluminum product orders appear to be bottoming out and auto-manufacturers have raised their production targets for the second quarter. However, the extreme volatility in world equities markets is preventing this from feeding through into metals price gains. In recent weeks, around US$4 trillion has been wiped from the wealth of American households, equivalent to 60% of annual income. If Americans compensate for this loss by raising their savings rate, we could see another dip in demand, and at a time when other regional markets are looking shaky. Several factors — disappointing data from Europe, low business confidence levels, and further deterioration in the Japanese economy — suggest that there is a risk of contagion spreading. We have not yet altered our bullish 18-month view on metals prices, but the events of the past few weeks have probably pushed the recovery a little farther away.

The decline in copper prices continued. Sharp falls in global equities unnerved the market and kept LME 3-month prices in the steep downtrend that they have followed since early March. The market is in desperate need of some positive fundamental news, and this was not provided by disappointingly small cutback announced by Phelps Dodge.

On the face of it, Chinese import data are bearish for the market, showing an 11% fall in refined copper imports, compared with levels in the first two months of 2000. However, on closer inspection, the data would appear to be more positive. As a result of the big drop in cathode exports (minus 35%, year-over-year), the fall in net imports was just 5%. In addition, there was strong growth in imports of copper scrap and concentrate. Anecdotal evidence suggests that demand growth in China is firm, with rod mills working at full capacity. Shanghai stocks are falling, and, so far this year, bonded warehouse stocks have been drawn down sharply. It appears the Chinese are substituting raw materials for refined copper purchases, though there is a strong chance that if metals stocks continue to fall, a switch back to cathode will occur later in the year.

Meanwhile, demand in other regions appears to be deteriorating rapidly. In the U.S., an expected improvement in orders for brass mill products in April failed to materialize, while the leading indicator of general economic activity turned down again (minus 0.2% in February, after plus 0.5% in January). In Europe, demand for copper products is sluggish, and general economic confidence is declining rapidly. Japanese demand is suffering from the slowdown in the global electronics sector. Normally, LME stocks should begin falling at this time of year, as seasonal demand kicks in, but there is no sign of this happening.

Following a sharp fall late in the previous week, aluminum prices exhibited an encouraging degree of resilience. LME prices found good support from trade-buying on dips toward US$1,485 per tonne and finished the week above the psychologically important US$1,500-per-tonne level. The market continues to draw support from the ongoing tight power situation in the U.S., falling global production levels, dwindling exchange stocks and strong Chinese buying. In the short term, US$1,485 per tonne is likely to continue to prove a key area of support, and if it gives way, prices could quickly fall to US$1,450 per tonne. On balance, we expect US$1,485 per tonne to hold, but the market will have to struggle to make much headway above US$1,500 per tonne if global equity markets continue to dive and other base metals (notably copper) remain weak.

Alcoa’s announcement that it is to cut output by a further 70,000 tonnes per year at its 280,000-tonne-per-year Ferndale smelter, in Washington state, was partially offset by the re-start of 25,000 tonnes per year of idled capacity at its 308,000-tonne-per-year plant in Warrick, Ind. Alcoa is clearly trying to reduce the impact of production cuts in the northwestern U.S. on its overall output levels, and on the market in general. The company must be mindful that global production levels are now in decline and wary of the impact that the resulting price volatility may have on end-use demand. However, there is a limit to what Alcoa can do in this respect. Its remaining 235,000 tonnes per year of smelter production in the northwestern U.S. is still at severe risk of closure, but, following the restart of around 200,000 tonnes of idled capacity last year, it is now left with only 135,000 tonnes per year with which to offset any further closures.

The release of Chinese aluminum trade data also provided a fillip to the market, showing primary aluminum imports up by 32%, year-over-year, for January and February (the net import figure showed a more modest, but still encouraging, increase of 17% after adjusting for a big rise in primary exports). However, a dramatic increase in alumina imports (up 53%, year-over-year, to 380,000 tonnes) is cause for concern. It is rumoured that a large amount of new primary production capacity will start up in China in the first half of 2002. The increase in alumina imports indicates that Chinese aluminum smelters are possibly taking advantage of current low alumina prices (quoted at US$165 per tonne) in order to buy now and then re-export the material as metal later in the year.

Nickel prices reached US$6,220 per tonne — the highest level for the LME 3-month since early March — but soon fell back again. A move above the 10-day moving average at US$6,042 per tonne at mid-week drew some knee-jerk short-covering from funds, but there was not enough momentum to take prices through the next major technical level at US$6,200 per tonne, and prices soon fell back again. In the short term, we expect the steady downtrend in prices to continue. A break below US$5,840 per tonne would signal fresh downside momentum.

The possibility of a late price spike late in the first quarter or early in the second appears to be fading. Demand prospects are poor because high stainless steel inventory remains a problem in the U.S., while further production cuts are planned by producers in Europe and Japan. There is a faint hope that a shortage of nickel units in the second quarter, owing to lower scrap availability plus a seasonal slowdown in Russian nickel exports, could bolster fundamentals. However, given the potential weakness in demand, this looks increasingly unlikely. Nickel supply from other sources is growing fast. This year, Falconbridge plans to produce 70,000 tonnes at its Nikkelverk refinery, in Norway (11,000 tonnes more than in 2000), and Anglo American’s recently inaugurated Loma de Niquel in Venezuela is slated to crank out 11,000 tonnes.

Early in the report period, zinc prices briefly broke out of their narrow range, as a move above the 10-day moving average drove the LME 3-month figure up to US$1,027 per tonne on a flurry of short-covering. However, the excitement was short-lived and by March 21, prices were back in their US$1,010-to-1,020-per-tonne range. Volumes in zinc remain extremely thin and, at present, interest is lacking. Without a substantial improvement in the global economic environment and the base metals complex in general, it is difficult to see zinc prices finding much upward momentum. Then again, given their already low level, the downside is limited as well. In the short term, we expect the recent US$1,010-to-1,030-per-tonne range to hold.

China’s zinc exports in February fell 27%, compared with year-ago levels. The drop is doing little to encourage the market, however, reflecting a belief (which we share) that exports are set to climb back sharply over the rest of the year. China’s zinc concentrate imports are up strongly in the first quarter, coinciding with a big increase in zinc-smelting capacity this year. At present, the Asian zinc market is oversupplied; witness the sharp rise in LME stocks in Singapore to more than 80,000 tonnes currently from less than 60,000 tonnes in early February. Chinese producers may be waiting for better demand conditions before exports take place.

Following recent high levels of volatility, things were quiet on the gold front. Prices trended gradually up over the course of the report period but balked at US$264-per-oz. resistance on March 23, ending disappointingly at US$261.4 per oz. Lease rates remain somewhat volatile but at much lower levels than those of early March. Also, the market’s nervousness over nearby liquidity appears to be easing.

Exchange rate movements suggest that gold may be in for a period of weakness. Lacklustre European data and the easing of the European Central Bank’s stance toward interest rate cuts suggest that the recent slide in the value of the euro has a good chance of continuing. If it does, the omens for gold prices are not good. Just as the value of the euro deteriorated from early 2000 until late last year, gold followed suit, but then it failed to benefit from the euro’s recovery. We believe that the firmer euro late last year and early in 2001 reflected temporary speculation on a U.S. recession. In the medium term, net capital flows from the Eurozone to the U.S. can be expected to continue, and our target for the euro is US85. The gold price looks set to move lower if its asymmetric relationship with the euro continues.

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