US manufacturing data point to rebound in prices

In light of much-better-than-expected manufacturing data from the U.S. and Europe, which pushed base metals prices to strong closes at the end of the report period Feb. 25-March 1, the short-term risk for metals prices has shifted to the upside.

Indeed, we would not be surprised to see fresh highs for aluminum, copper, nickel and zinc over the next week or so, particularly if data continue to be stronger than expected. However, the markets still lack consumer interest, and so, in the short term, they remain vulnerable to long liquidation by the funds that have been the main drivers of recent price strength.

Looking a little farther ahead, the strength of recent U.S. manufacturing data suggests a strong rebound in industrial production over the next few months. In particular, inventory-to-orders data from both the Chicago and the National Association of Purchasing Managers (NAPM) surveys are at their highest levels in many years.

Taken in combination with the stronger-than-expected rebound in the Eurozone Purchasing Managers’ Index (PMI), on March 1, it is now possible to construct a persuasive picture of a major recovery in global industrial production. This recovery should become apparent over the next few months.

Although there are signs of developing weakness in some key metals-consuming sectors (notably U.S. construction), the probability that metals demand will surprise on the upside in the seasonally strong second quarter is rising. Consequently, we’re in the process of revising our second-quarter forecasts for base metals prices.

Copper prices closed strongly on March 1 at US$1,597 per tonne, climbing almost US$40 per tonne after the release of a stronger-than-expected NAPM report. If the US$1,600-per-tonne level is broken convincingly early in the week of March 11, then a move to challenge the year’s previous high at US$1,637 per tonne is possible.

Trading on March 1 was dominated by one major broker’s suggestion that the market is still being led by short-term technical funds and so is still vulnerable to large-scale liquidation. However, the floor for the market now looks a little higher than it did in the previous report period, and a move back below US$1,500 per tonne appears unlikely.

Fundamentals continue to send mixed signals. Strong U.S. durable-goods orders during the Feb. 25-March 1 report period were combined with a move in the NAPM to an expansive 54.7 (the new orders index, at 62.8, was the highest since October 1994). This development, combined with the unexpectedly strong Eurozone PMI (output and new orders climbed for the first time since spring 2001), suggests an imminent upturn in the global manufacturing cycle. However, given the strength of prices in the face of rising copper stocks (London Metal Exchage inventory is now at an all-time high), substantial improvement in copper demand from this sector over the coming months may already be priced-in. One area of weakness over the next year or so could be the construction sector, particularly that of the U.S., which stayed firm throughout the recent slowdown. January’s 15% fall in U.S. sales of new homes could be an early indicator of what’s to come in this sector, which is a key one for copper.

Aluminum prices need to hold convincingly above the US$1,410-per-tonne level if they are to confirm that the recent upward move was more than a knee-jerk reaction to positive U.S. economic data. If they are not able to do so, a move back down to recent support at US$1,380 per tonne can be expected.

As with copper, the aluminum market is being dominated by commodity trading advisors, though there is consumer buying interest on the lows and some producer-selling at the highs. Prices appear to be hemmed in to a fairly narrow trading range by bearish supply-side developments, which are offsetting some positive signs on the demand side.

Zinc prices climbed strongly, benefitting from fund short-covering in a positive technical environment, as well as from strength in the rest of the base metals complex. The London Metal Exchange 3-month price gained US$43 per tonne from its low of US$777 per tonne on Feb. 22, reaching a 6-week high of US$820 per tonne before falling back but still closing strongly at US$815 per tonne. With the rest of the base metals complex appearing to be on the verge of further gains, a move up to test the next resistance level, at US$830 per tonne, looks possible.

Despite zinc’s strong recovery, there has been little change in its dismal fundamental picture. An upturn in leading indicators of industrial production in the U.S. and Europe holds out the promise of better demand going forward, but the supply side of the business is still a mess. Chinese mines announced production cuts late last year, yet there is little sign that this is stemming the flow of Chinese metal into Western markets, at least not yet. January’s zinc exports climbed 37%, year over year, and the 12-month moving average of exports remains constant at a historically high level. The lack of significant smelter cuts in Japan and weakness in demand (down almost 4% in 2001, compared with 2000) is leading to a constantly growing exportable surplus, pushing zinc exports up 82.5% in January to 6,037 tonnes.

Under the circumstances, it’s hardly surprising that London Metal Exchange stocks continue to rise, particularly in the Far East, where stocks in Singapore, at a little below 144,000 tonnes, are almost 60,000 tonnes above their year-earlier level.

Meanwhile, nickel prices have been left to follow the price pattern set since the start of the year: range-bound, reluctant to test areas of key resistance, and prone to dips after managing to register only lukewarm rallies.

The price strength seen on March 1 was surprising in copper and aluminum markets, and surprising, in its absence, in nickel and zinc. The rally’s spark is clear, and serves as tangible evidence from the U.S. and the eurozone that conditions in the manufacturing sectors are markedly improved. What’s fueling the price strength is also clear — speculative funds and little activity on the part of commodity trading advisors. With the smaller and more illiquid markets of zinc and nickel deterring much of the fund-related activity in these markets, the question arises: will this leave nickel playing catch-up by breaking out of its broad US$400-per-tonne range between US$5,800 and US$6,150 per tonne, or will the complex soften before nickel has a chance to break higher?

With risks in copper and aluminum moving much more confidently toward the upside, we assume the same risk will begin to affect nickel — if, that is, the momentum in the rest of the complex is sustainable.

Several factors — the thinness of nickel’s trading conditions, the illiquidity of the market, the persistence of the backwardation in the cash-to-3-month price, and the continued squeeze on nearby supplies — suggest nickel has a tendency to emerge suddenly and violently from dormant periods of range-bound trading. With this risk in mind, resistance at US$6,150 per tonne may still be in place, but, as well, support should be notably more resilient.

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