The downturn in base metals prices accelerated during the report period July 23-27, with average London Metal Exchange (LME) cash prices of tin, nickel and copper shedding 4.5%, 3.5% and 3.3% respectively. Aluminum also shed 1.9%, but zinc prices stabilized and registered no losses. Lead was once again the best performer, gaining over 6% on the week, and is now the only LME metal trading at above the level at which it started the year.
The prices of nearly all industrial commodities have been placed under severe downward pressure by speculative selling over the past month. In energy, the funds are now holding some of the largest short positions on record in both crude and oil products, as well as in natural gas. In copper, the shorts on the Comex division of the New York Mercantile Exchange are only a few thousand lots shy of their all-time high, and in aluminum, though the position is less clear (owing to lack of data), there are informed estimates that the fund short position is now over 1 million tonnes — much greater than the total level of exchange stocks. This aspect of the current market opens up significant upside price risks via short-covering rallies, particularly since, in certain metals (such as copper and zinc), prices are at levels where production cuts may be imminent. However, with no upturn in sight for key industrial or manufacturing indicators in either the U.S. or Europe (we expect to see further declines in data from both the U.S. National Association of Purchasing Management and the European Monetary Union), the fund shorts are likely to remain in the driving seat for the next few weeks at least.
Copper prices fell sharply lower during the first half of the report period and, despite a modest rebound on July 26 which took LME 3-month prices back above the US$1,500-per-tonne level, look poised to fall further. Despite already holding substantial net short positions, the Commodity Trading Advisors are not yet finished selling copper. With such large speculative short positions in the market, a short-covering rally is a risk that cannot entirely be discounted. The slowdown in the rate of LME stock increases was mildly positive during the week, at +3,850 tonnes, including a 1,125-tonne withdrawal on July 27. However, this is unlikely to have much impact on selling by the momentum trading funds. In the short term, the US$1,500-per-tonne level will likely come in for some thorough testing, and ultimately the funds may have the June 1999 low of US$1,365 per tonne in their sights.
Although the recent lurch lower was technical in nature, fundamental news was no less discouraging. Phelps Dodge announced it would not be extending Worker Adjustment and Retraining Notification statements at its Chino and Tyrone operations, dashing hopes that production cuts there were imminent. With Grupo Mexico also determined to maintain its copper output in the southwestern U.S., the most obvious source of cutbacks looks unlikely to yield anything positive, and prices will probably need to fall even further if other producers are to be persuaded to cut.
Like copper, aluminum prices are in the grip of technical traders, and are also now at 2-year lows. Prices have fallen much less quickly than corresponding figures for copper; consequently, the differential between the two has narrowed sharply. The low of US$83 per tonne, registered on July 26 (on the basis of the LME 3-month price), was only US$17 above the all-time low, reached in June 1999, and considerably below the peak of more than US$400 per tonne, posted in October 2000. Although the gap between copper and aluminum widened to around US$100 per tonne again on July 27, we would not be surprised to see a new record low set sometime over the next few weeks. After all, the widely held perception is that, in the short term, aluminum’s fundamentals are more positive than copper’s.
Kaiser Aluminium, in Washington state, underlined this when it said that any restart at its idled smelters would depend on lower power prices. Until recently, Kaiser had been stating its intention to restart its capacity at the earliest possible opportunity. Meanwhile, New Zealand’s growing hydroelectric power shortage and rising power prices have led to a production cut of around 20,000 tonnes at Rio Tinto’s 335,000-tonne-per-year Tiwai Point smelter. The closure ends the smelter’s exposure to the spot power market. Further cuts may take place if Tiwai Point is able to sell its contracted power back in to the grid.
Zinc prices have stabilized over recent weeks, moving in a narrow trading range of US$862-877 per tonne. Current price levels are close to average historical production costs (in U.S. dollars), and it is therefore unlikely that speculative funds would be willing to push prices much lower than they are. This probably explains zinc’s fairly resilient performance over the report period, relative to the declines seen in aluminum, copper and nickel. For this reason, it is likely that the period of stable zinc prices will continue, and in the week ahead, we expect support to remain at US$860 per tonne.
However, the zinc market may need lower prices more badly than it realizes. The appreciation of the American greenback against the currencies of major zinc producers in countries such as Australia and Peru means that prices need to fall much further than in previous downturns in order to bring about the production cuts required to restore balance to the market. At present, the zinc concentrates market remains well-supplied, and few, if any, smelters are short of material. The 15,000-tonne increase in LME stocks since the beginning of July is ample testament to the oversupplied nature of the metal market.
The danger for zinc is that prices may remain in limbo at levels that are low enough to reduce industry profitability significantly, but not low enough to encourage producers to shut mines. If this is the case, a long and painful period of attrition may be beckoning for zinc producers.
Two aspects of the current nickel market were on display. One was the downside risk from deteriorating fundamentals, fund short selling, and the lowest copper and aluminum prices for two years. The other was the resilience that has slowed the pace of nickel’s descent since the start of the year and resulted in a price fall of 14%, compared with a fall of 19% in copper and of 17% in zinc.
Fund activity has become the main driver of nickel prices on the downside. Until recently, funds had shown a greater degree of reluctance to sell fresh short positions in nickel. Compared with copper, where speculators have built up one of the largest short positions on record, the long-established cash-3-month backwardation in nickel has led to greater caution. The fact that fresh fund selling was able to push 3-month prices US$400 per tonne lower signifies the start of a greater willingness, on the part of speculators, to take risks on the downside and test support by holding short positions.
The fact that, by the end of the report period, nickel was able to halve its losses and climb US$200, to US$5800 per tonne, shows a considerable degree of nervousness in this market, as short covering produced a mild recovery. Despite this nervousness, however, funds have now shown a greater tendency to sell short, and we expect the focus to remain on support at US$5,600 per tonne.
Even though the gold market remained quiet, prices developed an increasingly bearish tone and began this week looking vulnerable. After several days of sideways and lacklustre trading, gold has increased the pressure on support at US$265 per oz. again. We consider this move to be particularly bearish for two main reasons. One is that gold started edging away from US$270 per oz., even though there was a risk of major industrial action taking place at South African gold mines. The second reason is that the U.S. dollar fell to its lowest level against the euro since mid-May. However, neither of these potentially bullish developments provided support, and by the close on July 27, prices had drif
ted below both the 100- and the 200-day moving averages.
Although the market remained dismally quiet for most of the report period, good levels of physical buying crept into the market once prices started edging downward towards US$265 per oz. This is important since, given the lack of substantial fund-selling interest, it may be sufficient to contain price falls and reinforce support at around the range of US$265 to $267 per oz. The technical indicators moved once again toward oversold territory, signaling the emergence of price support. Another source of support may come from the US$265-per-oz. line of support itself. This is a well-established area of support, which has prevented price falls in early July, early June and early May.
The major downside risk remains a break of support at US$265 per oz. This would signal a clear break of long-term support and a significant move away from the 100- and 200-day moving averages. The short-term risks associated with a break of support depend upon foreign exchange developments and the speculative funds. If the euro is unable to hold its gains and the U.S. dollar strengthens, gold prices could also weaken. The net speculative long position that remains in the market could also then be a rapid source of fund liquidation and eventually short selling.
— The opinions presented are solely the author’s and do not necessarily represent those of the Barclays group.
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