Metal price forecast — 2007

Metal investors can be forgiven for popping an extra bottle of Dom Prignon this New Year’s Eve. It’s been a rollicking 12-month ride for metal prices, and the shares of many of the companies tied to them.

But lingering behind the jubilation of the astute investor is a voice of skepticism. Can uranium prices really go any higher? What of record prices for copper, nickel and zinc? Is a major correction imminent?

The Northern Miner spoke with a fund manager and a research analyst, to try to get to the bottom what the coming year may hold.

And what better place to start than with gold?

So far this year the yellow metal has gained 14% or roughly US$76, and that’s after September and October corrections.

While such gains could cause some to ruminate over a drop, Charles Oliver, senior vice president and portfolio manager at AGF Funds, doesn’t think so.

“I’m most enamored by the yellow metal,” says Oliver of potential for metal prices in the coming year. The AGF precious metal fund, which Oliver co-manages, has gained 82% over the last year. Its three top holdings listed by portfolio weighting are: Kinross Gold (K-T, KGC-N), Inmet Mining (IMN-T) and Aurelian Resources (ARU-V).

The fund manages a total of $440 million and currently has a five star rating on the Globe Fund Investor website.

Oliver opines that with the US Federal Reserve in a flat to lowering mode on interest rates, “it doesn’t pay to own the US dollar.” So, he says, “you start to look at a bit of gold. It’s one of the most attractive options.”

In addition, there is a growing sense that China will add to the quantity of gold it holds in its reserves. Currently the Asian giant makes up just 1.3% of its reserves with gold. That compares with the roughly 14% that European Union countries are mandated to hold in gold and the roughly 75% that the US holds.

And then there’s that “unnamed Chinese official” who occasionally surfaces to say the amount of gold in the reserve could go up to between 4 and 5%.

Officially, the chief of the Chinese central bank will only say that the country is looking at alternatives to the US dollars that currently make up the bulk of its reserves.

“Like all other major currencies, it would probably be that they need to add gold over time,” Oliver says. “I have a personal expectation that they will, though it’s still not been clearly communicated to the market.”

As for ongoing troubles in the Middle East, Oliver says while a blow-up there would jolt the price of gold, geo-political disruptions generally cause gold to rise in the short term but then subside to their pre-incident levels.

Political destabilization, therefore, is not a key metric in his bullish forecast which puts the gold price in the US$1000/oz range within two to four years.

While Patricia Mohr, vice president of industry and commodity market research at Scotiabank, also says gold prices have room to rise in the coming year, she looks to uranium, zinc, and silver as the star metals for 2007.

Despite uranium’s continuing big gains the metal has gone from the US$43/lb range at the beginning of the year, to the US$62/lb range, a 45% gain Mohr says it still has room to grow. She expects the price to get into the US$70/lb range by the end of 2007.

“There’s tremendous expansion around the world in nuclear power,” she says, noting much of the impetus is coming from the lack of greenhouse gases produced by nuclear reactors. “There’s interest in new facilities, not only in China but also in India, Eastern Europe and the U.S.”

Mohr says while mine supplies are increasing, they are doing so slowly, and notes that yellow cake production was actually down for the first half of this year.

The delaying effect of a flood at Cameco’s Cigar Lake which was slated to provide the first large incremental supply of uranium to the market has also underlined the tightness of supply.

While zinc prices don’t share the same underlying fundamentals as uranium prices, Mohr says they will at least hold on to the massive gains they have made this year.

The reason? The huge deficit between consumption and production of refined metals as reflected in the dramatic drop in zinc inventories.

Zinc stockpiles, monitored by the London Metal Exchange (LME) plunged nearly 80% in the past year, sending them to their lowest levels since 1991. The drop caused zinc prices to reach record prices north of US$2.00/lb.

“There’s not much new mine supply for zinc until the second half of next year so it will take a while to ramp up,” Mohr says. “It won’t be until late next year or early 2008 before we see an incremental supply increase.”

The last metal in the limelight for 2007 in Mohr’s estimation is silver.

Buoying her confidence are new applications for the metal notably in medicine and electronics which more than offset the loss of demand from the photography industry, she says.

Silver is used in film manufacturing but the advent of digital photography has taken away much of that particular market

Mohr’s outlook is in line with Oliver’s with regards to the declining US dollar, which she says will also help boost silver prices as the metal is tied to gold as an alternative to cash currency.

She notes that silver has actually outperformed gold for the last two years. In 2004 silver gained 14% compared with gold’s 6% gain; in 2005 it gained 30% compared to gold’s 20%; and so far in this year silver is up 39% compared with gold’s 14% gain.

Is it a dog?

So much for the stars of 2007, what of the dogs? With so many metals burning up price charts, surely some are due to come off in the coming year?

Oliver and Mohr both believe in the continued strength of metal prices going forward, but both see slight corrections in the copper price.

“We think global growth in 2007 will be slower than in recent years,” she says, “partly because of a slowdown in U.S. housing activity and partly becasue of somewhat lower consumer spending in the U.S. Also the pace of economic expansion in China will probably be a little slower than in recent years.”

This year will be the fourth year in a row of more than 10% growth in China, which while remarkable, both Mohr and Oliver say such a pace is not sustainable in the long term.

Mohr anticipates a drop in economic growth to 9.8% from 10.5%, and says such a decrease, while not overwhelming, could have a psychological impact on demand.

“Business investment gains are slowing because the Chinese authorities are trying to cool down the economy to prevent overheating,” she says, explaining that by “cooling down” the economy she doesn’t mean the Chinese will fight rising inflation by raising interest rates, but rather, are targeting excessive investment in some sectors — like steel and real estate — so that a more sustainable pace prevails. Only then can a build-up in excessive capacity in certain industries be prevented.

Mohr projects US$2.50/lb copper price for the coming year. And while lower than this year’s average, which will come in around US$3.06/lb, she emphasize that the lower mark is still an extraordinary price for copper.

Oliver adds another note of caution on copper.

“One problem is, not everyone who wants to use copper or nickel is able to get it,” he says. “So you are seeing a natural demand destruction occur, because some businesses can’t get it or it’s not economic to run their business in this price range. That will act as a natural check on prices.”

But Oliver, like Mohr, insists he’s no copper bear. He argues against those who predict a drastic decline in copper prices based, they say, on the fact that supplies have become sufficient and prices are un-supportably high.

“I’m not expecting a major correction to long term prices,” Oliver says. “I don’t expect to see 95 copper for many years.”

Against the copper bears, Oliver cautions against putting stock in reports that cite copper inventory growths of 100% over a short-term period. He says such figures can be misleading if they don’t take into account the larger trend, which has seen copper inventories decrease to 20% of what they were five years ago.

“If you had 10 cars and then went down to just one, and someone gave you another car, sure you’d have a 100% increase, but you’d still only have 2 cars compared to the 10 you once had,” he says.