Cutbacks bolster nickel

What had appeared to be a promising rally in base metals markets earlier on in the week of April 2 turned into something of a rout on April 6 as both copper and aluminum prices shed US$30-40 per tonne. Both registered their lowest prices for the year to date. Zinc and nickel prices held up slightly better but, at presstime, appeared set to resume their steady downtrend.

Fresh demand concerns fuelled the latest bout of selling, with markets spooked by much-worse-than-expected U.S. employment data on April 6. These data are encouraging speculative funds (predominantly U.S.-based) to add to short positions, while the strong greenback discourages non-American consumers from buying for anything but their immediate needs. Further price weakness across the whole of the base metals complex is likely in the short-term, but the growing size of fund short-positions suggests that the complex is vulnerable to short-covering rallies that could prove volatile under the right circumstances. At present, it is unlikely we will see the kind of catalyst the market needs in order to test the upside, so it looks as if support levels will be under pressure again over the next few days.

Apart from the glum employment figures, some U.S. economic data were positive: construction spending and auto sales in March were above expectations, and the stock market is showing signs of a partial recovery. Nonetheless, copper prices were unable to move higher. After failing to break above resistance at US$1,700 per tonne, the LME 3-months fell back sharply on Friday to register a new 11-month low of US$1,655 per tonne. The U.S. economic good news was diluted somewhat by poor business indicators from Japan and Europe but even more damaging to market sentiment was the continuation of large deliveries into LME and Comex warehouses. All the indications are that copper market fundamentals are weaker than expected at a time when demand should be climbing to a seasonal peak. In the short term, we expect US$1,700 per tonne to continue to be the limit for the London Metal Exchange (LME) 3-month price on the upside, though US$1,650 per tonne should provide good support.

The net increase in exchange stocks of copper during the report period was greater than 13,000 tonnes — a 21,000-tonne increase in LME and Comex stocks, partially offset by a 7,000-tonne draw in Shanghai inventory. Following the large increase in LME stocks that occurred in early March, most market participants had expected the LME stock trend to turn negative again, but in the past two weeks LME inventory has climbed 24,000 tonnes, and it’s showing no sign of levelling out just yet. Most of this increase has been in the U.S., while many European warehouses continue to see good levels of withdrawals. However, should the recent downturn in European business confidence levels feed through into local copper demand, then a slowdown in European copper withdrawals could become a reality. The European consumers to which we speak are already concerned about their business outlook, and European LME stock levels should be watched closely over the next few weeks for any sign that withdrawals are slowing.

After trending upward for most of the second half of the report period, aluminum prices were hit by long liquidation on April 6 and fell back below US$1,500 per tonne to end the week disappointingly at US$1,472 per tonne. Earlier on in the week, support at US$1,475-1,480 per tonne had been tested yet again but held up well, partly because better-than-expected U.S. economic data (notably a smaller-than-expected decline in March car sales) had boosted sentiment. Another negative for the market was a 5,000-tonne increase in LME stocks over the second half of the week. LME stocks have yet to start trending downward, as is normally the case at this time of year, underlining the current weakness in fundamentals. In the short term, we expect a continuation of the recent US$1,475-1,520-per-tonne range for the LME 3-month price.

Power-related issues remain vital to the aluminum market. Kaiser Aluminum says that in October it plans to restart some of its 274,000 tonnes per year of idled smelter capacity in the northwestern U.S. in October, provided power rates and metal prices improve by then. However, we think this unlikely. The new power contracts of the U.S.-based Bonneville Power Administration come in to effect in October, but the BPA will not give any indication of power prices until July. The BPA is still short of power and must buy in additional supplies to cover all its commitments; it is then able to recoup the costs from its industrial customers. Given the tight power situation that is likely at that time (California power grid operators warn that they expect a shortfall of 5,000 megawatts this summer), we think power prices for the BPA’s big industrial customers will be set at US$40-50 per megawatt-hour. This is above break-even levels for Kaiser’s smelters and high enough to discourage restarts at other idled smelters in the Pacific Northwest.

A mini-rally in zinc prices was snuffed out, thanks to general weakness in the base metals complex as a result of poor employment data from the U.S. Earlier on, the LME 3-month price had climbed to a peak just below what is now becoming a new area of overhead resistance at US$1,000 per tonne. Prior to the collapse on April 6, the upward trend in prices was supported by a tightening in nearby spreads, which, at one stage, resulted in cash-to-3-month trading at a US$1-per-tonne contango, compared with US$18 in the previous week. By April 6, spreads had eased a little, but, with cash-to-3-months still at only an US$8 contango, spreads are still relatively tight. A move back up in the 3-month quote cannot be entirely ruled out in the short term, but it is difficult to see prices moving above the US$1,020-per-tonne level in under all but the most extreme circumstances.

Why spread tightness should have developed at this stage of the cycle, when LME 3-month zinc prices are at their lowest since mid-1999, is puzzling. One theory is that a major trading company is seeking to pick up North American warrants, which it would then use to supply Cominco’s commitments (the Canadian major recently announced a cutback of 100,000 tonnes of production at its Trail smelter in British Columbia). There is little evidence to support this theory, though we note that it was the same trading company that recently was instrumental in bidding up the nearby spreads and that, out of the total increase in LME stocks of just over 2,325 tonnes during the report period, there were small increases at several U.S. warehouses.

Nickel enjoyed the strongest performance of any base metal during the report period, as the market showed it is still vulnerable to short-covering rallies. The announcement made by Russia’s Noril’sk Kombinat, the world’s largest producer, that it will cut export by 20,000 tonnes this year was clearly supportive of higher prices. Even before the announcement, however, nickel was heading back to the US$6,000-per-tonne area, having bounced sharply away from the lows of the previous week.

These price moves do not, however, indicate a sustained recovery. The export reduction is a plus-factor, though, on the negative side, it comes at a time when nickel demand prospects remain uninspiring, given that poor macroeconomic and fundamental indicators confirm a global industrial downturn. It is therefore more likely that the ultimate effect of the Noril’sk cut will be to cushion nickel’s descent and prevent steep price falls during the second quarter. Meanwhile, economic concerns continue to place downward pressure not only on nickel but on the whole base metals complex.

Toward the end of the report period, gold moved out of the near-20-year lows suffered only days before and restored the US$258-per-oz. level of support. But despite the improvement, prices remain vulnerable, with moving averages still trending down.

Of course it is not just technical factors that leave prices vulnerable: the long-term downtrend encourages funds to go short; the above-ground stock levels continue to be a potent bear influence on prices (as the recent Austrian Central Bank sales reminded us); and physical demand is lacklustre. For these reasons, we remain convinced that despite the support gold prices have so far found in the low US$250s, it is only a matter of weeks before the gold price falls to below US$250 per oz.

The stronger close on April 6 was largely buoyed by increases in lease rates, as signs of nervousness continued to be detectable in the front-end lending market. Short-term lease rates peaked at 3% during mid-week, though they have since eased back. The source of the tightness is still cause for debate. A viable suggestion is that it is simply a consequence of the permanent and large short position that has become a feature of the gold market. As recent data from Comex has shown, the market is becoming accustomed to a sizable fund short position, and a natural consequence of this is higher short-term lending rates.

Unexpectedly, the European Central Bank acknowledged that a member bank had sold 30 tonnes of gold, and this quickly gave way to rumours, then confirmation, that the Austrian Central Bank was the source of the selling. The news is effectively price-neutral as the sales fall within the 400-tonne agreement struck in 1999 by the European banks to limit sales. The speed of the sales is perhaps a slightly more bearish fact, coming so soon after the Bank of England announced it would sell 30 tonnes less this year.

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


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