While economic data remain mixed, economic developments over the past few months have prompted downgrades to metal price forecasts. The Access Economics Survey, which monitors analysts’ commodities estimates, released its latest quarterly survey. It indicates widespread downgrades to base metal prices but upgrades to safe-haven commodities, such as gold and oil.
Until further signs of an economic turnaround are evident, we believe this diversification will largely persist, with industrial raw materials remaining capped in light of current weak demand, and gold and oil benefiting from political uncertainties relating to Iraq.
While the Access Economics Survey suggests estimates for the period 2002-2004 (bar nickel) have generally been overoptimistic (with aluminum, lead and zinc the worst-hit), the price trend overall remains upwards.
Consensus forecasts suggest nickel will be the first base metal to peak, in the second half of 2003 (at US$7,341 per tonne), while lead, tin and zinc will be the last to peak in the cycle, in the second half of 2004 (at US$562, US$5,512 and US$1,067 per tonne, respectively). Consensus is that aluminum and copper will peak during the first half of 2004 (at US$1,614 and US$2,004 per tonne, respectively).
In contrast, gold and oil are among the commodities that have seen the greatest upgrades to prices. The yellow metal is expected to remain above US$310 per oz. during the active forecast period, while oil is expected to stay above US$20 per barrel on an annual average basis, according to Access Economics. (It’s worth pointing out that the forecast adjustment process tends to be lagged, which would suggest the worst may be behind us.)
Following sharp downward movements in copper prices during June and July, in line with weakening equity markets and deteriorating economic indicators, a quiet August saw the recent downtrend halted.
Instead of uniformly negative economic data releases, recent data have been more mixed, though it’s still too early to read improving demand conditions into these numbers. With prospects of a deteriorating U.S. currency and the potential for a rate cut by the Federal Reserve later in September, we believe speculators will remain on the sidelines in the near term.
Further evidence that the economy is turning is needed for copper prices to move to higher territory on a sustainable basis. Nonetheless, from a fundamental point of view, the copper market remains well-placed to benefit from an improving macro-economic environment.
The news flow over the report period was relatively thin, especially in light of public holidays in the U.K. and Labour Day in the U.S. and Canada. However, we’ve seen the effects of the production cutbacks announced at the end of last year, with Chilean copper output reportedly declining 12.5%, year over year, in July (to 352,334 tonnes), and Japanese imports of copper-in-concentrates declining 25.3%, year over year, in June.
Any indication of demand during the report period consisted of comments from Umicore, which painted a fairly bleak outlook for European demand also for the second half of 2002. However, U.S. indicators are key, and the latest durable goods orders are looking more positive.
The downtrend in the aluminum market — in place for most of this year — was arrested in August, though prices still registered a small decline over the month (minus 1%).
As with copper, aluminum benefited from positive economic data releases, though this market is not as well-placed fundamentally as copper to respond to improving demand, given an existing large supply overhang. In addition, LME aluminum inventories continue to rise rapidly, with another daily rise of almost 8,000 tonnes reported at the end the week.
Although there were few fundamental developments over the week, preliminary data from the Japan Aluminum Association showed that domestic output of aluminum mill products rose 2.8%, year over year, in July (to 207,600 tonnes). This is especially encouraging given 18 consecutive year-over-year declines before that. However, as highlighted in the latest economic data, we do not expect any major help on the demand side from Japan. Industrial production fell in July (minus 0.4%, month over month) following a 0.2% month-over-month fall in June.
One of the key topics in the aluminum market is the prospect of Chinese production and exports to the Western World. Any growth will largely depend on Chinese ability to import alumina. However, as reported by London-based CRU International, central government legislation permitting only eight companies to import the raw material directly has continued to dampen Chinese buying interest. While alumina is entering China, under tolling agreement, to an increasing extent, this method of import may be threatened by bureaucratic requirements on smelters.
As a precursor of London Metal Exchange market movements,
However, the price developments over the report period have highlighted the uncertainty metals markets are currently experiencing. The fact that the key area of resistance at the start of the week at US$7,000 per tonne, only to end the week by sliding sharply below the 10-day moving-average line of support at US$6,730 per tonne, is an indication not only the volatile nature of nickel prices but also the rudderless nature of recent price moves.
While the stainless-steel sector continues to provide the main source of demand-based support for nickel, the main fundamental resistance to prices is emerging from uncertainties surrounding demand expectations. Until these improve, and until expectations of demand firm up, gains above US$7,000 per tonne will be difficult to achieve.
As the Aug. 30 Chicago PMI data showed, manufacturing activity in the U.S. may have slowed, but it has not yet stalled. We continue to forecast that gross demostic product in the U.S. will rise 3% in both the third and fourth quarters of this year. Furthermore, the durable goods data confirmed that manufacturing activity may be down but not yet out.
Against the backdrop of low stocks, low cancelled warrants and a declining risk-to-reward ratio for speculative funds to extend short exposure in the current environment, downside price risks continue to look less severe in nickel than in the rest of the complex, and we expect the 200-day moving average, at US$6,400 per tonne, to contain any price falls.
The zinc market has received lots of attention in light of an announcement by Outokumpu on the future of its Tara zinc mine, which was shut in November 2001 because of low prices.
Many market participants had expected Outokumpu to keep the Irish operation closed, given that the price environment has remained weak. However, as the company is exiting the base metals mining business, and reflecing also a tight concentrates market, it announced a partial (60,000-tonne-per-year) restart from the beginning of September. Prices reacted negatively to the news on the day but received renewed support shortly after.
In regard to the fundamental state of the zinc market, immediate prospects are poor in our view. However, given concentrate shortage, the facts that many operations are cash-negative and demand is currently lacklustre suggest that the medium-term outlook is more interesting, particularly if producers take action and respond to these issues.
Demand indicators continue to point toward uncertainty. So far this year, recovery in global zinc demand has been sluggish, and this is likely to remain a feature in the second half of the year, as highlighted in comments by Umicore about its results in the first half of 2002. However, galvanized steel prices in Europe have started to rise, and this might indicate that a rise in zinc prices is imminent, if necessary supply action is taken.
Gold prices made only tentative use of the b
ullish factors with which they were presented during the report period.
The (initially) weaker Dow and weakness in the U.S. dollar against the euro and the Australian dollar failed to lead gold to break resistance at $313 per oz, the 100-day moving average.
Renewed profit warnings from the American companies and further announcements of hedge reduction by gold producers such as Placer Dome also failed to create interest. Downside risks, however, should still be limited for the time being — the direction of equity markets is still highly uncertain, oil prices have recently risen to new highs for the year, and the U.S. dollar continues to face short-term downside risks.
Although the exact nature of any pre-emptive action the U.S. may take against Iraq is uncertain in nature, timing and outcome, observers are beginning to draw comparisons with the situation markets faced in mid-1990 when Iraq invaded Kuwait.
However, there are limits to how closely 2002 resembles 1990-91. Limiting the scale of a potential gold price reaction to any Gulf War II events is the comparative lack of shock. The Iraqi invasion caught the West by surprise, catapulting the U.S. and its allies into an unplanned military campaign to remove Iraqi troops from Kuwaiti soil. It was planned (and turned out) to be a short and targeted campaign, which did not set out to redraw the political landscape of the Middle East.
Furthermore, concerns over oil supplies at a time when the U.S. economy stood at the precipice of unprecedented growth were running high, and memories of the post-inflationary boom of the 1980s were fresh in the market’s mind.
A further key difference between the current environment and the prevailing environment in 1990 is the activities of speculative funds on Comex. Funds had turned quickly and aggressively against gold in the early 1990s. Interest rates were running at over 8%, prices had fallen below key levels, the practice of hedging was increasingly being employed as a price guarantee mechanism, bank lending was on the up, and the inflation concerns from the late-1980s credit boom were behind us. The times were not supportive for gold prices, and speculative funds made this clear by building a net short position on Comex of almost 25,000 lots.
The tight monetary policy of the Federal Reserve had recently seen rates pushed to almost 10%, encouraging even further the tendency of funds to sell gold short and producers to sell gold forward to protect themselves from a price fall, first below US$400 per oz. and then below US$350 per oz. just six months later. This clearly does not reflect the current state of the gold market, and expectations of sustainable price increases should be tempered by taking account of this.
— The opinions presented are the author’s and do not necessarily represent those of the Barclays group. For access to all of Barclays’ economic, foreign-exchange and fixed-income research, go to the web site at barclayscapital.com. Queries may be submitted to the author at kevin.norrish@barcap.com
In the absence of convincing positive economic data over the report period, base metal prices remained in a sideways trading pattern. However, downside pressure has been arrested, especially after the Chicago Purchasing Managers’ Index gave a positive spin to the end of the week.
The August Chicago PMI (54.9, compared with 51.5 in July) reflects an expanding manufacturing sector, which is positive news for the outlook of base metals demand.
Aug. 26-30 At a Glance
– A quiet August has seen the recent downtrend in copper prices halted. Positive economic data are encouraging.
– The downtrend in aluminum was also arrested, but supply overhang remains an issue.
– Nickel prices weakened further, but support above US$6,400 per tonne is expected.
– A rise in the price of zinc could be imminent if necessary supply action is taken.
– Gold failed to respond to bullish signals, but upside risks remain in place.
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