IMF forecasts spur optimism

Metals prices turned in another poor performance during the report period Sept. 24-28 as fears over the global economic outlook intensified. Of the major London Metal Exchange metals, nickel and zinc were hit the hardest, with average LME cash prices shedding 2.6% and 2%, respectively, compared with the previous week. Aluminum fell 1.7%, while copper, benefiting from suspicions that production cuts are imminent, actually gained, but only by 0.3%.

Although a great deal of uncertainty hangs over all markets, some recent developments provide grounds for optimism. Oil prices fell back sharply, registering their biggest daily loss in 10 years, and we are revising down our medium-term price forecasts as a result. Lower energy prices increase the scope for monetary easing, and another by the Federal Open Market Committee looks likely. Recent forecasts for the global economy issued by the International Monetary Fund are being misinterpreted by some as indicative of a world-wide recession. In fact, the forecasts project growth of 1.8% and 2.2% for 2001 and 2002, respectively. Stock markets tend to over-react in times of crisis, and the underlying economic data may not be as bad as the markets have priced in. The much-stronger-than expected Chicago Purchasing Managers’ Index, released on Sept. 28, may be the first indication of this (significantly, the bulk of the data was collected after the terrorist attacks of Sept. 11).

Copper prices barely moved during the period under review, trading in a narrow range of US$1,433-1,457 per tonne on either side of the 10-day moving average. LME volumes remain painfully thin, illustrating the uncertainty that continues to afflict most market participants. In the absence of any major fresh news regarding the response of the U.S. and its coalition, we expect LME 3-month prices to continue to trade within the recent range of US$1,425-1,460 per tonne.

However, price downside is likely to be limited in the medium term. In the wake of short-covering after Sept. 11, funds have re-established short positions, and a nervous market could still be vulnerable to good news further ahead. Again, the underlying economic data may prove less bad than is feared. Production cuts could also help, but, with most industry participants already expecting announcements to be made soon by U.S. producers, any cuts will have to be large if they are to make much of a difference. LME stocks have risen sharply over the past few weeks by almost 58,000 tonnes. However, the increase has had little impact on prices since it is related to the covering of LME short positions by a major trader ahead of third-quarter results and has long been anticipated by the market.

Aluminum prices continue to look weak. LME 3-month figures fell sharply on Sept. 24 to register fresh 26-month lows and, after finishing at the bottom of its subsequent US$1,333-to-1,350-per-tonne range on Sept. 28, appear likely to fall further in the days ahead. Support has been in the low US$1,330s, and if this gives way, a move down to US$1,325 per tonne is possible. But after that, we think, the chance of a move to US$1,300 per tonne is fairly limited, at least in the short term.

In recent weeks, forward prices have fallen by around US$10 per tonne more than the decline in the LME 3-month figures. This is partly due to lower interest rates, which are reducing the contango, and also to the simple passage of time. However, a key contributor to this decline is the significant amount of forward-selling by nervous producers anxious to lock in profit margins while they are still available. Forward prices are now getting to the kind of levels that look quite attractive to consumers, and there have already been some signs of buying interest.

Farther ahead, we remain bullish on aluminum prices, though prospects have become clouded as a result of widespread reports of large increases in Chinese production that are expected over the next 2-3 years.

The consolidation process that nickel prices have been undergoing is not surprising. Earlier in September, prices lost more than US$400 per tonne, and the rest of the base metals complex also moved sluggishly, providing no directional cues. The levels of business flow continued to be suppressed by current economic uncertainties.

Although prices were able to move away from earlier tests of support at US$4,800 per tonne, the momentum behind the moves higher lacked the required volume for it to be sustained.

Short-covering by speculative funds alone was unable to lift prices higher, and it was not surprising that prices on Sept. 28 registered their lowest close of the current price cycle, ensuring that while inertia remains in place, the downside risks will outweigh those on the upside.

How long will this inertia/downside bias last? News that Outokumpu is considering closing its 2,600-tonne-per-year Hitura nickel mine in Finland underlines the risks of production cutbacks as prices drift lower. But the impetus the nickel market requires will not come from price-related mine shutdowns. Attention in metals markets remains keenly focused on demand factors rather than supply, as has been well-illustrated in the case of aluminum. With a consensus developing that an economic turnaround may begin as soon as the first quarter of 2001 and with stocks still at their lowest levels since 1992, the market may not have to wait long before signs of an upturn emerge.

Zinc followed trading patterns similar to those of nickel, as short-covering briefly lifted prices above US$800 per tonne. At higher levels, the lack of follow-through interest is a reminder of the resistance that lies ahead. With consumer buying still unseasonally low, resistance becomes reinforced, and until consumption patterns start to improve, a test of fresh lows is expected.

An 8,050-tonne increase in LME stock levels during the report period is adding to the downward pressure, as is the lack of news from China regarding smelter production cutbacks. Although markets remain focused on demand-side factors, the issue of supply cuts is most pressing in zinc, given that the supply-demand balance is heavily in surplus. The extra overhang of supply combined with weak demand is being compounded by the slow reaction by producers to low prices. One of the drag factors on shutdowns has been the strength of the U.S. dollar as production costs measured in local currencies are kept artificially low. As the downside risks to the dollar increase, so must the upside risks to higher production costs and therefore production cutbacks. If cutbacks take place, they probably won’t be sufficient to create a sustainable recovery, at least not until the focus switches away from demand, which remains weak.

There are two ways of assessing the recent performance of the gold market. The more downbeat assessment focuses on price reaction to date. Clearly, this has been disappointing; despite continued nervousness and acute U.S.-dollar-related risks, prices have remained within a range of US$286-293 per oz. and have met firm resistance at the higher end of this range. The more upbeat assessment points to the strength of support on the downside, the scope of upside potential and the ability of prices to hold to a steady range at their highest level since 1999.

Although the levels of fresh fund-buying have so far been subdued, the level of interest registered by investors has increased, providing an indication of near-term price reaction. The lack of selling in the face of high local prices in Australia and South Africa (on the back of currency weakness) provides further evidence that higher prices are anticipated.

If, as seems increasingly likely, gold prices do test US$300 per oz., how sustainable will the price recovery be? Without knowing the direction political events will take throughout the fourth quarter and into 2002, this is difficult to ascertain. It remains questionable whether gold prices will be able to track the strong improvements we forecast in 2002. Although, in the short term, there appears to be a need for a “safe haven,” we know not how long this need will be felt.

The source of gold’s weakness over the past 20 years is the deterioration of its position as a reliable asset class against an increasingly broad and sophisticated asset range.

A reversal of this deterioration would require nothing less than a complete reversal of this 20-year trend which has shrunk the gold market and pushed it toward the periphery of investment flows.

In times when a safe haven is needed, prices are capable of moving higher, but what happens to prices when the need for a safe haven fades?

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


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