Metals markets still unsettled

Base metals prices trended gradually downward in the May 22-26 report period as the market continued to ignore the steady outflow of inventory from London Metal Exchange (LME) warehouses.

Total LME stocks of base metals have fallen by 522,000 tonnes since early March, but, despite strong demand growth in many regions, there is reason to believe that non-LME stocks of metal are rising, particularly in Asia.

U.S. data — notably an unexpectedly sharp fall in durable goods orders (down 6.4% in April against market expectations of no change) — continue to point to a slowdown in demand for metals. However, growth in the Euro-zone is exceeding expectations. Industrial production was up 4.8% in March and metals-related demand is extremely good at present.

Copper prices continue to disappoint. The market got briefly excited by the announcement of a production cut at the Grasberg mine (the cut is much smaller than reported by various wire services), and it appeared that an attempt at US$1,850-per-tonne resistance was likely. However, prices soon drifted back, ending the report period at US$1,819 per tonne. Technically the market lacks direction and needs to close above US$1,826 per tonne before the next major target of US$1,850 on the upside. Downside support is at US$1,790-1,800 per tonne.

Freeport-McMoran Copper & Gold has agreed to the Indonesian government’s request for a cut in output at its 750,000-tonne-per-year (contained copper) Grasberg copper-gold mine. Daily production from the open pit will be slashed to 200,000 from 210,000 tonnes; the underground mine will continue to crank out 20,000 tonnes per day. The total reduction in production is therefore 10,000 tonnes per day not the widely reported 30,000 tonnes, and this is equivalent to just 35,000 tonnes of refined copper on an annualized basis. The reduction is voluntary and temporary as stated in the press release and is expected to be in place until government officials complete their inquiry into the recent overburden landslide in the Wanagon basin. The investigation is expected to last three months.

We believe the news is market-neutral. The cut is only temporary, and shipments to smelter customers are unlikely to be affected since there is ample stock at the mine to fill the small shortfall in output. In any case, the concentrate market has eased considerably this year. Spot treatment and refining charges are at a US$90 per tonne and US9 per lb., respectively (compared with US$30 and US3 early last year) following higher-than-expected output of concentrates and the trouble-free startups at the Los Pelambres mine in Chile and Batu Hijau in Indonesia. Consequently, there is enough slack in the system to absorb a short-term cut to mine output without metal production being affected.

Meanwhile, suspicion continues to surround the rapid rate of LME stock falls (down 229,000 tonnes since early March). A lot of the recent withdrawals are headed for China, and there is speculation that not all of this is for immediate consumption and that it will be stockpiled there. If this speculation pans out, a much lower level of imports can be expected for the second half of the year (data released recently by various Chinese research organizations suggest that this is indeed the case). On the basis of contained copper, the net import of copper in all forms (concentrate through to copper semis) is running 55% above last year’s levels.

So far this year, local mine production has risen by over 20%, giving an increase in the amount of copper available in China of more than 40%, year-on-year. Industrial production in China is reported to be growing at around 10-11% at present, so even if copper consumption is running at twice this level of growth, the evidence suggests a significant build-up of copper stocks in China.

Aluminum prices continue to perform poorly, falling back sharply on May 25 after failing to break through the US$1,520-per-tonne level earlier in the week, and closing at US$1,498 per tonne. The market continues to disregard the steady decline in LME stocks because there is little sign of any physical shortage developing. Indeed, a steady decline in cancelled warrants from around 100,000 tonnes in March to just 48,000 tonnes on May 26 suggests that the rate of stock withdrawal will soon slow. One of the few positives in aluminum at present is that commodity trading advisors are still short, following heavy sales during the price decline of mid-March. However, short-covering is unlikely to be a factor in the market unless prices break convincingly above US$1,520 per tonne.

Nickel prices were volatile on May 26, just prior to the weekend strike decision at Sudbury, Ont. At one stage, prices fell to a 2-week low of US$9,965 per tonne but then recovered a little to end the day at US$9,945.

Russian nickel exports climbed sharply in the first quarter. According to Goskomstat, the state statistical agency, exports reached 56,100 tonnes in the first quarter — an increase of almost 18% over year-ago levels. Russia’s nickel exports traditionally dip in the first half of the year, owing to the difficulty of shipping nickel from Noril’sk via the port of Dudinka in freezing weather and then when melting ice causes water levels to rise. The latest figures show that first-quarter shipments were actually above the fourth-quarter level of 55,000 tonnes, an extremely unusual event.

One theory to explain the increase is that Russia exported more than normal in order to take advantage of high prices. With production at 59,700 tonnes in the first quarter (54,000 tonnes of which were produced by Noril’sk) and local consumption at around 5,000 tonnes, the high level of exports implies a stock rundown of around 1,500 tonnes, probably from state stockpiles.

Without this extra nickel, the market would have been even tighter than it currently is. Another factor that has prevented nickel shortages from getting even worse is a surge in the availability of scrap. The explanation is that high prices have encouraged higher exports from the Commonwealth of Independent States and more sales of old scrap by merchants. Scrap availability has also been boosted by the high level of stainless steel production, and this should continue to be the case for the rest of this year, regardless of how nickel prices behave.

Zinc prices ended the period down at US$1,167 per tonne following a bout of fund-related liquidation. This prompted others to take short positions, placing increasing downward pressure on prices and resulting in the lowest closing price in London for nearly two weeks on May 26.

Stock levels continued to set new records for historic lows as they moved further on their downward trend. Shedding 3,600 tonnes, LME stocks stood at 240,325 tonnes at presstime, their lowest in more than eight years. This news of increasingly tight supply was offset at the start of the report period by figures reported by Reuters. The figures show a year-on-year increase in Chinese zinc exports of 30.8% for the January-to-April period. Exports for the period stood at 199,806 tonnes, and, for the month of April, they reached 49,365 tonnes.

Technically, zinc prices have reached a critical level of around US$1,165 per tonne. This has provided the key level of support for zinc prices since late April. We believe this level will hold firm. Given the poor performance of base metals, we believe prices are, in fact, showing themselves to be somewhat resilient. Prices are therefore expected to consolidate and firm up around at around their current levels in the short term.

The mood of bearishness deepened in the gold market as conditions for prices pointed inextricably in a downward direction. After reaching a high for the week on May 23 of US$276.80 per oz., prices drifted down, following a feeble Bank of England gold auction on the morning of May 23. Prices fell heavily on May 25 as funds exited stage right and physical demand exited stage left, leaving the gold price to face the music and, in the process, avoid any trap doors.

Aggressive fund selling by speculators caused the price to fall heavily in New York on May 25, making the US$270-per-oz. level of support seem as weak as market confidence itself. Prices recovered a little on May 26, though they still ended the week poorly in London at US$271.80 per oz.

The sixth U.K. gold auction, on May 23, represented the second-lowest “turnout” (or cover ratio) since the auctions began, last July. On the other hand, the effect on prices by the auction was fairly minimal.

It is a sign of the times, perhaps, that the only positive news for gold is that wet weather is forecast in India. Drought has now hit five states, which has had the effect of reducing physical demand for gold in India. Droughts adversely affect incomes, and, consequently, farmers’ fields are not the only things to dry up — demand for gold also does as well. An official at the World Gold Council says that if the wet weather comes, it could boost demand by up to 5%.

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