All that glitters isn’t just gold

Take a growing world economy, supply-side problems and under priced commodities, put them together and you end up with metals, precious and base, hitting their highest prices in years. Silver, which has outpaced gold much of this year, reached a 22-year high in March, passing $11 an ounce — prices it has not seen since the 1980s. On top of this, copper has risen 25% so far this year, zinc is up more than 40%, aluminum has gained 12% and platinum set a contract high at the end of March. Metals, though, actually have been on the rise the last several years. And while some analysts and traders have treaded cautiously with these rising prices, others like Michael Purdy, a vice president with base metals at ABN Amro in New York, have been bullish from the beginning.

Purdy explains many of today’s commodities making new highs, particularly the base metals, are simply trading where they should have traded some time ago. For instance, looking at a copper chart and considering the fundamentals, Purdy says the London Metal Exchange’s copper price might reach $6,500 per metric ton. “It could happen. We certainly could see it if demand is there and supply disruptions come up as well,” he says.

Many, including Purdy, say this combination of soaring demand and supply side problems is exactly how the base metals story will unfold in 2006. Infrastructure demand for base metals is coming from China, India and numerous other areas around the globe, including South America and the Middle East.

Labor troubles and disruptions already have hit the supply side of the market this year; for example, the strike at the world’s third largest producer of copper, Grupo Mexico, and a landslide at Freeport-McMoRan Copper & Gold’s Gasberg mine in Indonesia both occurred in March. This, coupled with the numerous mining strikes and disruptions in 2005, paints a grim picture for today’s supply.

“We have had an inability to find new copper in the last 12 to 18 months,” says Paul Mladjenovic, author and investment consultant, who offers silver to clients as part of a diversified portfolio. “But the shortages are artificial because the United States and Europe are mining in politically unfriendly areas in which it can take years to open a mine,” he says. Copper has tripled in the past four years mainly due to dwindling supplies in warehouses.

Regarding labor disputes, Purdy, says, “This is going to be a big story this year for all labor fronts…mines, smelters…everyone. This is a big issue for supply of all base metals, it doesn’t matter if it is copper, aluminum, zinc or another base metal.” Why so many strikes this year? Purdy explains, “Unions gave up a lot in the bear market and have not gained anything back with these prices.”

George Gero, a vice president with RBC Capital’s futures division and director of Comex, Nymex and the International Precious Metals Institute, also points to labor disputes and high demand hurting copper supply in 2006. Gero says the rebuilding of the Gulf of Mexico, demand from China and India, labor problems at mines, and copper being used to build houses during a robust housing market that only recently has cooled off have all fueled copper’s short supply.

“The fact that all of these variables for copper demand have come together all at once in the last two years is what has caused copper to make contract highs,” Gero says.

INFRASTRUCTURE RULES

The other side of the story is booming economies that are building infrastructure faster than an eye can blink. Purdy explains while everyone knows China is flourishing, an enormous demand is coming from other areas. “There is a lot of demand coming out of South America. There is a tremendous amount of infrastructure for example being built in Chile, including subway systems and airports. There is also a lot of demand coming from the Middle East. Dubai is basically a construction site,” he says.

It is this worldwide demand for base metals that leads many analysts to say this bull run will be long lived. Purdy explains third world countries paying off their sovereign debt, Japan coming out of a long recession and an economic comeback in Europe all add fuel to the fire.

Copper, however, is just the beginning. Aluminum and zinc also hold a lot of promise for metal traders. Purdy says other base metals will follow copper’s lead. “We could get to $3,500 a metric ton [in aluminum on the London Metals Exchange] once it gets going without too much of an effort,” Purdy says.

One area of high demand for aluminum is in aircraft carriers. “Around the world airline orders have never been this high,” Purdy says, explaining analysts often look to aircraft production numbers when reviewing the health of the global economy.

Nevertheless, aluminum, like copper, has experienced its share of supply snafus. Aluminum smelters need a constant flow of electricity without any interruptions to operate properly, but recently smelters have ran into bottleneck situations with electricity. “Unfortunately, the regions that have the most aluminum smelters are the regions that have the least reliable steady supply of electricity flow,” Purdy says.

MY PRECIOUS

The increased desire for economies around the world to modernize has not only fueled base metals, but silver as well. While in small amounts, silver is used in a plethora of electronic devices that growing economies, like China and India, are buying hand over fist. Silver can be found in batteries, cars, cell phones, microwaves, televisions and other high demand electronics. In the past year, silver surged 58%, mainly due to demand for electronics and jewelry. Now investors have another reason to snap up silver. They are awaiting approval for the launch of a silver exchange-traded fund (ETF) from Barclays. The new silver ETF will trade on the American Stock Exchange and will give investors an alternative way to buy and store silver.

“Currently, investors from private to professional often find silver cumbersome to buy. With the ETF you will be able to trade it anywhere you have a stock account. This will hugely increase participation in the silver market,” says David Morgan, silver analyst at Silver-Investor.com.

Morgan’s sentiment rings true with almost any analyst and trader you ask. For instance, Mladjenovic says a silver ETF will pack a huge punch for silver. Between the ETF, the health care industry ramping up its usage of silver for bacterial fighting properties and Europe phasing out or curtailing the use of lead in favor of silver, Mladjenovic sees massive upward pressure on the precious metal. He predicts in the next few years the price of silver will shoot to $15, $20, $30, maybe even $50 per ounce by the end of the decade. “Supply is in a shortage and demand is skyrocketing,” he says.

Most, like Mladjenovic, though will be watching Barclays’ ETF to get an accurate read on silver. John Reade, UBS precious metals strategist in London, in mid March explained, “How high silver will go now depends on how much interest the silver ETF attracts. If it is small, say 10 million ounces, then silver will fall. If it is in the range of 50 to 100 million ounces within a few months, as I expect, then silver could trade to $12 or $14. But if a very large amount of interest is forthcoming, say 200 to 300 million ounces, which is beyond the maximum initial size based on the shares authorized, then silver could trade much higher, possibly to $20 or more.”

Peter Spina, proprietor with SilverSeek.com, shares similar price point views and commented in mid March, “The price of silver will trade as high as $12 to $15, with even a possibility for a further spike, but that will likely have to wait until 2007.”

While some analysts as long ago as two years ago predicted this kind of rally in silver, people needed to be convinced. Then $7 silver rolled around. The contract started gaining some respect, but it wasn’t until silver again reached $10, open interest soared and a proposal for a silver ETF came along that silver attracted a huge crowd. “Long term chartists are waiting for a breakout in silver and the creation of a silver ETF adds another reason for this breakout,” Gero says.

The flip side of this coin may be decided by the Federal Reserve Board. With talk of the Fed raising interest rates for the 16th time, the dollar could rise and inflation could yet again be curbed, which may affect traders’ interest in precious metals. Still, even with interest rate hikes, most agree with Gero, “Silver is finally coming back in the limelight.”

The buzz behind the silver ETF indicates there will be a flood of investors initially; but will this interest increase as time goes on or eventually fade? Reade explains, “Based on the initial reaction to the U.S. gold ETF, 50 million ounces might be expected. But the U.S. gold ETF was preceded by one in Australia and the U.K., so it is possible some interest had been reflected in these products. So perhaps 50 million ounces is too low. Also, metals are arguably hotter now and metals ETFs are now better understood by investors. All of this points to more rather than less interest in the ETF,” he says. Reade reminds us the withdrawal of physical silver from the market will influence silver interest rates and prices.

Spina also gives the silver ETF a solid long term forecast. “If one looks at the success of the gold ETF, which has exceeded many expectations so far, along with the large increase in the silver price over the past few years, the silver ETF is likely to do very well,” he says.

IS THERE ENOUGH SILVER?

Demand is growing and a silver ETF is coming on board; just how will the supply side hold up? Spina says, “In general, investors are becoming informed about the silver situation. This attention is attracting more investment capital, which will result in even great supply scarcity. Besides the silver that will be sucked up by the ETF, investors on the Comex alone hold silver futures contracts that are several times in excess of the approximate 125 million ounces of silver in all warehouse stock categories combined! So the supply situation is becoming increasingly problematic and growing attention will come about as silver continues to hit higher levels.”

As countries like China and India rush to become modernized, silver demand will grow. Morgan says supplies will get tighter. He explains when an electronics or automobile producer discovers that instead of the two weeks it normally takes to get the silver it needs, it may take six weeks; even though the company may only need a small amount of silver, they likely will decide to store more of the metal, further stressing supply. “There will be significant supply side issues very soon,” Morgan says. He adds the market could see problems as soon as this spring or summer.

Spina also expects supply issues to crop up shortly. “There remains a growing supply deficit and as investment demand increases with stockpiles falling, scrap metal accounts for about 1/4 of the world’s consumable supply. The market will continue to demand even higher prices. As of the end of 2004, data shows that there has been a 63-year long supply/ demand deficit, which means mine supply is not sufficient to meet demand. Instead, the above ground stock supplies have been used to meet the delta between supply and demand,” he says.

Silver and gold’s appeal is very apparent these days, but traders are being drawn to other precious metals this year as well, including platinum and palladium. In late March, platinum soared to more than $1,100 an ounce, which was a peak for the contract, and palladium reached its highest price level in almost four years.

Platinum is well known for its use in the catalytic converters of cars; initially, you might think that with U.S. automobile manufacturers’ troubles, demand may not be that strong. However, Gero reminds traders and investors to look at platinum and palladium from a world context. “Almost all platinum and palladium come from outside the United States. Russia and South Africa are two main suppliers. Frequently the metals have geopolitical threats on delivery, giving the metals a premium,” he explains. Concerning palladium, Gero notes the similarities between gold and palladium. “Overlay a palladium chart with a gold chart and you will see the same moves to the upside.” Gold this year already has shot to a 25-year high mainly due to inflation fears.

So what is different about this metals rally? Maybe the answer is global. “The world economy has never been this good. Countries around the world have decided they want our standard of living,” Purdy says. Luckily for bulls, countries worldwide want this standard sooner than later. “Metals and energies in general are the place to be for the rest of the decade,” Mladjenovic comments.

Carla M. Bauch is a freelance writer in Chicago.

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