Whether traded on Comex in New York or on the London Metal Exchange, base metals are priced in U.S dollars, and the relative value of the U.S. dollar has an enormous affect on prices. During this most recent global economic expansion, a debased U.S. dollar helped propel the commodities bull market in general and base metals in particular, leading to huge gains into the spring and early summer.
As the U.S. economy weakened and credit markets seized, U.S. demand has been shrinking, but China’s seemingly endless appetite had been able to compensate for our slackening demand. But now a broader economic slowdown is hitting the rest of the world and the landscape is shifting again.
“It used to be that it was easy to get base metals right, in that they were an indicator of the world business cycle,” says David Abramson, chief strategist for currencies and commodities at BCA Research. Until about eight years ago, traders didn’t even have to consider emerging markets, he adds. “The big shift was that you had to understand the demand pulse from China and its ability to sustain demand. They were inelastic, even as prices got high, because they had very strong income, wealth and productivity growth.”
NICKEL AND STEEL
“Nickel is inherently volatile, and that’s because about 70% of nickel is consumed in the steel industry for stainless steel,” says Catherine Virga, senior base metals analyst for CPM Group. “If you can track stainless steel production, you can track nickel prices.” Virga says because of the intense power requirements to make steel and the economics associated with producing it at maximum capacity, there is a predictable stocking and destocking cycle. Currently, nickel inventories are at or near 10-year highs and demand is down.
Those high inventories, combined with high energy and other input costs, have resulted in mine closures in Russia and the Dominican Republic, and those supply disruptions are only recently starting to appear in the physical market. “When [nickel] was trading at $52,000 [per ton], the market was very supply driven. But now that we have inventory levels at 10-year highs, we are demand driven,” and demand for stainless steel, and therefore nickel, will likely remain weak until the United States, Europe and China work through inventories, which is unlikely before October, she says.
One unknown factor is whether China, in the run up to hosting the Olympics, was accumulating or drawing down its supplies. A solid assumption though is that demand will slacken.
“Post Olympics, everyone’s economy slows down,” says David Toth, director of technical research at R.J. O’Brien and Associates. “The bigger issue is that the equity markets have shown some kind of vulnerability that hasn’t been shored up yet.”
COPPER
More than 40% of the copper produced globally is used in construction, and two years ago, nearby copper was in backwardation due to rebuilding after Hurricanes Katrina and Rita, says George Gero, vice president of global futures at RBC Capital Markets. “Everyone was taking delivery.” Then U.S. demand plummeted in response to the housing crisis. Meanwhile, demand surged in Brazil, India and China. Dealers responded by moving inventory to London from U.S. warehouses, he says.
“Most if not all of the price rise from November of ’01 is in,” Toth says. “This market will spend the better part of the next number of years doing something other than going up.” From a short-term perspective, it is a decent time to buy, he says, but with very tight stops. From a longer-term perspective, he suggests paring exposure and cautiously shorting, noting that copper above $ 3.75 per pound would reinforce the secular bull trend and could lead to new highs. “It’s premature to conclude that a major move down has begun,” he says.
TIN & ALUMINUM
“Since early February of this year, [tin] inventories have been declining,” says Ify Isiekwe, commodity analyst for CPM Group. At the same time, demand has been weak, especially with the United States and Europe. Chinese tin consumption has been the only geographic region that is proving tin some support. “It’s not just that there is less available, nobody really wants it,” he says. From the supply side, he says Indonesia’s PT Timah and China have cut production, and Congolese exporters had halted production to protest a tax hike. That dispute was resolved in early August and should result in more tin hitting the market and more downward pressure on prices, he says.
Aluminum is a standout among the base metals as prices continue to climb. “There’s a million and a half tonnes coming out of China every year,” says Jim Southwood, president of CRU Price Risk Management. “If we didn’t have those Chinese exports, the price of aluminum would look a lot like the price of copper.” China had been a net exporter of primary aluminum for years. In 2007, however, China altered its economic policies to favor domestic consumption; the country now exports 1.5 million tons of aluminum as extrusions, sheets and other products.
Abramson likens the current market for base metals to that of the early 1960s, as Japan rebuilt its capital structure and infrastructure, including roads, bridges, buildings and power stations. Copper broke out far above the cost of production. Supply increased in response and the price of copper acted as an oscillator. “The price of copper just could not keep up with the demand. The demand was price inelastic,” he says, adding this predated Japan’s rise as an exporting powerhouse. What finally ended that bull market was the first oil shock, he says. This time around, there is a separate dynamic: The emerging middle class in those emerging markets will want to buy cars, refrigerators and luxury goods, all of which require aluminum, tin for solder and lead for batteries.
