Sideways action that has been a feature of both base and precious metals markets for much of the past year is expected to continue in future months, although some upturn could come late in the year.
China continues to be one of the largest buyers of base metals, accounting for more than 40% of demand last year, according to the London Metal Exchange (LME), but consumption of metals in China has slowed with an apparent reduction of economic activity in that country.
“The last four months or so, what we have seen with metals prices — particularly on the LME — is pretty much sidelined,” says Peter Ghilchik, an analyst handling multi-commodity coverage for London-based metals and mining research firm CRU Group. “They are now pretty much where they were at the beginning of the year. In terms of metals markets, we’re just waiting for some positive news to come out from somewhere.”
Inventories have been falling for copper, nickel and tin, but rising for aluminum, lead and zinc. Institutional investing in base metals, after easing last year, has resumed and is approaching record highs, according to an analysis issued in early April by FCStone LLC, a London-based affiliate of INTL FCStone.
Primary capacity for base metals production is increasing, but planned and unplanned production cuts have been limiting output for copper, aluminum, tin and lead while overall output of zinc, lead and nickel has been surging.
Metals consumption is expected to accelerate this year from last year’s pace and continue into 2013, according to FCStone analysts. Chinese imports are expected to remain at high levels in copper, nickel and tin, contributing to tighter global supply balances, they say.
“The picture is a bit mixed this past quarter as copper, tin and aluminum were kind of the top three base metals,” Edward Meir, a Connecticut-based independent commodity consultant for INTL FCStone says, adding that zinc, lead and nickel recently have been the laggards.
“Having said that, the whole complex is under pressure because of the slowdown in China, which is the main market,” he says (see “One-sided demand,” above). “Any slowdown there would have a material impact on prices. However, prices have not really cratered because Chinese imports of copper are still strong.”
Meir notes, though, that the Chinese imports for the most part actually are not being consumed. “They are being brought in kind of as a trade play, as a banking play. As people bring copper in they get more collateral or more credit lines from their bank,” he explains. “So we have an odd situation where imports are very strong, but they are not being consumed. They are instead ending up in inventory and being financed by the bank. How long that game will continue is hard to say, but if it wasn’t for that, copper prices would be much lower.”
The longer term outlook for copper is weaker as new mine projects in the works are expected to bring an oversupply of the red metal by 2014 (see “Copper rush,” below). Paul Dewison, United Kingdom-based director of base metals for Intierra Resource Intelligence, says new production will add about 800,000 metric tons of new supply to the approximately 20-million-ton market this year and will continue to ratchet higher in the next few years until more than 2 million tons are scheduled to be added in 2015.
“But that’s very, very unlikely to happen,” he adds. “By that time, we probably will have had several years of market surplus. One way or another we’re likely to see projects slipping and projects falling off the current list.” But Intierra still expects the surplus to cut prices for copper to about $6,000 per ton by 2015 from about $8,000 a ton this year.
“The demand side this year is not brilliant,” Dewison says. “We’re likely to see it picking up to 3%-plus for the year. But production is likely to be growing that much quicker. We see it this year as being one of a very small surplus with a slightly larger surplus the following year. This year we’ll say it will be on the order of 50,000 tons and maybe 150,000 next year, and by 2014 maybe 250,000.”
Aluminum demand is not as vibrant as copper and is a bit more sluggish, Meir says. “If you look at the charts, that’s because we have so much inventory in stockpile and the inventory is not really available. It’s just another kind of financing play where people store metal and they sell forward aluminum like one year out or 15 months out and they lock in a certain contango, which nets out to about 1%-2% after all costs. So it’s like a risk-free trade. In the meantime inventories keep piling up.”
In contrast to the copper inventories accumulating in China, most of the aluminum stockpiles are building up in Detroit with other inventories held in the Netherlands, Meir notes. “You have the odd situation where the warehouses are owned by some of the big banks — JP Morgan owns a warehouse, Goldman owns a warehouse — and they are using very cheap money to buy aluminum, put it in storage, sell the forwards and lock in a nice rate of return.”
Patricia Mohr, vice president of economics and commodity specialist for Scotiabank in Toronto, notes that China recently has been developing a new aluminum industry in its western and northern provinces based on steam coal used for low-cost electricity. That also has been holding down world aluminum prices. “Last year prices for aluminum on the LME were roughly at cash cost for smelters around the world,” she says. “But the prices have lifted this year and are at modestly profitable levels.”
Gold feeling toppy
A series of sometimes contradictory and confusing statements by Federal Reserve officials and other central bankers have knocked gold forecasts lower, though many still expect that continuing economic challenges will push gold back above $1,900 per ounce later this year.
Meir says he “cannot rule out the possibility of the U.S. economic recovery topping out,” and bringing the quantitative easing option back into the picture to throw another lifeline to precious metals. “Although we are not seeing any significant deterioration in the U.S. macro numbers just yet, the recent batch of economic statistics have not been beating estimates as handily as they once were,” he says.
John Thomas, a veteran trader and market analyst, notes that for the first time in many years, gold is ranking high on the list of preferred hedge fund shorts and that the U.S. Treasury’s sale of America Eagle one-ounce gold coins is down 70% from last year and hitting a four-year low.
Open interest in gold futures in early April hit a two-and-a-half-year low, indicating that capital is fleeing the market. “This is usually what happens before prices die,” Thomas says, while also noting that physical markets in Asia, long a bulwark in the gold bull case, are suffering from declining volumes and that India, the world’s largest buyer of physical gold, just doubled gold import taxes, causing widespread strikes among jewelers.
Thomas tells his subscribers that a “chip shot” on the downside for gold here is $1,500 while more aggressive traders may want to reach for $1,450.
The next bull market?
Zinc and lead both are operating under surplus conditions currently with zinc inventories on the LME at a 17-year high, Meir says. “There is quite a lot of inventory in both and prices have been sluggish. Zinc and nickel are sort of more steel plays, so as galvanizing and construction slow down, it will impact those metals more,” he says.
But Mohr has labeled zinc the “next big trade,” noting depletion of some mines and plans for closing of others starting next year along with growing demand for the metal in the auto industry and construction (see “Next big trade,” below). “I’m quite optimistic in the medium term for zinc,” she says. “The supply demand balance is going to really tighten. So we would see zinc prices averaging about 94¢ a pound this year, moving up to $1.10 in 2013. Prices were 99¢ per pound in 2011. In the middle of the decade it could very well be quite strong, much higher.”
INTL FCStone is forecasting that most of the metals will be “mired in a kind of sideways range for much of this year because on the upside we’re going to be capped by the fact that growth is going to be very slow in the U.S. and also in Europe and the Far East,” Meir says. “Just like we ramped up a few years ago, we’re all kind of slowing down together right now. Growth will be sluggish and that will keep a cap on many of these metals. On the downside, though, China still is growing and still consuming metals, so they are kind of acting as a buyer of last resort. They’ll provide something of a floor.”