Challenging economic conditions, softer fundamentals and the potential for a stronger US dollar have led some analysts to predict a sustained bear market.

"In the next quarter and maybe the first of 2009, it looks like the market will stay weak. Indications suggest a softer period, but it is difficult to guess how much bad news is already built into the price,” says Calyon analyst Robin Bhar.

Commodities analyst Michael Widmer observes that global demand for base metals has been hit by shrinking construction markets in the US and Europe, most notably Spain. “The construction sector accounts for around one-third of aluminium, copper, nickel and zinc demand,” he points out.

No one, however, is predicting a crash.

“We shouldn’t get too gloomy,” says Bhar. “Prices have fallen a long way, but in lead, zinc and nickel we are already getting cutbacks in production, particularly among high-cost producers. The structural issues remain unchanged, with growing demand from emerging markets as they press ahead with urbanisation and industrialisation.”

“I’ve been of the view that we are at a tipping point,” says Standard Chartered’s Dan Smith. “Base metals will go lower, but the pessimism may have been overdone.”

Copper comes off the top

At around $7,000/tonne, copper is trading in a range last seen in January – well off its July peak.

“We expect the market to continue trending lower in the near term, although prices may continue to rebound on news of potential disruption,” says Andrey Kryuchenkov, analyst at Sucden Research. Hurricane Gustav’s landfall in the US, for instance, initially pushed prices up, though they fell away as its impact did not match expectations.

Other analysts believe the price floor is not far away.

“Copper is down $2,000 from its peak, so a lot of doom and gloom is already reflected in the price,” suggests Bhar.

Much depends, however, on how the construction sector fares. Widmer points out: “Construction is underperforming in many parts of the world ex-China. This is one factor suggesting that significant, demand-led price support can, at present, only emanate from China.”

China’s demand growth has slowed, although imports of crude copper and copper products still rose 7.1 per cent in July. The forced closure of manufacturing businesses for the Olympic Games in Beijing and rising copper scrap imports are two factors behind China’s weaker demand, but lower prices could spur restocking: China does not produce enough copper to meet its own needs, so demand could rebound in the next quarter.

Lower prices across the board have brought metals prices closer to production costs, but copper still enjoys the highest margins.

Aluminium nears its floor

The bullish sentiment that fuelled aluminium’s climb to more than $3,300/tonne in early July was based on the possibility of production cutbacks, but prices have been falling ever since. Sucden’s Kryuchenkov is among many who feel that in the near term the “momentum will remain to the downside”.

The reversal that has brought prices below $2,700/tonne stems from slacker demand and an increase in LME stocks to their highest level for four years.

“The drop in aluminum prices did not surprise us,” says MF Global analyst Ed Meir. “Chinese end-user demand continues to weaken. In addition, despite all the hype, Chinese production cutbacks have yet to take hold. We are looking for a modest surplus to set onto aluminum for both this year and next.”

Low premiums indeed suggest that there is no shortage of aluminium, but viewed over a longer period inventories remain relatively low, and with prices close to production costs there could be a limit to additional supply side gains.

“Aluminium especially is near a level where producers make cuts in output, so there are some mitigating factors. We would expect consumers to bargain-hunt,” says Bhar.

Power shortages remain a major factor constraining global output. China’s efforts to control the rapid growth of its aluminium output also seem to be taking hold, so the price floor may be in sight.

Zinc cools further on supply gains

Zinc production has responded more rapidly to historically high prices than other metals, and rising output has been pushing prices down. Data from the International Lead and Zinc Study Group (ILZSG) shows global production rising faster than demand, increasing the market surplus.

The fall in price, however, is enough for some producers to shelve planned projects and cut back supply. Teck Cominco and Xstrata, for instance, are closing their Lennard Shelf mine in Australia early. 

“There are three phases: prices fall, then high-cost producers come under pressure, then there is another downward leg to the price. Zinc and nickel are certainly in phase three,” says Smith.

For now, growing surplus is the consensus, though demand is still increasing and China’s trend of falling zinc exports could intensify after the scrapping of export rebates.

Nickel softer on weak stainless steel demand

In six months, nickel almost halved to below $18,000/tonne before a modest rally, but many predict further falls. Weak demand from stainless steel producers is unlikely to strengthen given shrinking construction markets and concerns over recession in the US and parts of Europe.

Analysts and producers have predicted prices of around $15,000/tonne next year, partly as new production capacity comes online. Lower prices, however, are starting to hit high-cost producers. Cost pressures are behind moves such as Xstrata’s temporary suspension of operations at Falcondo.

“News of closures is not unusual during a correction, and we believe that other high-cost ferronickel producers – like the Falcondo operation – may also be under pressure at the moment,” says Widmer.

Analysts are keen to point out, however, that nickel prices are still historically high. Standard Chartered’s Smith notes: “Nickel used to trade at $5,000 to $8,000, but it has been more like $20,000 lately.”

Lead corrects downwards

Lead pushed beyond $2,200/tonne in the last quarter and although the price has come down to around $1,900/tonne, it remains volatile at this level.

“Lead and zinc are much closer to their historical price ranges,” observes Smith.

The latest ILZSG data shows global refined lead metal output up 5.4 per cent in the first half of 2008, outstripping demand, which grew by 4.6 per cent. The expectation is a growing surplus, but like zinc there are mitigating factors.

“The fact that Chinese exports have collapsed to practically nothing should help stabilise the market somewhat going forward, but surpluses are nonetheless expected for both this year and next,” notes Meir.

Tin finds the most support

For now, tin is the metal with the most positive indicators. Having topped $24,000/tonne in April, some expect it to settle at its current level around $19,000/tonne. MF Global forecasts average prices of $20,000/tonne for the rest of 2008, and $19,000/tonne for 2009.

“The bright spot in the metals complex remains tin, where a deficit this year could ensure that prices stay relatively firm,” says Meir. “Much of tin’s supply is concentrated in Indonesia, and this makes the market especially vulnerable to singular country risk. Already, the Indonesians have said that production will struggle to reach target this year due to weather issues, increasingly the likelihood that we will get a larger-than-expected deficit.”

Jim Banks
LME Ringsider enewsletter
Autumn 2008