By Andy Home
Assuming, like the investment bank community, you are still keeping the faith with the overall bull narrative, the coming period will be all about divergence between both commodities in general and the LME metals in particular.
Or as researchers at Barclays Capital put it in the company’s most recent weekly research report, “the supply side is shaping a more diverse fundamental picture across the base metals, and we expect this to lead to increasingly divergent price performances in H2 11.”
Only one of the core base metals traded on the LME, nickel, showed consistent signs of being in supply-demand deficit in the first part of this year. Curiously, it was also the worst performer, attesting to the power of the bear narrative that has gripped the stainless steel input since the very start of this year.
Conversely, those metals such as copper and tin which seemed to have the brightest prospects coming into 2011 have suffered a reality check in the form of rising LME stocks and elusive expected deficit.
How will things shape up in the next three months? Here’s a snapshot of those divergent narratives.
COPPER The cornerstone of the red metal’s bull narrative, anaemic mine supply growth, remains solidly intact. Capacity utilisation remains chronically low and disruptions continue to proliferate, currently in the form of labour unrest at both the Grasberg mine in Indonesia (actual) and at Chilean state producer Codelco (threatened).
But, and it’s a big “but,” there is no sign of acute shortage in the concentrates market, partly due to the effect of Japanese smelter outages but also due to de-stocking by Chinese smelters.
Chinese de-stocking is the single most important dynamic in the refined copper market. The country’s imports slumped in the first part of this year.
The bulls are adamant that they will recover in the second part. The resolution of this starring-match holds the key to overall price direction and the twin monthly Chinese import releases, snapshot and full report, will remain the most important copper-specific data events until further notice.
TIN The most hyped base metal coming into the year has proven the most disappointing for bulls, the May price reversal triggering a stampede for the exit.
Expected deficit has proved elusive but it is just a matter of time, according to the bull narrative. Certainly, there has been no rush of investment in new tin mine capacity and in its absence it’s still difficult to see how supply is going to close the gap with demand over the coming period.
However, as with copper, this market needs some fresh evidence that there really is a deficit. A jump in cancellations of LME stocks last week is worth noting but until visible inventory starts falling consistently, bull enthusiasm will be tempered. Stocks hold the key.
ALUMINIUM The light metal was actually the best price performer in H1 2011. That was largely thanks to higher energy prices.
Remember there are many on the “Street” who trade aluminium as an energy derivative, which also explains why some of the heat has come out of the market since the release of US strategic oil reserves at the end of June.
However, aluminium has its own fundamental story right now in the form of a tightening Chinese market. The Shanghai contract is in front-month backwardation and visible stocks in the country have been tumbling at a fast rate.
Forget for a moment that part of Chinese demand for primary metal is to transform it into products for the export market. Taken in isolation, the Chinese primary aluminium sector is currently in deficit despite record production rates.
The potential for a power crunch over the summer months means production risks are skewed to the downside and price risks to the upside. Monthly production updates from both the National Bureau of Statistics and the China Nonferrous Metals Industry Association will remain the key data events this quarter.
NICKEL Analysts didn’t like nickel at the start of this year and they still don’t like it. Demand from the stainless sector can be expected to slow over the summer months, as is the seasonal norm in this market.
But what of supply? Nickel has seen a high number of supply-side disruptions in recent months, keeping the market in deficit.
New supply is widely expected to push the market back into surplus from now on, but with the high-profile, high-pressure-acid-leach projects still falling short of even reduced expectations, it’s a moot point.
Moreover, the most important supply-side variable, Chinese nickel pig iron production, is the least visible.
Given the weight of bearish consensus, predicated on fast-rising production in H2 2011, actual supply growth can probably only disappoint.
It’s interesting that there is a small but growing band of analysts mooting an upside price move after the hammering meted out to nickel in the second quarter.
LEAD The heavy metal was the second-best performer in the first half of this year. It was the only base metal to draw demand strength from the Japanese earthquake/tsunami in March in the form of stationary batteries for back-up power supplies.
The closure (again) of the Magellan mine in Australia reinforces the “toxicity premium” for lead.
But is there any global shortage of the stuff? The International Lead and Zinc Study Group says not and it is easy to over-state Magellan’s significance in the global supply picture.
The key to the next quarter, however, will be events in China, specifically the environmental clamp-down on the lead-acid battery sector.
Chinese smelters are already thought to be reducing run-rates to compensate for this demand-side hit, a useful reminder that the country is self-sufficient at the refined stage.
ZINC Too much stock, too much production and too much incentive for producers to bring more capacity on stream mean that even super-bulls such as Barclays Capital find it hard to get too excited about this metal.
Everyone will of course tell you that there is a concentrates shortage looming at some stage, citing the scheduled closure of big mines such as Century in Australia and Brunswick in Canada.
Yet while the zinc price remains comfortably above the production cost curve, more and more mine projects are being brought back out of mothballs, throwing an ever bigger question-mark over the timing and size of that expected concentrates deficit.
Zinc is the metal that poses the hardest questions about the base metals rally and the expectation that it has further to run. If zinc is trading “too high” based on fundamental considerations, what does that say about the speculative premium that may be priced into the more “bullish” metals?
Andy Home is a Reuters columnist. The opinions expressed are his own.
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