Base Metals: The new fundamentals

LONDON (Metal-Pages) 12-Oct-06. A number of features have changed in the current base cycle, says Natexis Commodity Markets in its latest base metal market analysis.  In a special report produced for LME week the ring dealing member makes its forecasts for LME-traded metals.

Not only have prices exceeded even the most bullish of price projections, but the key drivers of the price have also changed.  Traditionally the key driver behind a bull market has been a pick-up in the rate of demand growth.  While strong (above trend) demand growth helped to kick-start the bull market in 2004, we had the unusual situation in 2005 in that prices continued to trend higher even though demand was relatively weak.

The bull market rages on despite China!
The amazing demand growth within China has been a major factor behind the bull market.  However in 2006 the country’s impact on the fundamentals of the individual metals has been mixed.  Again somewhat surprisingly given the price performance of the two metals, China has had a negative impact on the fundamentals for refined copper and nickel.

Supply shortages remain a feature
Producers of most base metals are still struggling to catch-up with demand.  Part of the reason is structural i.e. under-investment in new capacity earlier this decade and technical problems associated with the next generation of projects (this is particularly the case for nickel).  In addition there have been a myriad of technical problems and strikes that have kept production below expectations.  As a result Natexis Commodity Markets has raised its disruption allowance in its supply-demand balance analysis i.e. the allowance for how much lost production we expect to take place in 2007.

What are treatment charges telling us about the state of the market?
Changes in spot treatment charges (and alumina prices) provide a reasonable indicator about current and future production trends.  For copper and lead, treatment charges have shifted further in favour of the miners, highlighting how the myriad of supply disruptions has tightened the concentrate market.  Opposing trends are emerging in the alumina and zinc markets.  Although the alumina spot market is largely based on trade with China, prices have collapsed reflecting the surge in alumina production in the country.  For zinc the current market is tight, but smelters are focusing on the surge in Chinese mine output and the likelihood of much higher Western World output in 2007.

What impact will the funds have in the future?
So far in this cycle we have seen investment funds have a massive impact from the long side.  At the beginning of the bull market the consensus view was that the investment funds would disappear as quickly as they appeared.  However, the increasing acceptance of commodities as an asset class has encouraged longer-term investors to the sector, which has helped extend the bull market.  Nevertheless with signs that economic growth is starting to slow, and that a supply response to the high prices is beginning to emerge, we expect that funds will tend to exert a bearish impact on price.

Aluminium
It appears that the aluminium market is not going to experience the extreme tightness that have sent copper, nickel and zinc prices to record levels.  Natexis Commodity Markets believes that there is not a shortage of smelting capacity and that primary aluminium production will fairly closely track demand growth.  The small deficit that we project for next year of 100,000 tonnes is unlikely to support sharply higher prices from current inflated levels.  Similarly there is little reason for a massive correction.  As such we are forecasting average annual prices of $2,500/tonne in both this year and next.

Copper
The copper bull market has been written off on a number of occasions; however the much-vaunted surplus has yet to emerge.  Elsewhere in our analysis