Base Metals Outlook All About China And Sustainability

Following a fall of around 5% in February base metal prices are tracking higher in March, National Australia Bank noting price movements have largely followed movements in LME stocks.

As the bank's economist Ben Westmore points out, in month average terms LME stocks rose in early February but were followed by consecutive draws in copper, nickel and aluminium stocks in the last week of last month and the first week of March.

The February falls were enough for the bank's Base Metals Index (BMI) to fall by 5% for the month, though as Westmore notes this followed impressive gains from the troughs of late 2008 as the world economy recovered from the Global Financial Crisis or GFC.

Westmore suggests prices now appear to be consolidating the gains made over the last year or so, as upward momentum is currently being hampered by fears of a lessening in financial stimulus in the Chinese economy.

But Westmore doesn't see this as a threat to base metal prices, suggesting rather that the policy moves being made in China are likely to sustain economic growth over the medium-term rather than push it lower.

What should also prove supportive in his view is the likelihood of a measured upward revaluation in the Chinese currency, as he expects a stronger yuan will support Chinese demand for US-dollar denominated commodities on world markets.

As well, Westmore notes the rest of the world economy is showing improved signs of life as recent PMI (Purchasing Managers Index) data in many economies in recent months are pointing to an expansion of production activity.

The flip side of the gains in metal prices over the past year is Chinese base metal production is resurfacing, so making it less reliant on world markets. But here Westmore expects production constraints at local facilities will hamper any chance of reaching self-sufficiency.

Westmore's view is in contrast to that of RBS Australia, as the latter argues a cautious outlook on base metal prices is required given the combination of current inventory levels and the potential re-starting of previously shelved capacity to generate further oversupply.

Over the last several years prices have defied oversupply to rise multi-fold, with China the main drive of physical demand. But as RBS points out, speculators and investors have also played a significant role in pushing up overall demand.

This has especially been the case over the past year, where RBS suggests much of the sharp rally has been the result of huge inflows of investment funds into the sector. This was driven by the availability of easy money as interest rates globally were slashed in the wake of the GFC and as stimulus measures were introduced to lift economic growth.

At the same time RBS suggests China decided to start a program of stockpiling major resources, as evidenced by a sharp jump in its base metal imports last year. Traders saw this and jumped into markets to try and generate some profits.

These factors are not sustainable according to RBS, so the stockbroker suggests industrial demand in the real global economy is not strong enough to justify current prices, let alone further gains. Westmore, however, disagrees, his forecasts calling for the bank's BMI to register gains of 7.0% this year and a further 7.5% in 2011.

As always in commodity markets the changes in prices won't be uniform as differing fundamentals in specific markets will impact on price performance. As evidence of this, the latest price changes from Societe Generale see increases to its forecasts for nickel, copper, aluminium and tin but cuts to its estimates for both lead and zinc.

SocGen's nickel price forecast has increased the most, reflecting its view stainless steel demand will recover enough to push the nickel market into deficit. This, in combination with low inventory levels, will push prices higher in SocGen's view. The analysts have lifted their forecast for 2010 to US$22,800 per tonne, up from US$21,210 per tonne previously.

RBC Capital markets doesn't agree, taking the view while demand may well grow by as much as 14.6% in 2010, this will be largely offset by increased supply, meaning no significant drawdown in nickel inventory levels should be expected.

Prices are currently being supported by labour disputes and stronger stainless steel production and so RBS has lifted its forecast for the year to an average of US$8.00 per pound, up from US$7.00 previously. This equates to a per tonne price of US$17,920, well below the SocGen forecast.

For copper SocGen expects resurgent Chinese demand will boost prices, especially as mine supply appears limited enough to see this market also return to a deficit this year. RBC agrees the copper market could enter deficits during 2010 as mine capacity constraints are limiting supply growth, meaning copper market fundamentals remain very positive.

Having said that, RBC notes recent price gains have pushed copper prices above levels justified by the historical inventory price relationship, meaning there are now some downside risks. In other words: RBC and RBS are more or less singing from the same songsheet when it comes to base metals in the year ahead (investors' influence is significant). RBC is forecasting an average price of US$3.10 per pound or US$6,944 per tonne, compared to SocGen at US$7,445 per tonne. SocGen's forecast is up from US$7,435 per tonne previously.

The fundamentals look less appealing in the aluminium market in SocGen's view as stronger production implies a continuation of surpluses, especially as higher interest rates could see more metal released from warehouses in coming months.

Given such a view, SocGen is forecasting an average aluminium price of US$2,170 per tonne for 2010, up from its previous forecast of US$2,134 per tonne. RBC in contrast sees scope for the aluminium market to remain broadly in balance through 2010, though the existence of excess production capacity means a meaningful decline in inventories is unlikely. RBS is forecasting an average aluminium price of US$0.90 per pound this year, which equates to US$2,016 per tonne.

SocGen sees a rebound in refined tin demand this year thanks to recovering global demand for electronic appliances, this coming at the same time as supply is being restrained by a lack of investment in new mine capacity. SocGen expects prices will average US$16,815 per tonne this year, up from its $15,705 forecast in December.

High stock levels and rising Chinese production will keep the global zinc market in surplus in SocGen's view, so it has trimmed its price forecast for 2010 to an average of US$2,415 per tonne, down from US$2,437 previously.

RBC similarly expects the zinc market will remain in surplus or at worst in balance in coming years, with inventories likely to peak sometime this year. Fundamentals don't justify the current price in its view, so RBC expects prices to average US$0.87 per pound of US$1,949 per tonne this year.

SocGen has cut its lead price forecast for 2010 US$2,470 per tonne from US$2,569 per tonne previously.