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Ardent Listener
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 Posted - 06/14/2007 : 20:32:01
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The bulls are still running
By Tom Stundza -- 6/14/2007
Base metals cost more than ever before—often substantially more—in a continuing inflationary surge caused by tightness in supply of feedstocks and scrap, a surge in Chinese buying of finished mill products and investment activity by retirement fund managers and speculators. The best guess from commodity economists is that buyers will see another 35% price explosion this year for a market basket of six key nonferrous metals that escalated by 56% in 2006.
"The bull market for base metals has already lasted longer, and prices have moved higher, than in previous cycles," according to the latest Metals Review by the Natixis Commodity Markets investment bank in London. Analyst John Normand at J.P. Morgan Securities' offices in London says that "the rise in base metal prices this year has been meteoric" and pins some of it to reduced inventories across the world metals landscape.
The dominant macroeconomic themes of strong non-U.S. growth and a weak dollar should keep metals prices relatively high all year, says Normand. In fact, global demand has exceeded most growth forecasts. That's because economic growth in Southeast Asia, Eastern Europe, the Middle East and Latin America, whose populations comprise more than 1 billion people, is outpacing North America and Western Europe, "stoking above-average consumption of commodities," says analyst Daniel Brebner at UBS Securities in London.
At the same time, the mining and smelting industry had been unable to keep up. So, prices for aluminum, copper, lead, nickel, tin and zinc already have risen above market forecasts, writes Peter Richardson, the chief metals economist at Deutsche Bank's offices in Melbourne, Australia. "That would support an interpretation that prices will be stronger for longer than many had anticipated at the start of the year," he says.
Then there's steel: Domestic market prices for carbon and alloy grades have gone up in recent months to offset rising scrap and energy costs even though demand has been weak. Still, steel is lower than the peak of last summer. But, stainless steel prices have continued to set records, partly because of good demand but mostly because of exploded prices for nickel, chrome and other key alloys.
Outside North America, steel prices are higher than expected because global demand for steel is higher than projected, due in part to major construction projects in such developing countries as India, Thailand and especially China.
Construction for the 2008 Beijing Olympics and the 2010 Shanghai World Exposition and for housing, bridges and highway infrastructure keep work crews busy. "World prices will remain firm and there is no likelihood of prices falling for the rest of the year," says J. Mehra, director of Essar Group, the Indian steelmaker that just bought Algoma Steel in Canada and the under-development Minnesota Steel project in the U.S.
Generally, this year's metals market has seen tightness in supply of alumina and various other concentrates that has limited production growth of refined nonferrous metals. "Continued growth, a weaker dollar and tight capacity have resulted in 2007 pricing that is stronger than 2006 pricing," reports economist Jason Schenker at Wachovia Bank in Charlotte, N.C. He points out that global economic growth is providing this price support.
"This year, growth is likely to be below 3% in the U.S., but global growth is expected to remain above its long-term trend of 4%," says Schenker. "This provides the fundamental pressure cooker environment, in which metals that have tight inventories, which are almost all of them, continue to see upside price risks."
The correlation between the dollar and commodity prices is important because metals are traded in dollar-denominated contracts on open commodity exchanges. "With the cessation of Fed hikes, and a gaping U.S. current account deficit," he says, "the dollar is likely to depreciate on-trend in coming quarters as fundamental interest rate differentials push the greenback lower." Metals prices also have been bolstered recently because the dollar has taken a hit in foreign exchange markets.
Steel. Although there has been a mini-surge in early 2007 carbon and alloy steel prices because of rising costs for energy and raw materials, first-half prices of most steel products have been erratic and generally about where they were forecast. The cost of hot-rolled sheet, the benchmark grade, remains 11% lower than the peak in mid-summer 2006. And, since first-half pricing hasn't matched mill expectations, Purchasingdata.com continues to post a 2007 full-year outlook of $577 (which is slightly under the 2006 annual average of $580/ton) while Wachovia has posted a slightly lower $569 forecast.
The market momentum is flat to down at midyear.
Purchasing by end-use companies has dropped because of soft demand triggered by the weak growth in gross domestic product and a weakened steel need by such industries as metalworking machinery, major appliances, commercial equipment and automotive parts production.
On the other hand, steel bull Aldo Mazzaferro at Goldman Sachs Group in New York believes that transaction prices "are about to confound the market again." While many analysts believe they are peaking and will decline along with discounted scrap prices, and others see soft demand as not supporting rising prices, Mazzaferro reckons that lower import supply will inevitably force U.S. steel prices higher.
However, he also admits that there still is "a risk of a speculative surge in U.S. steel pricing that could attract an over-abundance of imports that could end the good market," he writes in a note to clients.
Stainless Steel. Stainless steel demand has been so strong that nickel supplies haven't always met demand during the past three years. That's why nickel has jumped by 340% since 2003. About two-thirds of nickel is consumed in the production of stainless steel. Cold-rolled stainless sheet has risen by 160% from 2003 and has surpassed $5,000/net ton already this year—mostly because nickel has exploded to $23/lb.
Jacques Bacardats, CEO of Eramet, operator of the world's largest ferronickel plant, suggests that record-high nickel prices "are excessive"' and "may lead to a correction." If prices fall, service center buyers of stainless steel "would need to brutally reduce their stocks to avoid a considerable loss in inventory value," he says.
"Current nickel prices are unsustainable," agrees Jon Bergtheil, head of global metals strategy at the J.P. Morgan offices in London, who believes nickel might average only $16/lb this year because he thinks stainless-steel makers will buy less of the alloying material in the second half and that will boost stockpiles. Overall, though, the forecasts are widespread: Standard Bank's analyst Mike Skinner in London projects nickel averaging $24.95 this year; Wachovia's Schenker sees $19.64/lb; the purchasingdata.com outlook is $18.80; the Natixis Commodity Markets forecast is $15.88, and private banker Calyon of London sees $15.54.
There are some reports that nickel prices are prompting some buyers of austenitic stainless steels to actively seek alternative grades or other materials. However, Standard & Poor's primary credit analyst Donald Marleau says that "substitution with low-nickel stainless grades has been fleeting because end-users have limited tolerance for lower-grade stainless steels." Nevertheless, Marleau suggests that current nickel prices "are proving a strong incentive for customers to explore alternatives."
Copper. The price drivers in the recent past were the surge in Chinese buying and investment fund interest in speculative investments. Analysts really haven't been sure whether these factors would continue or wane as this year progresses. Still, there has been an ignition in the copper price on the London Metal Exchange (LME) since mid-February. In fact, first-half prices have surged by 24% over the same period of last year mostly because demand in China, the world's largest consuming region, has continued to surpass last year's pace.
"This may just prove to be a dead-cat bounce, a short-term recovery in a declining trend," says Wachovia's Schenker, "but if demand remains strong, it could buttress prices throughout the year." As such, he has revised upward the 2007 forecast to $3.29/lb from last year's $3.05. J.P. Morgan has a new forecast of $2.96 "because inventories likely will continue to decline through mid-year when additional supply and slower buying allow stocks to rebuild."
Purchasingdata.com has boosted its forecast to $3.05 from $2.60 because of the apparent end of demand slippage in North America and Western Europe. The most bearish view comes from The Natixis Commodity Markets, which still sees an inventory build ahead. The forecast of $2.88 for 2007 is based on the notion that "without a similar series of production disruptions to those in 2006, this year's increases in refined copper output globally will continue to counterbalance the rises in demand in 2007, resulting in a surplus of around 50,000 metric ton."
Aluminum. Aluminum prices have risen in recent years—to $1.16/lb in 2006 from an average 72¢ over the previous six years—buoyed by high costs, strong demand and speculative activity. "Aluminum inventories remain low and prices are likely to find support from demand fundamentals," suggests Schenker at Wachovia, who sees the 2007 price average at $1.28/lb. The average price of aluminum will gain 11% this year to $1.29/lb "because global supplies will continue to be constrained," says UBS analyst Brebner.
And even though Natixis Commodity Markets has a view that "demand growth will continue to be matched by higher output, creating a balanced market," the group's 2007 price forecast is just slightly lower at $1.25. That's the same price projected by purchasingdata.com. The pricing bear is Jon Bergtheil at J.P. Morgan, whose forecast is $1.17 because he sees "significant production coming on-line over the course of 2007 due to healthier operating margins"—noting that Chinese production already is 35% higher than in early 2006.
However, not all the market analyses see continued strength in price-dampening production. A market review by Abare, the Australian Bureau of Agricultural and Resource Economics, says that "expansions in capacity will be determined by the ability of new and existing smelters to secure competitive power contracts." And that will keep most expanded output in the Middle East (abundant low-cost natural gas supplies) and Iceland (abundant resources of hydroelectric and geothermal power).
In developed nations, where aluminum smelters compete with industrial and residential users for power, Abare says it will become increasingly difficult to replace or renew power contracts at similar prices, says the analysis. "Rises in electricity prices, in addition to increasing costs associated with aging technology and low economies of scale, have combined to significantly reduce the profitability of aluminum production" in Europe and North America, Abare points out. Even in China, where production has been skyrocketing, 800 smelters now are competing for energy as well as alumina and other raw materials.
Lead and Zinc. According to the Natixis Commodity Markets review, lead's cash price in 2007 could average 84¢/lb, up from the 60¢ average of 2006. The London-based analysts now say that a projected rebound in output now is unlikely to emerge until the latter part of the year so their revised supply/demand balance points to a 35,000 metric ton deficit. The purchasingdata.com outlook is 80¢ because of tight supply caused by production disruptions at faraway smelters and refineries.
J.P. Morgan's analyst is less bullish, expecting a 65¢ annual price, up only slightly from last year's 60¢ average. "Lead's price has been strongly supported via disruptions to supply emanating from the Northfleet (United Kingdom) and Magellan (Australia) force majeures, as well as strikes at Doe Run's Peruvian operations; hence, the market has remained tight into the second quarter," says Bergtheil. "But, we expect that looming additional supply and less robust demand conditions ahead will flatten prices onwards."
Most analyses forecast zinc prices being high in 2007 as global demand, particularly from Asia, continues to expand.
With consumption of zinc forecast to exceed production for a fourth year in a row, global zinc inventories are expected to drop. "High demand and falling inventories had been the greatest factor driving the price of zinc higher this year, says Schenker at Wachovia. "There is a significant upside risk to prices across 2007, especially that inventories could deteriorate further." He sees the annual average price at $1.73, as compared with $1.48 in 2006.
Natixis Commodity Markets also is projecting a deficit of 17,000 metric tons. "We expect that mine supply will finally begin to respond to the record level of prices, which should allow both Western World and Chinese refined zinc output to expand," the analysts project—and forecast an average annual price of $1.59. Not so, says Bergtheil at J.P. Morgan, who comments that "the market looks for supply to increase in excess of 11% for the calendar year," which would push prices down to $1.39.
2003 2004 2005 2006 2007
old new
Aluminum 65 78 85 116 110 125
Copper 81 130 167 305 282 305
Zinc 38 48 64 148 144 158
Lead 23 40 44 60 56 78
Nickel 437 628 666 1102 960 1757
Tin 222 386 335 397 336 677
Source: London Metal Exchange; Forecast: Analysts' consensus
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The Bulls are still running
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