The Hindu Business Line : Base metals: Where are they headed?

Metal prices have seen an upswing in the world markets. But opinion is divided on whether this is because of demand revival or factors such as cutbacks in production and arbitrage opportunities.

Recovery in aluminium prices appears more tentative than that in copper.

S. Hamsini Amritha

LME base metals have witnessed a surge in prices since March. What are the factors driving the upswing? Is it supported by fundamentals? We attempt some answers.

Copper

Copper, the heavyweight in the base metals pack, finds extensive use in the construction, electrical and telecommunications industries. This metal has tended to lead any recovery in prices, and has outperformed other base metals in terms of price and trading interest — visible in recent recovery too.

From its lows in December 2008 to current levels of $4,960 a tonne on the London Metal Exchange, copper has seen price gains of 80 per cent. Dwindling stock piles in LME have also fuelled the rally. From a high of over 5 million tonnes in February 2009, the inventories have steadily fallen to about 3 million tonnes by May. LME reports suggest that stock drawdown has been higher in the US than in Europe. .

Demand and supply

The trigger for higher copper prices in recent months has come mainly from tighter supplies, as the global majors resorted to production cutbacks — BHP Billiton, Rio Tinto and Xstrata have, for instance, cutback output by 20-25 per cent. According to an International Copper Study Group report for January 2009, the world copper market had moved into a surplus of 155,000 tonnes for the year ended January 2009, compared with a deficit of 22,000 tonnes in the same month of the previous year.

The report says that refined copper output for 2009 was likely to be 1.525 million tonnes, while consumption may dip to 1.370 million tonnes.

The trade body feels that the demand for copper depends on how the stimulus packages kick-off in each country. Currently, copper producers are focussed on reducing their existing stockpiles before restarting the closed capacities, suggesting there are no clear signals yet for a complete demand revival.

Chinese imports since March have been about 400,000 tonnes more than the normal stocking levels. This has been a key supportive factor for copper prices. Speculative interest, which has been building again across the commodity pack, has played a role in driving up copper prices too.

Since March, traders have been making use of the arbitrage opportunity that exists between copper contracts on Shanghai and LME. The LME price was at a discount to Shanghai by over 50 per cent in March. That gap has been steadily reducing to just about 20 per cent now.

Analysts expect to see demand tapering down with further narrowing of the differential.

Trading opportunities apart, there is also the seasonal factor. China has traditionally stepped up its copper imports between April and June each year and the replenishment activity tends to peter out from July. That pattern could well be repeated this year too.

Sustenance of Chinese demand appears crucial to prices. Nations belonging to OECD have said that they are beginning to see an end of the de-stocking process that has been going on for a long time. “We (the OECD Countries) have hit a bottom, and we are going to see an improvement. Still, re-stocking in the OECD won’t make up for a decline in Chinese import demand”, says a Metal Bulletin report. Analysts from Credit Suisse in May warned that “in the absence of Chinese strategic buying, real demand remains weak while inventories are plentiful.”

Mixed Views

The industry forecasters have divergent views on copper’s fundamentals. While some diversified commodity manufacturers such as Rio Tinto and Freeport-McMoRan expect the demand to remain subdued until the third quarter of fiscal year 2009, some research houses such as Royal Bank of Scotland and Goldman Sachs expect a much earlier recovery.

In May, RBS raised its copper price forecasts for 2009 and 2010 to $4,200 a tonne and $5,500 a tonne, from previous forecasts of $3,525 and $4,500 respectively. According to its reports, “Copper has emerged relatively unscathed and remains our most preferred base metal. A large surplus is likely this year but Chinese strategic stockpiling may absorb much of it”. On the other hand, Bret Clayton, CEO of Rio Tinto, has been quoted in Bloomberg as saying that higher prices have “not necessarily been supported” by demand.

Aluminium

The recovery in aluminium prices appears more tentative than that in copper. Not only were prices late to catch up, the gains have only been about 13 per cent from the February lows (from $1,251 a tonne to $1,406 now). With the demand outlook still unclear, the recent spurt in price can be partly attributed to the support received by most commodities from a weakening US dollar.

Production, consumption

The major user segments for aluminium are transportation, packaging and construction. Regionally, Asia (driven by China’s 30 per cent) accounts for about 44 per cent of consumption while Europe and the Americas account for 27 per cent each. World aluminium output rose by an average of 5 per cent during 1998-2001, and accelerated to 7 per cent after 2001 mainly due to the explosive growth in Chinese production.

Output began to contract from the second half of 2008, as producers opted for production cutbacks. Production is likely to decline by as much as 5 per cent for 2009.

Between 1998 and 2007, world primary aluminium consumption grew by an average of 5.6 per cent to reach 37.2 million tonnes, again driven by China.

Consumption remained more or less flat in 2008. Much of revival depends on the appetite of its user industries — mainly the transportation sector. Currently, fresh demand for aluminium is only from the packaging industry.

Going forward, forecasts project 5 per cent decline in consumption for 2009. While the Chinese market is expected to expand by a mere 3 per cent in 2009, demand from Europe, North America and Japan may decline by 5 per cent. According to the International Aluminium Institute, the market may recover in the second half of 2010, and global growth of 4-5 per cent thereafter may be led by China. On an average, growth until 2013 for aluminium will probably be about 2.6 per cent.

Though aluminium producers in Europe, Americas and Australia have shut down some of their smelters to reduce output, LME is still left with 4 million tonnes of the metal (a 50 per cent jump since January).

This stock-piling is being contributed by Asian producers, mainly India and Dubai, who have recently expanded their capacities.

When is the recovery?

With governments in Europe and the US pushing for fuel-efficient small cars, replacement of current engines (made of steel) with those using aluminium seems quite likely. This shift in focus does leave scope for demand revival, but only over the long term. Forecasts by producers and researchers for aluminium are far less bullish than they are for copper.

In its May 2009 report, RBS has downgraded its 2009 and 2010 price forecasts to $1,550 and $1,875 a tonne, respectively, from $1,650 and $2,000. RBS has hinted that, the light metal is economically geared with heavy exposure to the beleaguered transport and construction sectors. As a result, they forecast that demand will contract by 8 per cent in 2009.

Norwegian aluminium producer Norsk Hydro anticipates low aluminium prices for the rest of 2009, adding that visibility was limited and highly uncertain. It expects primary aluminium consumption, excluding China, to decline by 15-20 per cent in 2009.

“We do not see any short- or medium-term upturn in the market, and we will continue to take necessary measures in adjusting our operations and costs to the challenging market situation,” its CEO was quoted as saying in Bloomberg.

Related Stories:
Surplus seen in copper till 2010
Crude, base metals turn out star performers
Stimulus package may boost copper prices

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