Base metals ride technical upswing

Written by Naveen Mathur | Naveen Mathur | Updated: May 31 2009, 05:39am hrs
The base metals pack delivered a strong performance in May with only aluminum ending the month in the negative territory. Nickel emerged as the outperformer on the LME and the MCX. During the month of May we have witnessed a sharp weakness in the dollar and on the other hand we have seen a sharp appreciation in the rupee. Both these factors have affected base metal prices. A weaker dollar makes base metals attractive for the holders of currencies, and this factor provided a strong cushion to base metal prices. However, a stronger rupee capped the upside in base metals on the MCX.

Factors affecting base metal prices

Weakness in the dollar

Strength in the equity markets

Better-than-expected US economic data

The fractured dollar

The trend in the dollar is down, as stronger equity markets have reduced demand for low-yielding currencies. The dollar has also lost ground because the US Fed is expected to increase the purchasing of mortgages and government debt. A weaker dollar makes base metals look attractive for holders of other currencies. The dollar has weakened in the last three months and prices have received support on the back of this. The US currency fell to a 2009 low and this factor has helped to provide a cushion to the downside for base metals.

Rally in base metals

The global economic outlook has shifted from absolute pessimism to hope that the situation could improve by the end of this year. A rise in base metal prices in the last few months is based on very little evidence of improvement in demand or the economic situation.

Nickel monthly outperformer

The metal still remains in a poor fundamental state but has managed to make whopping gains of more than 18% on the LME in the month of May. There is strong optimism about revival in the economic situation. Also, production cut in the case of Nickel has come in as a saviour to prices. But data indicates that the nickel market is expected to remain in a surplus of 80,000 tonne in 2009, according to the International Nickel Study Group. World production is expected to decline to 1.26 MT and world demand to 1.18 MT. Despite the indication of surplus of the metal, prices traded higher due to news of nickel mines closures. Since production cutbacks have taken place on a large scale, prices have received a sigh of relief.

The stainless steel industry accounts for more than 60% of nickels offtake. Demand from the stainless steel sector is not expected to pick up until the end of this year. Acerinox, the worlds largest stainless steel producer accounts for around two-thirds of nickel offtake. The company expects demand to revive by the second half of this year. Hence, the real recovery in prices is expected to come in by the second-half of this year.

Strong cushion to the downside

Nickel prices have rallied sharply in the last few weeks. We feel that there is no fundamental shift and the demand side still remains weak. There have been reports indicating a rise in Chinese refined nickel imports. This has also added to the upside in the metal. However, we feel that this data has more to do with the premium between Chinese nickel prices and the LME prices. Hence, we feel that the rise in nickel prices is not on the back of improvement in the fundamental scenario. The metal has taken cues from the overall optimism in the global financial markets. Prices could face pressure on the downside in the medium-term i.e. (June-July), on the back of the slow summer season.

Short-covering: next bullish feature

Nickel prices after finding support at Rs 442 levels in the month of December 2008 have bounced back sharply higher towards Rs 660 levels and are currently trading in the range of Rs 570 to Rs 650 levels. Prices need to close above Rs 660 to confirm that a short-term bottom has been posted in the market and thereby opening the door for a major upside rally initially towards Rs 735 then Rs 830 and then finally towards Rs 912.0. Nickel prices will now find strong support at Rs 580 to Rs 560.0 levels. A daily close below Rs 550 would temper the near term bullish outlook in the market.

Focus - copper

The weaker dollar pushed buying in LME copper. Copper prices on the LME gained almost 3% as a weaker dollar made base metals look attractive for holders of other currencies. The dollar weakened more than 4% and provided a support to copper prices. Though LME copper prices gained in May, the red metal did not make huge gains on the MCX as the rupee appreciated. LME inventories for copper showed a sharp drawdown by 21% but this factor is not giving major cues to the copper market currently. Copper prices are currently taking cues from 1) equity markets, 2) currency markets and 3) from the macroeconomic front.

Surprise revival in US economic data

Copper gained on the LME mainly due to the weaker dollar and better-than-expected economic data. Existing home sales in the US jumped for the second time in three months in April as foreclosure actions and cheaper prices spurred buying by bargain hunters. This pick-up in sales could help reduce the glut of unsold homes and give support to property prices. This data gave rise to positive sentiments and helped base metals trade higher. The US housing market is key to the base metals sector and improvement in the housing data will be positive.

Consumer confidences in major developed countries, like the US and Germany, fuelled hopes of recovery in the second-half. The base metals complex received strong support from this data as it indicated that in the coming months the US economic recession could recede.

Inventories of the red metal have been on a steady decline. In the month of May itself copper inventories have slumped almost 21%. But this has not been the supporting factor to prices as cancelled warrants; the metal booked for removal has been declining. This indicates that the metal booked for removal from warehouses is less, signalling that inventories could rise in the near future. In the month of May itself cancelled warrants have declined sharply. This decline in cancelled warrants suggests that buying from the SRB of China has come down due to lower arbitrage opportunity between LME and Shanghai prices. The SRB has indicated that they could sell around 50,000 tonne of copper in the near term.

The Baltic Dry Index provides an assessment of the price of moving the major raw materials by sea. The index has witnessed improvement in this year and it supports our view that demand for base metals could increase by the second-half of this year. In December 2008, the index had dropped by 94% to 663 points, its lowest since 1986. But since then it is witnessing strong improvement. Since it is a leading indicator of business activity across the globe, we believe that demand concerns for raw materials could ease off going forward.

Medium-term outlook - restrained

Restocking in China help provide a push to base metal prices. But we feel that the restocking surge in China may have run its course and demand could fall again due to the slow summer period. We expect base metal prices to remain under pressure in the medium-term i.e. (June-July).

Long-term outlook - bullish

Overall we feel that copper prices could head lower in the medium term but the dips could be relatively short-lived as lower prices attract production cutbacks and strategic buying by the SRB. However, we expect real recovery in demand to come in by the end of this year as the brightest aspect for the base metals market is the stimulus packages. Since the Chinese stimulus package of $586 billion is infrastructure intensive, we feel that demand for copper could rise tremendously in the long-term.

Dips to be relatively short-lived

Copper prices have bounced back from their lows of $2815 witnessed in December 2008. Since then, prices have recovered as prices were trading below their marginal cost of production. Prices consolidated for many weeks and later on, towards the 2nd week of March, prices witnessed an upside move, breaching its resistance zone of $3,650 - $3,670. Currently, prices are around the $4,600 level with sideways trading. Prices continue to be in a downtrend unless we see a close and consistent trading above the $4,905 mark. Weekly MACD Histogram is in positive territory whereas 14-Week RSI is at 55 levels. We expect prices to trade sideways with a negative bias. A further trading below the $4150 mark shall confirm the overall weak sentiments. LME Copper has support at $4,150/$3,590 whereas resistance is seen at $4,920/$5,395. MCX Copper has support at 200/170 whereas resistance is seen at 236/260.

The author is associate director (commodities and currency) Angel Commodities