Tue Jan 20, 2009 6:03am EST

http://www.reuters.com/article/marke...

-- Andy Home is a Reuters columnist. The opinions expressed are
his own -- 

 By Andy Home

 LONDON, Jan 20 (Reuters) - The LME "street" doesn't do
prolonged recessions very well. A natural tendency to bullish
exuberance has been accentuated by the extraordinary bull run of
the last few years.

 That part of the cycle is definitively over but there is
already a palpable impatience with metal prices that are
languishing at multi-year lows.

 The market is poring over the news for signs of a turning
point that might herald a return to the good times.

 Will China's State Reserve Bureau come to the rescue of the
copper market by buying up half a million tonnes of the red
metal ?

 How many more zinc mines must close before that market moves
to balance? And does the stalling of the uptrend in LME nickel
stocks signal that prices are now close to the bottom ?

 Nickel, though, far from being at a turning point may serve
as an object lesson in the perils of false dawns.

 STOCKS STALL

 It is indeed true that the seemingly inexorable rise in LME
inventories of nickel has lost a lot of momentum since the start
of January.

 LME stocks of the metal rose by 9,342 tonnes in Q3 2008 and
by a further 22,788 tonnes in Q4 2008. They ended last year at
78,822 tonnes, their highest level since mid-1995. 

 So far this month, however, the rise through Friday
(reported Monday) has been a highly modest net 186 tonnes, in
stark contrast to the accelerated stocks build that is still
being seen in other metals such as aluminium, copper and zinc.

 This divergence in nickel stocks behaviour is down to one
key development, the absence of arrivals of full-plate metal at
Rotterdam in the first two weeks of 2009.

 The last warranting of such metal at the Dutch port took
place on Dec. 31, 2008. Through Jan 16 Rotterdam received no
metal at all and the system as a whole no full-plate cathode. 

 The pattern is not a new one. Rotterdam was similarly
inactive in the first half of January in both 2007 and 2008,
part of a broader pattern which tends to see LME stocks decline
in the first two months of any year. That reflects a seasonally
strong period for nickel demand. 

 Or, to be more precise, some forms of nickel demand.

 It is worth making the obvious point that only refined
nickel is deliverable against the LME contract.

 Ferronickel, which is exclusively used in the stainless
steel sector, is not deliverable and therefore does not show up
in LME stocks. Nor is the cheaper-priced alternative for many
stainless mills, stainless scrap.

 STAINLESS SHOCK

 So, even assuming that LME stocks do not start building
again in the coming days, the apparent levelling out of the
uptrend provides only a highly limited signal about the state of
the non-stainless nickel market. 

 Stainless, however, accounts for the lion's share of nickel
demand at around 70 percent and there is no sign yet of any
turnaround in this all-important sector.

 Indeed, there are strong suggestions that the stainless
market is weakening even further. Harder evidence will come with
the start of the Q4 2008 reporting season but one major
stainless producer, Finland's Outokumpu, has already waved a red
flag in the form of a Dec. 23 profits warning.

 "Stainless steel demand has weakened further and Outokumpu's
fourth quarter performance will be below earlier indications.
The company is taking actions to prepare for a period of
possible prolonged demand weakness and will now prioritize
profitability improvement and cash generation in the
short-term," Outokumpu warned.

 Another red flag is coming from the ferrochrome market,
which like nickel is closely linked with the stainless steel
cycle.
 Japan's biggest stainless producer Nippon Steel & Sumikin
Stainless (NSSC) confirmed to Reuters last week that it is
considering skipping entirely first-quarter shipments of
ferrochrome from South Africa because it simply doesn't need
them.

 South African ferrochrome producers are responding. Merafe
and Xstrata said last week they were idling another 6 furnaces
at their joint venture, meaning around 80 percent of annual
capacity has now been cut.

 That surpasses anything yet seen in the nickel market when
it comes to curtailments at the biggest producers.

 The concern must be that nickel producers, particularly
ferronickel producers, are going to have to implement a second
round of cuts if the stainless sector doesn't improve soon.

 Not only is there no sign of that happening but
macroeconomic indicators are still deteriorating, suggesting the
bottom of the current manufacturing recession is still some way
off.

 In this context the apparent bull signal coming from LME
nickel stocks is very probably a false one, the first of what is
likely to be a number of false dawns for metals demand.

 OVERSUPPLY

 That is not to say that economic recovery is not going to
happen, unless you believe that the world is entering a
recession of the magnitude seen in the 1930s.

 And when it comes, the economic up cycle could be just as
explosive as the downturn currently taking place. The stainless
steel sector will be a major beneficiary. 

 However, the impact on nickel prices may not be quite what
the hibernating bulls imagine. Not only will idled production
capacity be quick to restart to meet recovering demand but the
market risks being swamped by metal from new projects. 

 These were planned at the height of the 2005-2007 bull
market, a supply surge that anticipated the good times would
roll without interruption. Currently on hold, they now represent
the potential for structural oversupply even when the good times
do roll again.

© Thomson Reuters 2009 All rights reserved