BASE METALS FORECAST

Further forward a tightening supply outlook, limited inventory cover and increased investor appetite for metals should maintain significant upward pressure on price.

Author: Rhona O'Connell
Posted: Tuesday , 29 Sep 2009

LONDON -

The latest quarterly Commodity Review from Société Générale describes how the copper market is characterised by "limited visible stock coverage, little in the way of idled overcapacity overhanging the market, strong Chinese import demand, and an expectation of limited supply going forward" that will take the market into a deficit that will start in 2010 and deepen thereafter.

Noting how China represents the key fundamental factor driving the base metals sector, the bank forecasts that China's share of global base metals consumption is expected to approach 40% in 2010 - despite a downgrade in the bank's forecast for Chinese growth in 2010 to 8%.

SocGen is looking for healthy price increases across the board in the base metals sector, with the strongest gains actually projected for nickel, both from late September prices and from the 2009 forecast average. Nickel and copper are both expected to sustain averages in 2010 in the region of 20% higher than late September prices and to be higher still in the following year. Aluminium's price increase in 2010 lies behind those of copper and nickel, but it goes some way to catching up between 2010 and 2011. Aluminium, however, has plenty of idled production capacity while copper has a relative lack of committed new projects and this is an important part of "very positive fundamentals" from a copper pricing point of view.

The economic outlook painted in the study looks for the world economy to pull out of the recession in the third quarter this year and suggests that there could be some "positive surprises" over the next one or two quarters, stemming from a technical rebound and powerful base effects. The auto industry is expected to lead the recovery worldwide. For the longer term, however, the recovery is likely to be anaemic as a number of growth drivers are missing.

These include, inter alia, poor investment incentives, and a normalisation of savings, while global merchandise trade is expected to remain relatively weak. The output gap is expected to take longer to close than in previous recovery periods and the employment outlook is expected to remain persistently weak, although unemployment rates are likely to peak during 2010.

Interest rates are not projected to rise before the end of 2010 (with the likely exception of the UK in the light of inflation expectations) and further dollar weakness looks hard to avoid. "Lower global risk aversion means a weaker greenback". The bank does warn, though, that as far as fiscal tightening is concerned, it is not a question of "if, but when".

The review is a comprehensive study of the whole commodities spectrum, including energy, softs, plastics, the base and precious metals. Within the non-ferrous sphere, copper aluminium and nickel look to have the brightest prospects for the medium term.

While SocGen expects Chinese copper imports to decline over the second half of this year, and despite the fact that LME copper inventories have been rising since August in the face of this easing, the study argues that there are clear indications that the downturn in non-Chinese copper consumption bottomed out in the second quarter. A degree of inventory building should be expected in an increasing number of consuming nations in the second half-year following the "savage destocking" during the economic downturn. The very low global surplus forecast for this year means that there is very little by way of a cushion in the event of any more production losses although Chinese warehouse inventories in Shanghai are reputedly very high and it is perfectly possible that China may be holding a total of roughly one million tonnes of refined copper stocks. These inventory levels have been weighing on domestic Chinese prices, with the result that Shanghai, which traded for so much of this year at a premium to LME, is now at a discount.

For the longer term, constrained supply will be a growing issue in the copper market. In the short term there is little idled capacity in the market (in complete contrast to aluminium). Furthermore, there is a relative lack of committed new copper projects that could contribute towards satisfying resumed medium-term demand in growth. This is perhaps highlighted by the postponement of expansion plans at Escondida in Chile.

The market is forecast to move into a real deficit in 2010, a deficit that is expected to widen significantly thereafter.

Despite signs of short-term demand weakness (as illustrated by inventory increases in LME warehouses), SocGen is looking for copper prices to remain well-supported, especially as copper remains the bellwether metal for investors looking for exposure to economic improvements. Further forward a tightening supply outlook, limited inventory cover and increased investor appetite for metals should maintain significant upward pressure on prices.