ABN AMRO Warrants Corner!

Commodity Corner – Anniversary of May 2006 Price Crisis

Exactly a year ago, base and precious metals, driven higher by intense speculative attention, reached a collective price peak. Copper hit a record US$4/lb, aluminium a multi-year high of US$1.45/lb, and even precious metals joined in with gold at US$725/oz and platinum at a record US$1,325/oz. There then began a nasty rout in commodity prices and global mining shares triggered by higher US inflation and fears of additional interest rate hikes. By mid-June, metal prices had tumbled 16-35%. Miners too slumped, with the Dow Jones UK Mining Index dropping 25% between 11 May and 13 June. So here we are a year on. Of the 10 key base and precious metals, only four have managed to recapture their May 2006 highs. As we look ahead, the supply-side response is under way and we expect eroding LME inventories to rise sharply in the months ahead, driving prices lower as surpluses begin to appear.

No safe haven when the price rout occurred

Industrial and precious metal prices were sent tumbling across the board. Table 1 shows double-digit percentage declines, with lead the worst of the industrial metals as it dropped 30% and silver the worst of the precious metals suite, dropping 35%. Gold was also hit by the price decline, falling 21% from peak to trough. This was in part due to gold getting caught up in basket trades, but also gold has a key insurance role within a portfolio. It pays out when there is a crisis and funds need to raise liquidity – so it’s actually not underperforming, merely doing its job.

As we reach the anniversary of the 2006 May price slide, without doubt some have adopted a more cautious stance. That’s due in part to their fear that lightning may strike twice, but also due to fears that pricing momentum will be lost in the coming months. As Chart 2 shows, it has been a good year thus far for metals. Aluminium and zinc have been the laggards, hit by record aluminium output and sharply higher exports of refined zinc from China . Net exports of refined zinc in 1Q07 were 0.126Mt vs net imports of 0.041Mt in 1Q06 – a big turnaround.

Illusion of a continuing bull market for metals

Chart 3 may surprise you. The chart shows the percentage movement in commodity prices since last May. What it shows is that a year on, of the 10 metals, only four have managed to recapture their previous price peaks. All the precious metals remain in negative territory. In addition, despite copper’s handsome 50%-plus increase since its February low of US$2.40/lb, it remains 12% below its May 2006 record high of US$4/lb.

As far as the LME is concerned, nickel, lead and tin are its minor contracts in terms of turnover and LME inventory. However, these three metals have low value inventories, with the nickel inventory worth just US$230m, tin US$114m and lead a paltry US$90m. Aluminium, which accounts for 53% of the inventory by value, is worth US$2.5bn, and copper is at US$1.15bn. Total inventory is worth just US$4.7bn against LME turnover in 2006 exceeding US$3trn.

Much has changed a year on

We have been surprised by the strength in industrial metal prices during the opening months of the year. The savage January-February price sell-off when price were going our way has been comfortably reversed. Pivotal to this turnaround was the return of Chinese buying for copper. Beginning in December, net imports of refined copper in 1Q07 were 0.483Mt, 135% higher than in 1Q06. This buying, which has overwhelmed the copper market surplus and drained LME inventory, has helped drive copper up more than 50% from its US$2.40/lb low in February. We expect Chinese buying to moderate sharply in 2H07.

Nickel too played its part, with LME inventory remaining critically low at around the 5,000-tonne marker to support global demand of around 1.45Mt. However, we still expect the nickel price to halve in the year ahead. Triggers could well be the Russian port of Dudinka thaw in June allowing the release of Russian nickel, stainless steel cutbacks in the months ahead (eg, Outokumpu), increased Philippine and Indonesian low-grade nickel laterite ore displacing as much as 0.100Mt of nickel units into China, and the move towards nickel-free chrome-based stainless steel.

In the case of aluminium, record Chinese output has been augmented by increased production in the Middle East and North America . Global output has hit record levels and 1Q07 output reported by the International Aluminium Institute was at 8.866Mt, up 12% yoy. Of the 0.946Mt of additional metal produced, China accounted for 85%, or 0.800Mt. Trade magazines talk of huge stocks of aluminium building within China , with exports being discouraged by the export tax; hence the switch to exports of aluminium products that still qualify for a tax rebate. Zinc was the other surprise. For the past five months, China has been a net exporter of zinc to the tune of 0.202Mt. Indeed, in just 1Q07, China exported 0.126Mt vs just 0.007Mt for all of 2006. We expect this export trend to become more onerous considering that zinc concentrate imports in March at 0.156Mt were up 227% yoy and the highest on record. This will be converted to metal.

Industrial metals enter the summer months at record levels

Chart 5 shows the ABN AMRO base metal price index which has risen 530% since October 2001, with this boom now in its sixth year. We expect to see 3Q seasonal demand weakness take its toll upon the metal price momentum. At a time of rising supply, inventory erosion should cease and begin to pressure prices. We have comfortable global market surpluses in aluminium, copper and zinc for 2007, and these are the metals to watch for demonstrable evidence that the good times are finally nearing an end. Nickel will likely remain buoyed by the supply deficit, but each day that passes brings us closer to the day when we will switch on our screens and see the news that the nickel bubble has finally burst.

Precious metals, our top 2007 commodity picks, back in the frame

The week of 14-18 May is Platinum Week in London (watch platinum plays such as Anglo American, Lonmin, Norilsk , Zimplats and Aquarius Platinum), Johnson Matthey will publish its key review of the platinum group metals. These metals have been buoyed by the rash of exchange-traded commodity products recently issued. These physically backed products will likely quarantine already-tight platinum supplies. The market will be keen to see what Matthey has to say about diesel penetration into the US and its impact upon vehicle auto catalyst demand as well as the impact of higher prices upon jewellery offtake.