Doubts over the duration of base metals bounce

By Chris Flood in London Published: April 22 2009 03:00 | Last updated: April 22 2009 03:00 Spring appears to have sprung in the base metals sector as a powerful rally has lifted prices for copper, lead, nickel and tin sharply higher, leaving investors who had bet that weaker economic growth would push prices lower shouldering big losses. The strength of the rally - copper is more than 40 per cent more expensive now than at the beginning of the year, for example - has not only caught some traders by surprise: the mining industry is also astonished as it comes in the face of collapsing industrial output and construction activity worldwide. Some analysts are warning that the rally - which has lifted all metals barring aluminium and nickel - has run too far too fast. "This current base metals price rally looks to have little in the way of fundamental support," says David Wilson, a metals analyst at Société Générale in London. Since the beginning of the year, copper has rallied 46 per cent; lead is up 46.5 per cent; zinc has risen almost 21 per cent while tin is 12.7 per cent higher. Only aluminium and nickel, down 5.4 per cent and 0.8 per cent respectively, have posted losses. "The bulls have bolted too early," Mr Wilson adds, echoing a view widely held among traders, analysts and mining executives. Indeed prices have fallen about 10 per cent in the past fewdays, as concerns about the outlook for the global economy have intensified again. The gains are all the more surprising when taking into account that some of the largest consumers of the metals - construction in the case of copper and zinc or cars sales in the case of lead because of its use in batteries - are among the hardest hit by the recession. The surge gained further momentum recently after prices broke above their 100-day moving average, an important technical signal for short-term traders. Most market participants agree that the rally appears supported by a mix of temporary factors, particularly Chinese buying of copper and other metals for its strategic inventories in January and February; a lack of scrap supplies as current prices are not attracting enough recycling; and some investors closing previous bets on falling prices, a trade known as short covering. Some believe that as those factors vanish, prices could fall sharply. Industry executives familiar with Beijing's State Reserve Bureau say China bought about 300,000 tonnes of copper for its strategic reserve in the first two months of the year, when the price of the red metal traded consistently below $3,500 a tonne. But the executives add that the SRB rejected offers to buy more stocks once copper prices surged above $3,500-$4,000 last month. Copper peaked at $4,925 a tonne last week, trading yesterday at just below $4,500 a tonne. The lack of scrap supplies appears to be a far more important factor. Some traders and executives suggest that the world has lost up to 5 per cent of its metal supplies because low prices did not attract enough scrap flows. The combination of both factors has created a sense of tightening markets in China, particularly for copper. Prices in Shanghai for the red metal, but also for aluminium and zinc, have been trading at a premium to London Metal Exchange, helping to draw supplies into the country and bringing down LME inventories. But as base metals prices moved higher, China stopped buying for its strategic reserve. At the same time, fresh supplies of scrap have arrived, damping the market. Whether prices can be sustained, therefore, will depend on demand. But analysts and executives say consumption is unlikely to support prices at their current levels. Following last week's gloomy warning from the International Monetary Fund that the global economy is likely to face an unusually severe and long lasting recession, Johan Bergtheil, of Citigroup, says conditions for the base metals sector still look "dire". "Inventories have yet to show signs of a persistent downtrend and demand in the developed world is extremely poor," he says. Stocks of base metals stored in LME warehouses have risen almost 1.6m tonnes this year, taking the total to4.7m tonnes. The rise in aluminium stocks at more than 1.3m tonnes accounts for the vast majority of that increase but all the base metals have seen substantial inventory accumulation in 2009. Until stocks drop on a continuous basis, something analysts think unlikely without a recovery in demand, metals prices are going to be at the mercy of strategic stockpiling and the vagaries of scrap supplies. Additional reporting by Javier Blas in London