The Hindu Business Line : Expert sees bullish outlook for base metals

Strong fundamentals
China is likely to account for over 30 per cent of world demand by 2010
Inventories are at low levels
Investment fund flows are causing price spikes

Mumbai , March 21

We are in the midst of a prolonged bull market in base metals that is driven by acceleration in demand growth (mainly due to China), a delayed supply response and more recently increased inflow of investment funds into underlying commodities," according to Mr Adam Rowley of Macquarie Bank Ltd.

Speaking at a base metals summit here recently, the expert argued that a substantial slowdown/downturn in demand growth (driven by weaker economic growth), a strong supply response (which of course looks less and less likely) or a slowdown/reversal of fund flow can potentially end the bull market. This is only the fourth major bull market for the metals in the past 40 years; and in terms of scale, it is similar to the late 1980s bull market.

Both demand side and supply side factors are fundamental drivers of the market.

China's voracious appetite for main base metals may be gauged from the fact that the country's metals demand accounted for 20-30 percent of world metals demand in 2005, up from 7-10 per cent in 1993.

"Even allowing for a slowdown from current growth rates, China is likely to account for over 30 per cent of world demand by 2010," Mr Rowley asserted.

On the supply side, production has failed to arrive in time. For example, copper mine production was over nine lakhtonnes lower than expected last year due to lower ore grades, higher molybdenum production, strikes, earthquakes, floods etc.

Stating that copper provided a good example of accelerating demand and delayed supply, the expert pointed out, during 2000-2002, weak demand and over-supply prompted production cuts; but in 2003-2004 there was very strong growth in demand with inadequate response from supplies leading to a massive deficit. In 2005, slower economic growth and consumer de-stocking caused demand slowdown; but supply did not still quite catch up.

In 2006, however, supply is expected to catch up with demand, but only just.

Higher fund flows

Non-fundamental factors have assumed significance of late. Investment fund flows are causing price spikes.

Around $80 billion are estimated to be invested in commodity index funds at the end of 2005, up from around $55 billion at the end of 2004 and less than $30 billion at end-2003.

Industrial metals have attracted anything between 7 per cent and 20 per cent of the total investment funds.

It is predicted that by the end of 2006, the fund size will grow to $110-120 billion.

Talking about outlook, Mr Rowley said the economic indicators were looking strong, while the raw material markets were extremely tight - for example alumina and zinc concentrates. In addition, inventories were low and in some cases, should go much lower. For example, copper inventories have been at critically low levels for the past year, while zinc inventories will be at their lowest levels ever by the end of the year.

There are also cost pressures. Aluminium costs are up by $300 a tonne in past two years because of increasing in smelting costs as well as energy price impact continuing to feed through.

Summarising base metals supply/demand situation, Mr. Rowley asserted that demand growth would accelerate in 2006 after slowdown of 2005; that in copper supplies are responding, but just enough; that production growth in aluminium closely matches demand growth; that zinc deficit is growing due to lack of supply response; that nickel was in over-supply in 2005, but back into balance in 2006 and 2007.

Aluminium, copper, zinc and lead prices are all expected to be much higher in 2006 than in 2005. In 2007, prices are expected to be generally lower than in 2006; but if supply fails to arrive as planned, there is the risk of prices moving up.

While copper is briefly moving into oversupply next year, it is likely to tighten again later in the decade.

Zinc prices are likely to be higher in 2007 than in 2006, and risks for zinc remain on the upside.

In sum, prices for all the base metals are expected to remain above historical `normal' levels through to the end of the decade, according to the expert.