LME MORNING – Metal sentiment turns buoyant, but downside risks remain

London 26/10/2010 - Base metals firmed on Tuesday morning on the LME after staging an exuberant rally in the previous session, with upbeat sentiment and improved risk appetite helping to shield the complex ahead of next week’s crucial Federal Reserve meeting.

“With the market long metals and short dollars there remains the risk of sharp corrections should today's data disappoint or ongoing failure by EUR/USD to conquer 1.4050 trigger a reversal in sentiment,” James Moore, research analyst at FastMarkets, said.  “However, the increasing likelihood of additional stimulus from the Fed continues to create negative dollar sentiment, which is supportive for further commodity gains with traders set to maintain their dip-buying mentality.”

Yesterday’s initial run higher in the dollar – which traded as weak as 1.41 against the euro - triggered a wave of buying in the metals complex on Monday, with copper hitting a 27-month high and lead and zinc both reaching 10-month highs. But while some floor traders are now targeting $9,000 for copper – and Goldman Sachs forecasts a price of $11,000 in the next 12 months - there are a number of factors which could challenge any lasting run higher. 

The failure of ETFs, for example, could weigh on prices over the medium-term, according to an analyst from Standard Chartered, who said on Monday, “Storage fees will create significant headwinds, which will drag down returns,” and that “these ETFs will be difficult to sell to investors, and therefore we do not expect them to be particularly successful as a simple investment tool.”

He added. “If they fail to take off, the markets will be disappointed.”

Additionally, Chinese demand for copper appears to be waning, as higher prices are now being passed on to end consumers and some demand destruction has occurred.  In the case of copper, the premiums being paid by Chinese importers on the LME price have fallen sharply recently. “After spot prices for copper on the Shanghai exchange surged to their highest level in 27 months, consumers are now holding back and are using up their stocks instead,” analysts from Commerzbank wrote on Tuesday. “Should demand momentum ease further, this could lead to falling prices.”

Moreover, many wonder how China will adapt its industrial base to currency appreciation.  “The Chinese seem to be in no hurry to buy copper, especially if you think the Rmb is going to increasingly strengthen against the dollar,” Ted Arnold of Ambrian wrote on Monday. 

Asian stocks fell on Tuesday off 28-month highs, and US stock index futures slipped in early trading as uncertainty took hold ahead of next week’s Federal Reserve policy meeting on November 1 - 2, and markets remain unclear as to the extent of “QE2” – if any – that they can expect.   

The macroeconomic data calendar is light on Tuesday, with consumer confidence expected at 15:00 BST, with economists expecting a reading of 49.0 for October.

IT'S THE SUPPLY, STUPID 

Base metals saw another positive inventory report on Tuesday, with investors firmly focused on supply constraints - particularly in copper and tin - where long-term shortage fears dominate.

“With LME Week still fresh in participants’ minds, ‘It’s the supply, stupid!’ seemed to sum up the bullish sentiment that was much in evidence,” Robin Bhar, analyst at Credit Agricole, said on Tuesday. “This was amply illustrated by last week’s news of the closure of China's third-largest lead and zinc smelter to comply with a provincial government pollution investigation.”

He added, “Onwards and upwards for prices in coming months looks the most likely trend although the path higher is unlikely to be smooth, with macro shocks along the lines of the China rate hike providing buying opportunities.” 

Copper traded down $47 at $8,471, after hitting $8,549 per tonne on Monday, a fresh 27-month high, and just below the all-time high of $8,940 hit back in July 2008.  Stocks are at their lowest since October 2009.

Aluminium traded up $6, at $2,380, after closing indicated at $2,372/2,374 on Monday.  According to research institute CRU, China’s largest aluminium producer, Aluminum Corp. of China, has shut capacity of 400,000 tonnes. This is about 10 percent of its total production capacity. In order to counter lower supply and a further sharp rise in prices, China is to sell 96,000 tonnes of aluminium from its state reserves at the beginning of November.

Lead traded at $2,575, down $10, and zinc traded at $2,587, up $22, after both advanced to new 10-month highs on Monday.   Zinc inventories have fallen on 17 of the past 18 days.

Nickel traded at $23,315, down $285 from yesterday’s session, while inventories increased for the sixth successive day - up a net 486 tonnes at 127,254 tonnes, the highest since June.  On Monday, Societe Generale said the nickel market deficit should be around 67,000 tonnes this year due to double-digit consumption growth before it slips back to balance in 2011 as demand growth slows to seven percent while supply rises nine percent.

Tin was down $300 at $26,600, while the price of steel billet continues to rise,  indicated at $495/502, the highest since September 15.  Steel inventories fell for the 23rd day in a row - the 1,560-tonne decline lowered the stockpile to 54,210 tonnes, a fresh low since July 26.

On Tuesday, Arcelor Mittal, the world’s largest steelmaker, announced that its third-quarter profit rose 48 percent, but warned that the rest of the year will be tough, with a forecast for lower prices and weak demand. 

In the minor metals, cobalt cancelled warrants rose for the second day in a row, up 14 tonnes to 47 tonnes. Cobalt was quoted at $37,000/39,250 and molybdenum at $31,000/37,450.

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