Where are we in the supercycle?

Implications: Base metal prices have come under pressure on the back of weak demand, not only in in the US, but also increasingly in Europe and Japan.  This threatens to overshadow, in the short-term, the still strong demand growth from China.   Nickel and zinc prices have already fallen by 50% from their bull market peaks.  Is this a harbinger of things to come for the base metals sector?

Analysis:  

Where are we in the supercycle?

The base metals cycle is looking slightly less “super” than earlier this year. For example, both nickel and zinc prices are more than 50% below their bull market peaks. Such volatility seems inevitable given the exceptionally inflated base. Trends in these markets reinforce how prices can fall dramatically on only a modest deterioration in the fundamentals; this has particularly been the case for the zinc market.

A constant stream of bullish news is required to sustain the elevated price levels, when they are so far in excess of the marginal cost of production. Since the metals industry gathered in London for LME Week in early October, this news stream has not only dried up but has also turned negative. GFMS Metals Consulting’s base metal index now stands at around 305 compared to the October high of close to 400.

Long-term the fundamentals are positive

Although many aspects of the supercycle remain relevant – delays in the commissioning of new capacity; increasing costs associated with bringing new projects on line, high utilization rates at mines and smelters, an increased number of labour disputes, the rise in resource nationalism, strong metals-intensive economic growth in China and India, a declining dollar and on-going interest from the investment community with a long side bias – in the short-term these factors are likely to continue to take a back seat.

Weak demand will be carried over to 2008

The base metals industry is increasingly reliant on strong demand from China to support the market. This will continue to be the case for the rest of the year (and into 2008) as demand weakens in most of the other markets. The latest key economic indicators – almost without exception – are pointing down. In addition, the anecdotal evidence that we receive also points to a weak demand environment, and importantly it is no longer restricted to the US construction sector. For example, the rebound in demand in the Euro-zone, after the summer slowdown, has yet to materialise. Offtake is also weak in Japan.

Trends in physical premiums tend to reinforce the lacklustre demand outlook. The decline in copper premiums has been the most extreme. In the US, they have more than halved from the early summer peaks to below $100/tonne. This reflects both the resolution of earlier supply disruptions such as at CCR, as well as the weak demand conditions. Premiums in both Europe and Asia are also under pressure, but the decline is from a lower base. In other metals, we are also generally seeing lower premiums.

With LME inventories continuing to trend higher, and with a supply response unlikely in the short-term, there is the potential for the recent price weakness within the the base metals sector to be extended into 2008.