Price correction likely in metals

MUMBAI: The coming year could witness a significant correction in base metals like nickel, lead, zinc and tin that are still making new highs. According to Jon Bergtheil, vice-president, JP Morgan Securities, London, highly liquid commodities — oil, natural gas, gold, silver, platinum, copper and aluminium — all peaked in the second-quarter of ’06.

“Over the past few months, energy prices, both natural gas and crude, have fallen on average by 25%, natural gas even more. At one point, the gold price had fallen 20% , and now it’s down 17% from its May high of $720. The same goes for silver and platinum. The two leading base metals, aluminium and copper, are down by 15-20%.”

This has shifted the attention to nickel, lead and zinc which are still scaling new highs. “It worries us a little bit that lower liquidity commodities are the ones that are performing. If you look at the value of consumption on average, in nickel, lead and zinc, it is about a quarter of the size of the copper and aluminium markets. And all the falls have occurred in the higher liquidity commodities,” Mr Bergtheil said.

\This has given rise to a problem of sorts. All the funds, some having burnt their fingers through wrong bets in the natural gas market, are now shifting their focus to the so-called lesser liquidity commodities.

He pointed out that the fundamentals for nickel, lead, zinc and tin are very good as their inventories are very low. He, however, said that even while zinc rose as much as 27% in a month (October), it probably deserved to go up by 10%.

“So I would think it to be some extra bit of froth on the top,” he said, adding that while they deserve to have gone up, the money chasing after them is huge, and would require some caution, given the accident that took place in natural gas, where some funds collapsed after losing heavily on wrong bets.

“We don’t want to suddenly discover in the new year that one or two funds like that are facing problems in the base metals markets,” Mr Bergtheil sounded a note of caution.

He observed that judging by the activity, liquidity and trading volumes of these metals, it is a rational expectation that funds are active, although there would be no concrete proof of it.

Another concern voiced by him was that funds are not only buying paper exposure through derivatives but also buying in the physical market, which may be exacerbating the lower level of inventories on the LME. “Balancing the physical and paper exposure would be a reasonable thing to do, But there is only that much space in the physical market,” he said.

Taking the example of nickel he said that the surplus in ’07 would only be about $65m compared to a $150bn that has gone into the commodity markets in the past three years. This would afford very little leeway for exposure in the paper and physical market.

“These are very limited-availability metals with a lot of bond and equity money going into them. For instance, in copper you have to multiply the inventories in LME by 50,000 to get to the global equity market capitalisation. Elephant money chasing guinea pigs!”

Given the scenario, he quickly reassures that while no disaster is imminent, the threat of one is ever present, given the huge leverage that some of these funds are operating under. While Mr Bergtheil is of the view that the market will get into a bear cycle anytime soon, he does not completely dismiss the idea.

The prices that the high liquidity metals have fallen to are at least 50% above where they started this bull market, he said. “In spite of the huge demand coming from the emerging market countries we will still have cycles. What we believe is that the trough levels we fall to in these cycles will be deeper each time,” he added.