Natexis Commodity Markets Limited of London, England, a subsidiary of Natexis Banques Populaires released the following Base & Precious Metals Review including price forecasts for Gold, Silver, Aluminium, Copper, Lead, Nickel, Tin and Zinc.

Base Metals markets diverge...

      The phrase "base metal super cycle" tends to suggest that the base metal metals will all perform in a similar fashion. However this has not been the case in recent months. Copper prices have made new highs, while most other base metals have fallen by around 15%.
      One theme common to all markets is the turnaround in the value of the dollar. Although the twin deficits (trade and fiscal) remain a feature, the currency markets appear to have focused on the superior performance of the US economy compared to its peer group. The dollar performance against the euro has also been helped by the failure to ratify the EU constitution. We do not believe that the small revaluation of the Renminbi against the US Dollar will have a significant impact on the metals markets.

...as demand disappoints

      The demand conditions seen so far this year have certainly not been in the super cycle category. Initial statistics suggest either sluggish or negative growth so far this year with the data from ICSG suggesting that copper is one of the poorest performers. It is only the continued strong demand growth in China that has supported the market.
      In the downstream markets many of the indicators are showing sharp year-on-year declines. The semis producers are in the process of reporting their second quarter results. Among the first was the European aluminium manufacturer, SAPA. The company notes that its profiles operations in Europe were weaker than the corresponding period of the last year with volumes 4-5% down in the first half. We expect that many other semis producers will echo these comments when they release their results.

Base metals are not alone

      It is by no means just the base metals, with the notable exception of copper, that have come under pressure. Natexis Commodity Markets notes widespread weakness in the steel industry, which serves similar end-use markets to the base metals. Prices in the smaller alloying markets have also come under pressure. Detailed below are some recent declines experienced in these markets: Steel (HR coil) -35%, Molybdenum -22%, and Ferrovanadium -52%. At the other extreme is the oil market which has held onto its bull market gains. What this highlights is that the individual fundamentals are going to come more into play from now on compared to earlier in the bull market, when a herd instinct tended to operate.

Is demand weakness temporary?

      A key question facing the base metal producers is whether the demand weakness is a temporary response to last year's excess, or whether it is something more serious. At this stage many of the economic indicators are unclear. Although many of the industry-specific statistics are starting to show lower year-on-year declines, this partly reflects a lower base than an impending improvement in demand.
The bottom line is that Natexis Commodity Markets is expecting weak demand conditions to prevail until the fourth quarter. Demand should then rebound but will not return to the rate of expansion seen in 2004, when demand was above trend in all regions.

Are there still supply bottlenecks?

      The market temporarily ignored the supply tightness in the early summer as demand growth weakened. However the focus of the market is likely to return to the issue in Q4. For many markets, the raw material position will remain tight - notably aluminium, nickel and zinc. For copper, we expect the current sharp gains in mine output to filter through to similar advances in metal output, while for lead production growth seems to be outpacing demand growth.
      Funds: What is the next move? In our view even if you take a positive stance on the fundamentals, there will not be a huge amount of upside for most metals, particularly for the flagship copper contract, while the downside risk is massive. We got a flavour of the potential in the early part of summer. As the markets start to move into surplus we might begin to see some more aggressive trading from the short-side as well as long liquidation. If we are correct that Q2 will prove to be the peak for most metals, funds may soon begin to exert a bearish influence.
      Aluminium: Prices have bounced back from the recent low of $1,691/tonne as the focus switched from poor demand to the potential for lower supply via reduced Chinese exports and power-related cuts. At the time of going to press in late July, there had been no formal announcements concerning changes to tolling arrangements in China. However the market priced in rumours that toll traders will have to pay higher taxes that may render the business uneconomic. Therefore lower Chinese exports may help to keep the market in deficit. The weak price performance so far this year has caused us to reduce our price forecast for 2005 to $1,810/tonne from $1,900/tonne in our April report. Our projection for 2006 is unchanged at $1,750/tonne.
      Copper: Low inventories and a myriad of supply disruptions have pushed copper to new highs. With a number of strikes underway, further gains cannot be ruled out. However most of other factors - weak demand, sharply increased mine supply and associated high treatment charges, low premiums and the latest ICSG data, all suggest that copper is on the cusp of moving into over-supply. Even the bulls of the copper market would agree that current inflated prices are not sustainable. Once a surplus develops there is significant downside. Prices would have to fall a long way to bring about any supply response. We forecast a 27% fall in the average copper price next year to $2,300/tonne from $3,150/tonne in 2005.
      Lead: Recent inventory trends suggest that the lead market has moved into surplus with LME stocks having doubled. This has already caused a 20% reduction in the price. Although prices may rebound after this sharp correction, our analysis of the market suggests more sustained pressure in 2006 as the surplus increases. Natexis Commodity Markets forecasts an average annual price of $725/tonne in 2006.
      Nickel: The nickel market is having to cope with a sharp fall in demand from its largest market - stainless steel. This trend looks set to continue over the next few months as most of the mills have only recently implemented cuts, which will remain in place over the summer. Anecdotal evidence suggests that the physical market is out of kilter with the still high LME quote. Although we have raised our price forecasts for 2005 to $14,000/tonne, we retain our cautious projection of $9,500/tonne for 2006.
      Tin: In the section on the tin market we analyze the higher levels of informal output. Despite this (and lower consumption), tin inventories on the LME remain at critically low levels. Given a likely revival in demand and the dramatic change in China's trade position we retain our relatively bullish stance towards the tin market. It is the only metal where we are forecasting higher prices in 2006 ($9,000/tonne) than in 2005 ($8,000/tonne).
      Zinc: Zinc's relatively high inventory position left the market vulnerable when demand growth disappeared in the second quarter. Now however, the focus of the market is returning to the concentrate shortage - witness the low treatment charges and the immediate impact of the strike at Tara (now resolved) on Boliden's smelters. With Teck Cominco seemingly adamant that Lennard Shelf will not be brought back on line in the near future, zinc should remain in deficit. The high overall stocks levels will, however, still put a cap on price rallies. We forecast that the average price will peak at $1,275/tonne in 2005 followed by $1,150/tonne in 2006.

Gold Outlook

      Having twice failed to break through the $450 mark so far this year, fears are beginning to grow that we are approaching the end of the overall bull market for gold. To a degree, this failure stemmed from dollar strength, or perhaps more accurately euro weakness in response to a rejected EU constitution.
      Sentiment could turn however should investors react negatively to the physical demand situation that seems to be emerging at present. Back in May this year when the price dipped below $420, strong physical off take materialised this proved critical in preventing the price correction becoming a rout as many investors seemed content to take profits rather than actively short gold. However, on the current price correction, the rebound in physical demand does not seem as strong as before.
      A final slightly bearish factor to consider is that producer de-hedging is unlikely to provide the scale of support to the market that it did last year. Recent months saw a pick up from the very low levels seen at the beginning of 2005 and we could see a further increase in such levels for the second half, say to 70-80 tonnes a quarter or possibly higher. This, however, could well remain notably below the 100 or so tonnes a quarter on average seen last year and current expectations are for slightly lower de-hedging in 2006.
      In conclusion, we could see some further modest upside to the price from ongoing investor interest but this could easily fade towards the end of the year as more disappointed longs take profits. With little else in the pipeline to drive the price higher, a slide could get underway but its scale is likely to prove modest given the absence of active pressures. Firstly, official sector selling for the moment is quite restrained, scrap volumes are subdued and we could see a stronger physical demand response on any price dips.
      As a result, an average of $430 for the full year is forecast (in comparison to an average for the first half of just over $427). Looking to 2006, the average price might well slide to around the $400 mark, largely as investor interest continues to wither and de-hedging fades further.

Silver Outlook

      Over the first half of the year, the silver market looks to have found it difficult to sustain levels over $7.50, which some fear could presage a more severe price correction in the coming months. However, we are not expecting to see a speculator-led price slump for the moment since the market is not under great pressure from the official sector. In 2004, selling by the Chinese fell notably but this was partly compensated by decent volumes from Russia. However, this year Chinese volumes look to remain subdued and to date there are few signs of sizeable amounts from Russian sources.
      The other principal sources of supply, namely mine output, producer hedging and scrap, are also not deemed likely to put any undue pressure on the market in the coming months.
      As regards physical demand, industrial off take (for example from the construction and electronics industries) is said to remain strong on the back of still healthy growth in global industrial production, particularly in East Asia. Any growth here, however, should be broadly matched by the ongoing slump in photographic off take due to digital inroads.
      A factor to watch here would be any evidence of a technology jump in the developing world from no camera to digital without an in between conventional camera. This happened in telecommunications as consumers with no phone skipped the land line and went straight to mobile phones but, to date, the incidence of this in photography appears more limited.
      In the West, recent growth in jewellery consumption is slowing (for example in the United States) or even reversing (the case for Italy). As for India, bullion import data points to some demand growth in the first half and we are expecting a not dissimilar performance for the second half of 2005.
      To summarise, we could see some further investor-led upside this year for the price, but with broadly neutral physical markets, a retreat as stale longs exit the market may well occur. This should bring about a price average for 2005 of the order of $7.00, versus a first half price average of $7.06. As we move forward, we could see a more concerted wave of disinvestment. If as feared, the investor bail out is strong, the narrow silver market could see a price average of just $5.75 for the year as a whole.
      Source: Natexis Commodity Markets Metals Review published by Natexis Commodity Markets Limited, Capital House, 85 King William Street, London EC4N 7BL, United Kingdom. Tel: +44 (0)20 7220 5107. Natexis Commodity Markets is a ring-dealer member of the London Metal Exchange and an associate of the London Bullion Market Association and the London Platinum and Palladium Market. www.natexiscm.com.