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SMM Exclusive: Analysis of Large Price Corrections in China Base Metals Market
Jan 28,2010 18:54CST
smm insight

SHANGHAI, Jan. 28 (Non-ferrous Metal Market Research Department, SMM) -- The previous bullish sentiment for the global economy has been overshadowed by a string of unfavorable news. The Chinese Central Bank's moves to raise the yield of three-month bills and deposit requirement reserve ratio triggered market concerns of waning demand in China. The Central Government's measures to squeeze the real estate bubble and stabilize the property prices also exerted negative impact on the base metals markets.

Meanwhile, other major economies also reported unfavorable news. On January 27th, the US Federal Reserve announced to keep the low interest rate unchanged, and reiterated the plan of completing its mortgage-bakced securities purchase by the end of March, which helped the US dollar strengthen, and weighing on base metals markets as a result. SMM believes that the negative impact from the announcement of the plan will continue to negatively affect the commodity market for a while, since the news recently released by US government is mixed, and particular attention should be paid to it.

Standard & Poor's Ratings Services said on January 26th that it revised the outlook on Japan's sovereign long-term credit rating to negative from stable, and saying it would issue a downgrade to AA- "if economic data remain weak and measures to boost medium-term growth are not forthcoming, given the country's high government debt burden and its weak demographic profile."

The European economy will remain in recession for a long term, since Greece has experienced fiscal crisis.

In general, it seems the pessimistic sentiment toward market outlook dominates the global economy, and it will take a long time boost investor confidence, and metals prices will not likely report improvement in the short term.

According to SMM sources, China's downstream demand failed to improve since 4Q 2009, so base metals prices were mainly driven up gradually by hot money, but not by market fundamentals, from mid-November 2009 given lackluster transactions.

Therefore, long position showed weak performance when pessimistic sentiment weighed on previous soaring prices. Base metal prices have struggled for three weeks since January 7th while prices didn't fall back to the levels at mid-November of 2009.

Struggles between short positions and long positions came to an end thoroughly yesterday when the news was certified that additional 0.5 percentage points of reserve requirement ratio should be applied to four domestic banks including Industrial and Commercial Bank of China, Bank of China, China Citic Bank and China Everbright Bank. Triggered by this news, global financial market was in a panic and benchmark of Shanghai Composite Index fell below 3000 points. Affected by this panic sentiment, base metal prices in LME market and SHFE markets both slumped, almost falling to the levels on December 20th, 2009.

Pessimistic sentiment will further expand in base metal market in the short run, and base metal prices may have difficulty in climbing up in the short run. However, whether prices of base metals can stand firm or not, still lies in the support from fundamentals.
Copper market fundamentals are relatively strong compared with other base metals. Despite of high inventories and reducing power grid investment, the Central Government is continuing to step up efforts to promote the development of urbanization. Moreover, imports of scrap copper remain low, resulting in insufficient supply of raw materials. Hence, buying interest is expected to emerge when copper prices fall. Copper prices will likely rebound firstly among all base metals, given stock replenishment from falling copper prices before the arrival of Chinese New Year holiday. Based on market movements on Thursday, SHFE copper market represented moderate performance when other base metals plunged, with balanced long and short positions.
SMM believes the May-delivery copper contract prices on the SHFE market will unlikely drop below RMB 55,000/mt in the coming two weeks.

Aluminum prices fell at a slower pace compared with other base metals amid current economic environment. Approximately 35% of aluminum is used in construction industry, and aluminum market fundamentals were pessimistic, since real estate industry has been affected heavily by China's moves to curb lending. However, the freezing weather in north China resulted in electric power shortages in some regions. Meanwhile, Chinese government will accelerate industrial structure adjustment, reduce energy consumption, and protect environment in 2010, and the hike in electricity prices will be inevitable, which will help raise production costs at aluminum producers, but the strong optimistic sentiment in aluminum market will not likely appear again in the long term. In this context, SMM predicts aluminum prices will move narrowly, returning to price trends before November 2009.

SMM predicts SHFE 1005 aluminum contract will get support at RMB 16,000/mt in the coming two week, but selling prices of alumina declined gradually recently after large amounts of alumina arrived at ports, eroding its support for aluminum costs. In this context, SHFE aluminum prices may fluctuate for a long time.

Zinc prices experienced the largest decline among all base metals, with SHFE 1005 zinc contract prices falling to daily limits today. As speculative funds played a major role in pushing up zinc prices, with market fundamentals remaining weak, so zinc prices plunged with the withdrawal of long positions. Galvanization industry, as the major zinc downstream sector, was not in peak demand period currently. In addition, zinc products failed to flow into spot markets, but were stockpiled as bank pledge, and speculators preferred to invest in SHFE zinc market compared with other metals, and the reservoir capacity of SHFE zinc warehouse was limited. In this context, zinc prices were pushed up by speculative funds since November 2009, and also led base metals prices declines this time.

SMM predicts zinc prices will fall further in the near term, with SHFE 1005 zinc contract prices expected to fall below RMB 18,000/mt.

Domestic lead market fundamental is weak. Domestic lead prices have been weaker than LME lead prices since after October 2009, due to weak demand from lead-acid battery sector, with the spread between the two gradually expanding. SMM held a meeting in December to discuss the reason behind the depressed lead prices in China, and led the industry-wide and heated debate. To sum up, the capacity surplus, weak demand, and no consumption advantages of imported ores are mainly blamed for the sluggish domestic lead prices.

In this context, domestic lead prices dropped along with falling prices of other base metals. On Thursday, SMM lowered lead prices by RMB 400/mt to RMB 15,850/mt. falling below RMB 16,000/mt.

However, SMM believes domestic lead prices will find support, since domestic lead producers will keep prices firm at this price level in view of costs.

It is expected that prices of tin in the spot market will fluctuate narrowly, with prices of major brand tin at around RMB 138,000/mt and prices of unknown brand in the RMB 135,000 -136,000/mt range. Since there is no futures market for tin in China, tin prices suffered relatively less negative impact than other base metal prices. It is expected that any downward room for tin prices will be limited, and consumers may mainly adopt a wait-and-see attitude or make purchases on an as-needed basis. In addition, downstream semi-conductive industry may be highly focused in 2010 under the context that the government tops the agenda for the development of science and technology industries.

On January 27th, LME nickel prices opened at USD 18,050/mt and closed at 17,800/mt, testing the highest level at USD 18,175/mt and touching the lowest level at USD 17,737/mt, with daily decline of USD 220/mt. Nickel inventories increased by 1,116 mt to 163,704 mt on January 27th, setting a record high. Wait-and-see sentiment from stainless steel mills expanded as sales at stainless steel mills declined day by day and as nickel prices were constantly dropping. Tight supply of NPI gradually eased as stainless steel mill slowed purchasing pace and supply of goods increased in the market. Coke prices also declined. Prices in the Shanghai nickel market were relatively firm due to support of relatively tight supply of goods in the market recently as well as firm prices offered by Jinchuan Group. Traders kept offers firm at RMB 140,000/mt since Jinchuan Group made no changes in ex-works price. Today, LME nickel prices opened at USD 18,000/mt, and it is expected that nickel prices in domestic spot market will move in the RMB 139,000-140,500/mt range.

To contact the writer on the report: angelawang@smm.cn


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