LONDON, Feb. 9 -- A month-long rally in nickel prices risks running out of steam as import demand from top consumer China eases due to a well supplied market and a lack of appetite in Europe saps demand for stainless steel.
Benchmark nickel on the London Metal Exchange (LME) have risen more than 17 percent since the beginning of the year, partly due to strong buying from China at the end of 2011 and short covering by funds.
It traded at a five-month high at $22,150 a tonne on Wednesday, but analysts warned Chinese buyers could stay away from the market due to rising prices and an adequately stocked local market, leaving nickel prices vulnerable to a correction.
Rising prices are also likely to push Chinese consumers to turn instead to cheaper domestic nickel pig iron (NPI), a lower grade nickel used to make stainless steel, the production of which tends to pick up pace once nickel prices move above $20,000 a tonne. ID:nL6E7NF3E7]
"Today's nickel price is a good environment again for the NPI (nickel pig iron) producers and that means that the Chinese... will probably not import more scrap so there will be temporary scrap oversupply in North America and Europe," said Markus Moll, managing director at consultancy Steel and Metal Market Research (SMR).
"Scrap availability has improved. There is sufficient scrap supply and if nickel holds over $20,000 as it is at the moment, that very quickly you will see more NPI production."
Nickel's rally from the beginning of January coincided with a drop in LME open interest, suggesting short covering, <0#MNI-FUT-OI> and highlights the disconnection between the futures prices and the weaker fundamentals in the physical market.
A softer outlook for demand prompted money managers to build short positions in the base metals complex at the end of last year, but strong Chinese import numbers at the end of the year sparked a short covering rally within the base metals complex.
"Our feeling is that the nickel price now looks to have neared a peak as Chinese import demand eases and the risks of a correction in the short run are growing, despite a non-Chinese demand recovery," Macquarie analysts said in a note.
The weakening underlying fundamentals has begun to show in the physical market, where premiums for nickel have fallen.
Premiums for cut NI-RDM-CT and briquette NI-RDM-BRQ nickel in Rotterdam, paid over the LME cash price, were both quoted at around $250-300 a tonne, down from around $300-$325 in early January, while fullplate NI-RDM-FP was at $100 a tonne.
"There's a discount into the Chinese market so there's metal on the ground in China. So excess material flows into the European markets," a physical nickel trader said.
"There's a total disconnect. (The futures) market will run out of steam soon and we'll soon be back at $18,000," the physical trader said.
With the debt crisis in Europe keeping demand for physical nickel soft in Europe, the metal's medium-term prospects look bleak.
"It all depends on whether the Greece debt issue gets sorted out and if confidence returns. It's so volatile and will continue being so for the first half of the year at least," a second physical trader said.
MORE PAIN TO COME
Although some bright spots have emerged, with global stainless steel production expected to rise this quarter and signs of restocking by stainless steel mills after destocking in 2011, it may not be enough to stem a slide in prices.
"This may well delay a correction but, only temporarily in our view. We think that the current supply demand balance can support nickel prices in the $18-20,000/tonnes range for this year... but not sustainably above $20,000/tonnes," Macquarie analysts said.
With the second half of the year traditionally seen as a slow period for stainless steel demand, nickel prices could slump further into the end of the year.
"There is a ramp-up of stainless production in the first quarter and second, but once we get into the summer, the market will not be strong enough to support a high stainless steel production in Europe and North America," Moll said.
"So we could see the first half better with relatively high nickel prices, then over the summer things cool down and after the summer the market is not coming back as people had expected and for the rest of the year things just look softer."