Bullion, Energy & Base Metals

Transcription

1 Bullion, Energy & Base Metals FORECAST 2009

2 TABLE OF CONTENTS PRECIOUS METALS... 2 GOLD... 2 SILVER ENERGY CRUDE OIL BASE METALS ALUMINIUM COPPER LEAD NICKEL ZINC SELECT AND CLICK ON SPECIFIC COMMODITY FOR DIRECT NAVIGATION P a g e 1

3 PRECIOUS METALS GOLD Historic highs and yearly lows were the order of the day for the yellow metal in The volatility was truly phenomenal as a series of reasons impacted the price movement. The highlights of gold as an inflation hedge, an alternative asset, and a safe haven received its due importance during the year. Bullion prices remained buoyant during the first half of the year, although it was in a corrective mode thereon. The bailouts, the collapsing financial markets, and the declining dollar proved supportive for the uptrend in gold. Nevertheless, the increase in prices took its toll on jewelry demand as it constitutes over half of the total gold demand. Figure 1: Trend in Gold price, dollar index and crude oil price For the full-year 2008, we saw the bulls dominating the bears as gold prices recorded a gain of 5.80% Y/Y. The financial crisis, which originated in the US in 2007, started showing its impact from early 2008, as stock markets crashed and the dollar started depreciating strongly against the majors. The U.S. Federal Reserve Bank (Fed) was in dilemma on whether to control rising inflation or reduce interest rates (to boost growth and liquidity in the region). The speculative and investment demand, which seemed to be never ending, took spot gold to its historic highs of $ a troy ounce, while the greenback was battered sharply to its life-time lows of $ against the euro. The Fed, which began slashing interest rates from 5.25% in September 2007, took its key target lending rate to 0.25% by the year-end, thus eroding the appeal of the dollar. The surge in gold prices was strongly supported by the crude oil prices, which rose relentlessly and peaked in July at $ a barrel. Higher commodity prices across the globe fuelled inflation in the world economy, thereby enhancing the appeal of the yellow metal as an inflationary hedge. Furthermore, bail out of Bear Stearns, state-owned investment firms, P a g e 2

4 Freddie Mac and Fannie Mae resulted in global financial uncertainty, attracting demand for gold as an uncertainty hedge. Figure 2: GDP growth in US, Euro-zone and China The tables turned thereafter as the slowdown in the US spilled over into Europe. With the European Central Bank (ECB) s interest rates running high, the downside risk to the economy increased significantly, and the euro plummeted southward. The US dollar moved to a low of $ per euro after disappointing economic numbers from the Euro-zone weakened the 16-nation currency. The contraction in economic growth coupled with stable interest rates were the major factors for the decline in the euro. The 16-nation currency declined sharply as it was now the turn of European companies to get bailed out. In addition, the poor performance of energy prices also triggered a lower movement in the bullion. Spot gold prices dropped to $ per troy ounce, the lowest since September The second half of 2008 witnessed the fallout of many large US financial firms as the credit crisis continued to take its toll. Lehman Brothers filed for bankruptcy and Merrill Lynch merged with Bank of America (BOA). The next in line was the bailout of American International Group (AIG), the largest US insurer, by the Federal Reserve, followed by JPMorgan Chase s bailout of Seattle-based Washington Mutual, which faced losses worth $19 billion due to bad mortgages. The fallout of some big names on Wall Street led the Federal Reserve to call in for a hefty bailout plan worth $700 billion. In addition, financial assistance was also provided in an effort to inject capital into the credit-deprived banks. Central banks across the world reduced their lending rates by not less than 200 basis points. The US, Europe and Japan simultaneously entered into a recession for the first time and global equity and commodity prices tumbled. Interestingly, the only asset which moved higher was the US dollar. P a g e 3

5 Figure 3: Movement in lending rates The rally in the US dollar was quite noteworthy, as the currency of any nation in such a situation should have depreciated. In a financial crisis, while bullion takes center-stage as a safe haven, the story in H208 was slightly different. After initially gaining on the back of a deepening financial rout, gold prices changed tracks later to trade low as it gave in to the rising US dollar. The financial crisis has shrunk liquidity, eroded investor confidence and downgraded most of the currencies. In this context the safe-haven status of the metal has taken a backseat as investors became apprehensive of the markets. The dollar was seen strengthening, not because of its own fundamentals, but due to varied factors. There was increase in dollar hoarding and flight of cash in such uncertain times as banks were reluctant to lend money and short-term borrowing rates spiked to yearly highs. For instance, the 3-month US dollar Libor moved to 4.75% when the Fed target rate was 1.50%. In addition, with other currencies losing sheen, the US dollar rose further despite the chaos raging in the US economy. Gold demand Demand for gold is broadly classified into jewelry fabrication, industrial application, government and central banks, and private investors. The demand is generally concentrated in the Indian subcontinent, Turkey, and the Middle Eastern nations. The rising prices generally reduce consumption in these pricesensitive markets. Over 50% of the demand comes from the jewelry sector while industrial & dental and investment contribute to the rest. In Q308, jewelry demand constituted 58% of the total gold demand, while the remaining two categories had a share of 9% and 33%, respectively. Compared to Q208, investment demand saw a significant rise, witnessing a growth of 58%, to 183 tonnes, in bar and coin retail investment alone, while ETFs and similar demand surged by 8%, to 150 tonnes. P a g e 4

6 Figure 4: Demand structure of gold Source: World Gold Council On a cumulative basis, until Q308, demand for jewelry showed a decline of 13.38%, to 1,658 tonnes, compared to 1,914 tonnes during the same period in Jewelry demand declined as India, the world s largest consumer, posted declining imports. Indian gold imports stood at 722 tonnes in 2007, whereas in 2008, until November, the imports stood at tonnes, representing purchases of only 63%. Huge volatility in prices was a major deterrent for demand in India, as it contributed to rising inflation and slowing economic growth. This phenomenon was observed in other countries as well. Meanwhile, demand from industrial applications of gold, too, fell as the sharp economic downturn worldwide had a negative impact on consumer activity in a number of markets. Total cumulative demand in 2008, until Q3, stood at 327 tonnes, reflecting a modest decline of 6.84%, compared to the same period last year. Declining industrial activity around the world coupled with higher gold prices reduced the demand for the yellow metal. Demand from dental, decorative and traditional jari uses was heavily affected by the sustained increase in gold prices. Figure 5: Trend in Jewellery, Industrial & Dental and Investment demand for gold Source: World Gold Council P a g e 5

7 Investment demand (bars, coins, retail, ETFs, etc.) for gold in 2008, until Q3, recorded handsome growth of around 30%, to 671 tonnes, driving prices to historic highs of $ a troy ounce. The investment demand can be measured by the flow of investments into ETFs and increase in the futures trade. The rise of ETF as a mode of investment in the gold market is evident from increase in fund holdings. In Q3, funds participation rose to a high of tonnes, which is more than Japan s holdings. This indicates that the appeal for the metal as a safe haven has been enhanced given the uncertain times. However, investment demand took a backseat as weakening European Union economic outlook combined with falling oil prices resulted in a strong appreciation in the US dollar, taking gold prices to $681 levels. With short-term borrowing costs surging higher and lending getting heavily affected, the dollar was being hoarded by major financial institutions, thus enhancing the demand and appeal of the currency as a safe haven. Figure 6: SPDR Gold ETF Funds Source: The total net long non-commercial and non-reportable positions, which provide a good proxy for investor sentiment, rose above 30 million ounces in January 2008, then dipping to 22 million ounces in June, and bouncing back to 30 million ounces in July, only to plunge to 14 million ounces in December. Meanwhile, commercial long positions surged to 15 million ounces in early September and fell to 7 million ounces by the year-end. The credit crisis, which started deepening in August-September, resulted in resumption of investor sentiment towards gold, as evident from the rising positions during the period. However, with the dollar gaining and gold prices moving in the range of $ levels, the investor confidence dropped as they preferred to stay in cash. In December, speculative positions recorded some increase, suggesting higher movement in prices in the short term. P a g e 6

8 Figure 7: CFTC net-long positions & the Gold price Gold supply More than 72% of the gold supply is contributed by mine production, followed by old scrap sales constituting 16% and official sector sales, 2%. Hence, mine production plays a predominant role in price determination. In the recent past, the power problems in South Africa have caused the nation to relinquish its position as the world s largest gold producer to China in 2007, when its annual output dropped to 270 tonnes compared to China s 280 tonnes. China has continued to produce more gold than South Africa in 2008, with H1 output reaching 134 tonnes, an increase of 5% year-on-year. Global mine production for Q3 08 is up by 2% compared to the same period in the previous year. Through the first three quarters, it totaled 1,790 tonnes, which is 2.87% below the same period year-on-year. Figure 8: Gold mine production Source: World Gold Council P a g e 7

9 The signatories to the second Central Bank Gold Agreement (CBGA) sold the lowest amount of gold during the year from September 27, 2007 to September 26, 2008, as the CBGA began in September WGC preliminary estimates put the total sales at tonnes compared to tonnes in the previous year. Figure 9: Gold supply and demand in tonnes Fundamental outlook Source: World Gold Council The US economic condition deteriorated with every passing month in 2008, with home sales and manufacturing activity falling to decade lows, unemployment at its highest levels in over 15 years, companies posting losses, automobile majors striving to survive and consumer confidence witnessing a record drop. Although economic stimulus plans by the new US government will help the dollar in the short term, the long-term outlook on the dollar remains bearish. Panic and fear among investors about the global financial markets is leading to uncertainty. This is likely to result in a slowdown in investment demand, which grew rapidly in Jan-Sep We see the rally in the US dollar and the weakness in gold short-lived, and investors are likely to look for better investing opportunities in their own respective markets. Once this happens, the US dollar would come down and gold would bounce back, in our view. Figure 10: GDP Forecasts by IMF Source: IMF P a g e 8

10 Growth forecasts globally have been revised downwards, with major developed nations expected to show negative growth. The IMF sees global growth slowing down from the projected 3.7% in 2008 to 2.2% in Advanced and emerging nations are expected to post a significant downturn in their economic activity. In such a scenario, the appeal of gold as an alternate asset class will take center-stage, and this may result in large purchases of the metal. However, demand from jewelry and the industrial sector may get hit due to lower consumer spending and weak industrial activity. Taking into consideration the effect of the economic stimulus packages, combined with the significant monetary and fiscal changes, we expect the dollar to gain support in the short term. The economic slowdown facing other nations will see the dollar moving higher. However, as debt explodes and economies come to a standstill, we expect investors to turn to gold as an alternate asset class, and, we believe, this will take gold towards and above its historic highs in the medium to long term. Clearly, uncertainty hedge and safe-haven demand are likely to support the higher movement in gold prices in As far as crude is concerned, it is expected to recover in H209 and is likely to provide support to gold prices. Technical review and outlook The year 2008 was quite eventful for gold as markets recorded historical highs at $1030 levels and managed to close in positive despite the erosion of value witnessed in both stocks and commodity markets across the globe. Markets carried forward the bullish momentum that was evident in the last few years taking prices to the historical highs in the month of March. However, the momentum was short lived as markets, which were long due for a good correction nose dived. The RSI (14 day) treading around 85 levels in monthly charts was an indication towards how overbought the market was. The psychological barrier at $1000 together with the already overbought market conditions ensured that prices didn t move any higher. The selling that ensued in the market pulled the prices drastically lower, making them test the then crucial support at $845 levels. Market staged a swift recovery from around $845 levels moving to $987 levels. But the bearish sentiment that still lingered in the market pushed the prices lower again as bears took hold of the market, taking them past another crucial support at $730, which was the previous swing high posted in the year 2006 and also the 38.2% retracement for the entire rally that started towards the end of 1999 till the recent high posted at $1030. The fall advanced towards the 50% retracement levels at $640. However, markets fell short of the target as prices bounced back from $680 levels and managed to move beyond the previous years close around $830 levels, and thus closed in positive on the whole. P a g e 9

11 The outlook however looks rather indecisive and slightly biased towards lower price action as the bearish strength seems to be gaining momentum. A close below $790 levels would augur well for the bearishness in the market and a close below $680, which is the recent swing low, would confirm the same taking prices to $640 and later to $540 levels. If we observe the previous major rally in gold, which occurred between the periods from 1969 to 1980, it can be noticed that market retraced more than 61.8% of the move. This has been the case with the rally from $410 levels to $730 levels also, with market retracing almost 61.8%. Going by this precedent and the recent bearish overtone prices may maintain the lower bias at least in the first half of 2009 with some possible consolidation towards the end of second half. The RSI (14) is in neutral territory and is trending lower in monthly charts, supporting a lower price action. The MACD, though above the 0 line is showing some bearish strength with the MACD line crossing the signal line from above. On the whole gold prices are likely to trade with a lower bias. However a close above $930 may turn the tables around. Figure 11: Spot gold Technical chart Click to go back to index page P a g e 10

12 SILVER Silver, being both a precious and industrial metal, has been the worst hit in the ongoing economic and financial crisis. In 2008, silver was seen moving more in tandem with other industrial metals as investors gave less importance to its characteristic as a precious metal. This is evident in that gold posted returns of 5.80% in 2008 while silver gave returns of %. In the initial half of the year, prices mirrored the gains in gold prices, rising to hit the yearly-high levels of $21.44 per troy ounce when gold prices hit record-high levels. The move was the outcome of the impinging financial crisis which enhanced the appeal of the metal as an alternative asset class. However, with economies slowing down in the latter half of 2008, the varied use of silver in the industrial arena took centre-stage. Industrial activity in the US fell to decade lows while other nations such as the European Union, China, Japan, etc., also recorded a sharp slowdown. Major global central banks were seen reducing their lending rates, given the liquidity crunch and the economic slowdown worldwide. Investors turned cautious about the widening credit crisis and markets recorded huge losses after a spate of bad news rocked the financial sector. In the given scenario, silver prices plunged to its 34-month lows of $8.40 a troy ounce as demand destruction, stemming from a global economic slowdown coupled with an appreciating US dollar, resulted in value erosion for the metal. Figure 12: Price movements in Gold and Silver The global financial crisis increased the demand for the US dollar as a safe bet. Rising overnight lending rates, banks reluctance to lend each other, and plummeting investor confidence all resulted in the hoarding of dollars, thereby leading to a sharp appreciation. The dollar rallied to an over two-year high level of $ against the euro, resulting in a major fall in commodity prices, including industrial metals. The US dollar holds an inverse relationship with silver; therefore, an appreciating US dollar dampens demand for silver as an alternative asset class. P a g e 11

13 Figure 13: Silver vs. Dollar Index Silver prices usually move in tandem with equity markets, as stock markets are used as a proxy for the current condition and future prospects of the economy. The correlation between silver and the US stock markets stood at 85% in Being an industrial metal, the correlation between silver and copper is also high at 89%. If calculated against the dollar index, then the correlation is about -93%. Figure 14: Silver vs. Copper vs. Dow Jones Index Demand-supply In the wake of the current global slowdown, the industrial demand for silver appears to have sapped. The varied uses of the metal in industrial applications are likely to be weighed down due to global economic slowdown concerns. The falling prices are the outcome of depleting demand and strengthening of the US dollar. With industrial applications accounting for more than 50% of the total fabrication demand, the slowdown will have serious repercussions on the metal use. Moreover, the invention of digital photography has already hurt demand from that sector. P a g e 12

14 Figure 15: Silver fabrication sector overview Source: Silver Institute Fabrication demand is forecasted to be around 1% higher year-on-year in 2008, broadly flat from 2007 levels as industrial demand slows down considerably. Although demand from industrial applications was predicted to be higher in 2008, it was far less in the last few months of Figure 16: Silver - Sources of demand Source: Silver Institute A substantial decline is now expected in 2009 given that the world economy would contract, electronics industries would face a downturn and consumers would spend less. Demand from the photography segment is expected to drop by about 11% in 2008 due to the impact of digital technology and reduced usage from consumer films. Jewelry and silverware demand is anticipated to have dropped due to lower income and spending patterns. However, in terms of substitutability, there have been some gains at the expense of higher gold prices. Coin demand has increased substantially in 2008, with full-year gains forecasted to increase by around 69%. P a g e 13

15 Figure 17: Silver Fabrication Demand (Sector wise) Source: Silver Institute Investment demand in early 2008 was robust, but with the dollar gaining against the majors combined with the liquidity crisis, the demand from this avenue fell. The total net long non-commercial and nonreportable positions, which provide a good proxy for investor sentiment, declined substantially from the levels recorded in early 2008 as prices plunged, affecting the investment demand. The net long noncommercial positions, which stood at million ounces in early February 2008, declined by over 54% to million ounces by the year-end. Figure 18: CFTC net-long positions & the Silver price Almost three-fourth of the world silver supply comes from mine production, while scrap (one-fifth) and government sales (one-twentieth) contribute to the rest of the supply. World silver supply is expected to decline by 4% in 2008 after recording an increase of 3.58% in The 2008 forecast has been provided by GFMS and the institute predicts modest growth in The institute, in its interim report, pointed out that world silver mine production is forecasted to be up moderately (<1%) in Mine output is expected to push towards 700 Moz in However, downside risk to output remains if base metals closures continue. Prior to the crash in silver/base metals prices, the output in 2009 was P a g e 14

16 expected to reach about 730 Moz. According to GFMS, scrap supply is expected to fall over 6% in 2008 due to continued reduction in the amount of silver recovered from photographic waste, the main source of recycled metal. The government sales, too, have dropped sharply in 2008, with Russia accounting for the bulk. Figure 19: Silver Mine & scrap supply Fundamental outlook Source: Silver Institute The financial crisis in developed nations has had its spill-over effect across the globe. Emerging nations such as China and India have slowed down significantly and industrial activity and consumer spending around the world have taken a hit. Weak industrial demand and falling prices of peers (base metals) is likely to weigh down on silver prices in the near term. The dollar, which should have actually declined in response to the poor economic performance from the US, has risen due to its trait as a safe haven asset. Figure 20: Trend in US and Euro-zone Industrial production activity Economic measures to revive the slumping economy combined with cash injection steps are likely to lend support to silver prices in the medium to long term. Closure of mines on base metals front is P a g e 15

17 expected to reduce the mine supply of silver as a byproduct. However, we expect it not to be positive for prices as demand plunges down. We expect supply to overwhelmingly exceed demand in 2009, given the significant industrial downturn across advanced and developing countries. This is likely to keep prices under pressure in the short term. For the medium to long term, we expect silver prices to gain support from the likely higher movement in gold prices. The economic measures will also prove positive for silver during the period. Technical review and outlook Silver prices crashed in 08, following gold prices after the initial surge higher. Markets traded on a firm note in the initial two months taking prices past the highs posted in the year 06. However, the bullish momentum was short lived as prices crumbled under the selling pressure put by the bears. The bulls though, posed a stiff resistance and took the prices higher once again. But the prevailing bearish sentiment, together with the fall in gold prices, which is usually tracked by silver traders, had its impact as prices eventually crashed. Markets found some respite near the crucial supports at $8.45, where some buying resurfaced and stabilized the prices. The outlook for silver prices continues to remain weak in the fiscal 09, with prices expected to breach $8.45 levels and move towards $6.5-$6 levels. The RSI (14) is treading in the neutral territory with a lower slant, indicating the possibility of further lower price action. MACD has just entered the negative territory suggesting that the bearish sentiment is far from complete and a good move lower is still pending. A close below $8.45 levels holds crucial for the bearishness to continue in the market. On the whole, moving forward we expect prices to remain weak with the probability of a close below $8.45 levels looking more likely at present. Figure 21: Spot Silver Technical Chart Click to go back to index page P a g e 16

18 ENERGY CRUDE OIL The year 2008 was truly phenomenal for crude oil prices. The unprecedented rally during the first half of the year reached the pinnacle in July with prices hitting $ per barrel an all-time high record. The record price was the outcome of geopolitical tensions, weakening US dollar and the unparallel inflow of investment into commodities. The year 2008 was rather eventful as it sustained volatility in prices. From production cuts to increasing supply threats to slumping economies and dwindling demand all these were factored in the price movement. Figure 22: Crude & Dollar movements The historic highs in the first half of 2008 can be strongly attributed to, among other things, Iran s standoff against the West and Israel in regard to the former s uranium enrichment program. Moreover, war games by Iran, testing long-range missiles, and the war-like situation between Russia and Georgia raised alarm in regard to Caspian crude supplies, creating uncertainty on the geopolitical front. The Nigerian military threats reduced the country s production levels and resulted in Angola taking over as the largest African producer. Moreover, the hurricane threats in the form of Dolly, Edouard, Fay, Gustav and Ike affected fuel production, adding to the spiraling prices. Prices spiked sharply after the US dollar reached a record low against the euro, giving rise to speculative investment demand. P a g e 17

19 Figure 23: CFTC net-long positions and the NYMEX crude price However, given the unprecedented rise in oil prices, the demand from major consuming nations took a backseat. Prices started falling as concerns of an economic crisis impinged on demand growth. With the US slipping towards a recession, the prospects of fuel demand reduced for the world s largest energy consumer. Thereafter, the spillover of the financial crisis into the European and Asian economies and the decline in industrial activity further lowered demand prospects for energy. It has been a free fall since then for crude oil prices and even production cuts by the Organization of Petroleum Exporting Countries (OPEC), the supplier of about 40% of the world s oil, could not stop prices from falling below $40/bbl. The drastic decline in prices has continued as developed economies moved into a recession while developing nations witnessed significant economic slowdown. The rallying dollar and the dwindling equity markets have kept the bears in full control. On the whole, prices fell by over $108 a barrel from their peak levels this year, prompting the OPEC to announce a further production cut of 2.2 million barrels a day, starting Oil demand According to the IMF, global economic growth is projected to be 2.2% in 2009 compared to 3.7% in With advanced and developing nations going through a significant slowdown in economic activity, demand for fuel is likely to reduce significantly. The Energy Information Administration (EIA), in its latest monthly bulletin (December 2008), forecasts that world oil consumption will decline by 800,000 bbl/d in 2009, after witnessing a largely unchanged consumption pattern in According to the institute, the total world oil consumption is expected to record a modest rebound in 2010, rising by 880,000 bbl/d from its year-ago levels, based on the assumption of an expected recovery in global economic growth. P a g e 18

20 Figure 24: Percentage growth in oil consumption region wise Source: EIA The sharp projected demand decline in Organization for Economic Cooperation and Development (OECD) countries is expected to be offset by the growth in non-oecd countries, especially China, the Middle East, and Latin America. If the world economy recovers sooner or is stronger than the EIA currently anticipates (estimated 0.6% for 2009), oil consumption could decline at a slower rate or potentially increase at a faster rate than expected. OPEC supply The OPEC decision to implement deeper production cuts is likely to lend support to prices in the medium to long term, once the economy starts showing a recovery. In a nutshell, OPEC s has decided to cut output by 4.2 million bbl/d to take the new overall production target (excluding Iraq) to million bbl/d. According to EIA, adherence to the announced cuts will be challenging, as several individual countries are motivated to maintain higher production levels to generate revenue needed to finance their government programs amid falling prices. The lack of transparency in the new agreement, highlighted by the failure to publicize individual country production cuts, is one indicator of the reluctance of countries to cut production consistent with the group s new overall production target. OPEC now plans to meet again on March 15, 2009 in Vienna to evaluate the effectiveness of its recent actions. The EIA projection shows that OPEC crude oil production (including Iraq) will fall by over 2 million bbl/d from 31.4 million bbl/d in September 2008 to 29.3 million bbl/d in the first quarter of Nevertheless, the capacity expansion in several OPEC nations is likely to increase the surplus production capacity to 4.0 million bbl/d in 2009 against the current 1-2 million bbl/d of surplus capacity. Moreover, adding to this surplus will be the lower demand prospects. P a g e 19

21 Figure 25: OPEC crude oil production (q/q) Non-OPEC supply Source: EIA A modest rise of 180,000 bbl/d is the projected non-opec supply by the EIA for The year 2008 saw a decline of 340,000 bbl/d in supplies due to project delays and supply disruptions. Supply growth in countries such as the United States, Brazil, and Azerbaijan is expected to more than compensate for the continued decline in many non-opec nations, particularly Mexico, the North Sea, and Russia. Figure 26: Non-OPEC crude oil production (q/q) Crude oil in the US Source: EIA Amidst soaring prices and weakening economy, the total petroleum product consumption fell by 5.7% in 2008 from the 2007 average. The summer driving season also posted increasing stocks, resulting in consumption declining by 3.3%. Distillate fuel also witnessed a slump of 5.3% despite the cold weather stated by EIA. For 2009, the total consumption in the US was projected to fall by nearly 400,000 bbl/d, or 2%, due to continued economic weakness. P a g e 20

22 Weak demand and lower offtake of the fuel has resulted in US crude oil stockpiles reaching its highest levels in over seven months. Crude oil inventories reported by the Department of Energy rose by 8.24% in Q408, while gasoline and distillates increased 15.84% and 10.69% respectively. Refinery operating margins improved substantially to 84.57% from Q3 levels of 72.27%. Figure 27: US DOE reported movement in oil stockpiles Fundamental outlook The price movement in 2009 will be driven by the impact of the global economic downturn, pointing towards declining oil consumption, with additional production capacity from both OPEC and non-opec nations boosting surplus production capacity. The actual OPEC production and the depth and duration of the economic downturn will be the major price determinant factors in The demand numbers will continue to be the most important price driver in 2009 as they resulted in a 55% price decline last year. Figure 28: World oil demand and supply pattern Source: EIA P a g e 21

23 The credit crisis has resulted in worldwide recessionary fears. With the liquidity crisis deepening further, the producers and processors are likely to get lesser access to funds. The inflow of money into commodities as an investment avenue is likely to take a backseat in the coming days. The US, China and India, which are crucial demand drivers for the fuel, are likely to slow down, hurting consumption levels drastically. Given the lower demand prospects in the coming years followed by lower growth forecasts for developed and developing economies, we expect crude prices to remain on the lower side. According to the International Energy Agency (IEA), the global oil demand in 2009 will grow to a downward-adjusted 86.3 mb/d. The 2009 forecast is based on the IMF assumption that the global economy will gradually recover from H209, and is slightly higher than the projected demand of 85.8 mb/d in As a result of this, the US Department of Energy reduced its forecast for oil prices by 15% to $43.25 per barrel. On the flip side, measures have been taken by various central governments to revive their respective economies, and this is likely to result in a short-term pullback in the market. The government support by way of bank debt guarantee, buying equity stakes in banks, and extending bailout packages is aimed at increasing the liquidity in the markets. Although these measures are aimed at easing the markets, an immediate revival cannot be guaranteed as the process will be time-consuming. The measures taken will provide relief to the markets in the short term, and initiate a step towards recovery. This might result in a lower-than-expected downturn in the world economy, limiting the downside risk to oil prices. In 2009, we expect crude prices to be range-bound, taking cues from the weakened fuel demand. Prices are likely to trade with a downside bias in H109 and may recover by the latter half of the year. Lower consumer spending and weak economic activity is likely to adversely impact the demand for fuel. In a nutshell, responding to the recent production cuts and measures taken by various central banks to revive economic activity, we expect crude oil prices to recover in the later half of the year. Technical review and outlook Crude oil prices witnessed one of the most volatile trading years in the last decade or so with prices posting the historical highs around $147 levels and subsequently falling more than $100 and closing in red. Prices opened on a weaker note registering a fall in Jan. However, that seemed only a slight aberration as prices started to march higher again taking them past the psychological barrier at $100. There was no looking back once this was breached and prices started to rally higher at an unprecedented pace, that too consistently. Prices peaked around $147 with markets already treading in overbought conditions without any correction. The selling that started as a mere correction gathered momentum of mammoth proportions taking prices well beyond the opening prices at $95.90 levels and P a g e 22

24 posting fresh lows at $38 levels, breaching the lows posted at $41.60 in Markets finally settled at $48.59 levels shedding nearly $50, when compared to the close in the year 07. The outlook for crude oil prices, though looking bleak, may take some good correction higher with prices testing $70-$80 levels in the near future. The fall from the tops at $147 levels has been more or less one sided with prices continuing the journey southwards without any major correction. As such markets are very much near oversold conditions in weekly and daily charts, while monthly and quarterly charts continue to show further scope for a fall. This only indicates there isn t any reversal signal yet in the markets, with the long term charts continuing to look bearish. Any move higher shall be considered as a correction until unless any clear reversal signal emerges from the market. RSI (14) is treading around 35 levels and is trending lower showing some more potential for lower price action. The MACD has just ventured into the negative territory in monthly charts indicating possibility of bearish price action. Though this doesn t in any way indicate a major fall, it sure points towards at least some consolidation in prices with some lower bias. On the whole we expect some pull back in prices initially and consolidation later, with prices expect to trade in the broad range of $80-$25 for most part of Figure 29: NYMEX Crude Technical chart Click to go back to index page P a g e 23

25 BASE METALS Investment demand, speculative demand and the depreciating dollar were the three main reasons that drove base metal prices higher in the first seven months of this year. These were over and above the growing consumption demand from emerging nations, resulting in prices testing new historical highs. Production costs moved higher and natural calamities reduced the availability of the metals. Global investors pumped money into commodities, without any exception, to safeguard their portfolio returns as other asset classes such as equities and currencies generated less returns. The labor strikes in the Latin American countries, power shortage in China, Africa and America and, above all, the spiraling crude oil prices, increased the value at which metals were readily available in the market. Moreover, major production disruptions due to strikes and production cuts added to the bull-run. Figure 30: Movement in metals and equity markets However, prices witnessed a complete reversal since early August, eroding the earlier gains as investors turned cautious about the widening credit crisis and the economic recession. Prices plunged to fresh multi-year lows on fears of a global recession and tumbling equity markets. Concerns about demand destruction coupled with an appreciating US dollar resulted in a steep fall in base metal prices. A series of bad news emanated from the US in September, erupting across world markets, as the US hurtled towards its worst financial crisis since the 1930s. The banks reluctance to lend money to each other created a worldwide liquidity crunch, raising short-term borrowing rates and adversely affecting investment sentiment. Concerns of more defaults and credit crises forced global central banks to reduce interest rates by more than 200 bps. The US government approved a $700-billion dollar package to buy stakes in banks and boost consumer confidence. Slowing economic growth rates around the world, including emerging nations like China and India, coupled with a liquidity crunch resulted in a wide sell-off in commodities.

26 Investors sold base metals and other commodities heavily to seek refuge in safer assets, such as gold and government securities. Inventories rose and spot demand weakened, dragging down prices deep into the negative territory. Chinese imports remained sluggish and industrial activity around the globe kept declining. In 2009, base metals are expected to trade with a downside bias with demand outlook remaining bleak. The advanced and emerging nations are expected to slow down significantly, and this may hurt demand for industrial metals. However, short-covering rallies and bargain hunting at lower levels will be seen in the market. In the first quarter, we maintain a downside view for base metals, and taking into consideration the output cuts and the economic stimulus plans by several countries, we expect prices to start gaining from the second-to-third quarter onwards. The Chinese government s $586-billion stimulus plan, primarily aimed at infrastructure and earthquake reconstruction in the Sichuan province, is likely to support metals prices in the medium to long term. Having discussed on broader terms, let us now look at metal-specific fundamentals, the causes and effects of several events, and the respective commodity price forecasts. P a g e 25

27 ALUMINIUM Aluminium, mainly used in transport and packaging industry, saw a sharp increase in the first half of Prices rose to record-highs of US$3, as reduced power supply and power cuts in major producing areas raised concerns of higher costs and lower supply. China was grappling with its sixthyear of power shortages, caused by economic growth that averaged more than 10% annually in the past five years. Insufficient coal supplies forced the closure of at least 2.5% of the country s coal-fired power plants, resulting in an increase in average electricity tariff by yuan a kilowatt per hour (kwh), or about 4.7 %, resulting in an increased input cost for power-deprived aluminium smelters. The rise in power costs because of the spurt in crude oil prices proved to be positive for aluminium prices as power accounts for nearly 35-40% of the total production cost of aluminium metal. The power problems affected a number of smelters around the globe leading to output cuts and increased prices. Figure 31: LME Aluminium vs. NYMEX Crude With China hosting the Olympics games, the country s government ordered the shutdown of major polluting industries to clean up the environment. In response, China s top-20 aluminum smelters, which account for 70% of the country s output, agreed to cut production by as much as 10%, or about 3% of the nation s output last year. They all decided to cut production by more than 350,000 metric tonnes on an annual basis as part of an agreement to reduce energy consumption and boost prices. Apart from production problems, the weakening US dollar and higher crude oil prices were the other major drivers of prices. A weak US dollar makes dollar-denominated assets cheaper for overseas buyers and the higher crude oil prices points towards increased energy and production costs. P a g e 26

28 Figure 32: LME Aluminium vs. Dollar Index Thereon, the story changed completely for the metal in the second half of Growing concerns of worldwide economic slowdown followed by a sharp decline in crude oil prices led to correction in prices to below $1,500 levels. Prices failed to take support from the 15% increase in exports tax by China, which the country imposed in order to increase the domestic supply and do away with the power shortage in the country. Huge build-up in stockpiles was another major reason for the fall in aluminium prices. Inventories in 2008 rose by a massive %, or 1.39 million tones, to take the headline figure to 2.33 million tonnes, the highest in fourteen years. Figure 33: LME Aluminium stocks vs. prices The rapid fall in prices took prices to near its production costs, resulting in production halts by major smelters. According to Macquarie Research (November 2008 issue), aluminium smelter costs in November was estimated at 13,088 yuan or around $1900 a tonne. For many smelters, it had become uneconomical to continue their operations in light of these lower prices and demand as well. P a g e 27

29 Alcoa idled its Rockdale smelter (capacity of 550,000 tonnes a year) in the US after cutting production by 120,000 tonnes in June. The company also announced a reduction of 350,000 tonnes of production in late 2008 from other operations around the world. The Russian Federation producer, Rusal, closed the Zalk smelter in the Republic of Ukraine (capacity of 265,000 tonnes a year) in late 2008 and the Romanian producer, Vimetco, announced a reduction in output by upto one-quarter of its 265,000- tonne capacity. A few of the other major Chinese smelters closures/plans are given in Table 1. Table 1: Aluminium smelters Closures / plan Company Country Closure/Plan Chalco China T Aostar Aluminium China Closing T Emei Aluminium China Closing less than a third Zhongfu China Has Shut 50,000 T, Delaying start up of T Zhongfu-subsidiary China Has halted building T Longquan Aluminum China Has shut T Yunnan Aluminium China Has shut less than 10% Weiqiao China No plan to shut Alcoa Various 1,000,000 T Rusal Ukraine 265,000 Vimetco Romania 66,000 Source: Reuters & ABARE. Demand-supply According to ABARE, world aluminium production is estimated to have increased by 3.85% in 2008, to million tonnes, which is much lower than the previous estimate of 40.9 million tones. That is because many producers cut output in the first half due to higher input costs and power problems, and later, in the second half, due to slump in demand and prices. The overall production in 2008 is expected to exceed supply by one million tonnes, with closing stocks surging to 3.99 million tonnes. In 2008, closing stocks stood at 5.4 weeks of world consumption, which is much higher than 4.12 weeks of consumption in P a g e 28

30 Figure 34: Aluminium - production & consumption Source: ABARE For 2009, production is forecasted to outpace consumption by a further one million tonnes, taking the total stocks to 5 million tonnes, or 6.67 weeks of global consumption. Production of the metal is expected to increase by 1.57% to million tonnes while consumption is anticipated to increase by 1.63% to million tonnes. Figure 35 & 36: US Vehicle sales & Construction spending Global consumption of aluminium saw an increase of 2.90% in 2008, with demand rising in the first half and then significantly slowing down in the latter half of the year. Chinese consumption in H108 was robust due to continued growth and spending in industrial and commercial activities. In 2008, China s consumption of aluminium is estimated to have averaged around 8%, at 13.3 million tones, and is forecast to increase by around 5%, to 14 million tonnes in The Chinese consumption growth will be supported by a $586-billion economic stimulus package, aimed at spending on infrastructural activities, which are aluminium-intensive. However, global consumption is likely to be weak due to lower consumer spending, reduced housing and construction activity, and declining vehicle sales. P a g e 29

31 Fundamental outlook The global economic activity is likely to be weak during H109, with modest recovery expected in the latter half. In wake of the financial crisis taking its toll on global aviation, housing and construction sector, aluminium demand and prices are expected to be lower in Q109. Measures taken by various central governments are likely to support prices in the medium to long term (expected Q2 onwards). Production cuts may not be enough to erode the excess surplus in the market; however, it will result in sharp short-covering rallies within the period considered. Technical review and outlook Aluminium market witnessed one of the most volatile trading in the recent years with prices posting historical highs initially and then falling down all the way to close in red. The year started on a firm note with prices marching higher and posting historical highs at $3380 levels, erasing the previous high at $3310 posted in the year 06. However, prices couldn t sustain near the highs and as was the case in 06, crashed lower falling well below the opening price of $2410. This took the prices below the upper band of long term trend channel, which further helped the bearish cause. Finally prices settled in the red shedding $870 over previous close. Aluminium market is currently trading at a crucial juncture, with prices hovering near the lower band of the long term trend channel. Any close below this would see prices moving lower by another $300 odd point to $1100 levels. These being a crucial support along with the fact that the prices have been on the fall without any correction; there can be some pullback in prices in the offing. However, this pullback in prices may not have much impact on the overall trend in the market and we expect the prices to maintain the lower bias for the year 09. The RSI (14), though nearing the oversold conditions is showing potential for further lower price action. The MACD is treading in the negative zone showcasing the bearish strength prevailing in the market. The widening of the gap between the MACD and signal line, which is just below the 0 or base line also supports a bearish move in the near to medium term. On the whole prices are expected to maintain the lower bias in 09, with some consolidation and recovery in prices towards the end. P a g e 30

32 Figure 37: LME Aluminium Technical chart Click to go back to index page P a g e 31

33 COPPER The year 2008 was the most volatile period for copper as prices of the red metal reached historic-highs initially and then plunged to its four-year lows. Copper, which is used in housing and construction, was extremely buoyant in the first seven months of 2008 due to investment and speculative demand and the depreciating dollar. Moreover, a growing consumption demand from emerging nations, especially China, saw prices breaching the earlier historical highs. The 3-month forward copper prices made a new lifetime high of $8,940 per tonne, taking cues from the record-low US dollar ( 1 = $1.6038), continuous supply disruptions in the Latin American regions, depleting stockpiles and stable-to-weak Chinese imports. Production costs moved higher and natural calamities reduced the availability of the metals. Global investors pumped money into commodities, without any exception, to safeguard their portfolio returns as other asset classes such as equities and currencies generated less returns. The labor strikes in the Latin American countries, power shortage in China, Africa and America and, above all, the spiraling crude oil prices, increased the value at which metals were readily available in the market. Some of the major production disruptions during the period were the strikes in Chile s Codelco mines, Southern Copper s Cuajone and Ilo smelter mines, Freeport-McMoRan Cerro Verde mine, BHP Billiton s and Xstrata s Antamina copper pit, and Peru s nationwide strike, among others. Figure 38: Copper vs. Dow Jones vs. Dollar Index However, prices witnessed a complete reversal since early August, eroding the earlier gains as investors turned cautious about the widening credit crisis and the economic recession. Prices plunged to fresh multi-year lows on fears of a global recession and tumbling equity markets. Concerns about demand destruction coupled with an appreciating US dollar resulted in a steep fall in base metal prices. A series of bad news emanated from the US in September, erupting across world markets, as the US hurtled towards its worst financial crisis since the 1930s. The banks reluctance to lend money to each other created a worldwide liquidity crunch, raising short-term borrowing rates. Therefore, the US dollar rose P a g e 32

34 strongly against all majors. Against euro, the US dollar touched a two-year high of $ and against the British pound, the currency made a high of $ Concerns of more defaults and credit crises forced global central banks to reduce interest rates by more than 200 bps. The US government approved a $700-billion dollar package to buy stakes in banks and boost consumer confidence. Slowing economic growth rates around the world, including emerging nations like China and India, coupled with a liquidity crunch resulted in a wide sell-off in commodities. Figure 39: CFTC net-long positions & the COMEX copper price Investors sold base metals and other commodities heavily to seek refuge in safer assets, such as gold and government securities. Inventories rose to a 58-month high and spot demand weakened substantially, dragging prices deep into negative territory. Chinese imports remained sluggish as it slowed down remarkably in 2008, with imports falling by over 10% to 1.24 million tonnes in the first eleven months of As per International Copper Study Group (ICSG), the refined copper surplus rose to 120,000 tonnes in the first nine months, compared with a surplus of 72,000 tonnes in the same period a year earlier. Moreover, declining industrial activity, construction spending, and orders for durable goods had a bearish sentiment on prices. Demand-supply According to ICSG, the refined copper usage in the first nine months of 2008 rose by 2.7%, or 363,000 tonnes, compared to a year ago. Among the US, the EU, Japan and China (representing 65% of the total world usage), only China recorded a growth of 12.7% while the others witnessed a slump of 3.3%, 1.5% and 9%, respectively. World copper usage, excluding these four regions, grew by 4.1%. During the same period, global refined production increased by 3%, or 411,000 tonnes (Y/Y), with production down in many regions, such as the US, Japan, South Korea, India and Poland, where output was affected by operational problems, labour issues, maintenance shutdowns, lower-ore grades and adverse weather P a g e 33

35 conditions. However, those decreases were more than offset by increases in other countries, such as Australia, Canada, Chile, China, Congo and Peru. Meanwhile, copper mine production fell by 93,000 tonnes and was 0.8% lower than the 2007 level for the same period. For 2008 as a whole, ICSG has forecasted world copper consumption to increase by 2.97% to million tonnes. In 2008, OECD demand remained weak as many developed economies entered a recession and other consuming nations witnessed significant slowdown in housing, construction and manufacturing activity. Demand from the US dropped by 4% in 2008 and is expected to fall further by 3% in Weakness in residential and industrial construction markets, which account for around 40-50% of the US domestic copper consumption, is likely to result in lower copper usage in the region. In October 2008, housing permits and housing starts, two leading indicators of residential construction, recorded historical lows. The US housing market is expected to remain weak at least in H109, contributing to lower copper demand. Economic and policy measures by the Federal Reserve may help in improving the performance of the sector in the latter half. Figure 40 & 41: US Housing Starts & Durable Goods Orders In 2009, consumption is expected to remain weak in these countries and world copper use is expected to grow by 3.4% to reach 18.9 MT. The world growth is expected to be mainly supported by China, India, Egypt and the Gulf countries. The Chinese government s fiscal stimulus package, meant to boost infrastructural development, investment in housing and power sector, is likely to increase demand for copper. In addition, OECD demand is expected to rebound towards the end of 2009 as economic measures will start showing their effects. P a g e 34

36 Figure 42: Copper Production & Consumption Source: ICSG The world copper mine production in 2008 is forecast to have increased marginally by 1.80%, to million tones, as weak demand and labor disputes in Chile and Mexico offset production from commencement of the new mines. Lower grades, technical production problems, utility constraints, and labor unrest resulted in a lower capacity utilization rate. In 2009, mine production is expected to increase by 1.7 MT (10.7%) to 17.4 MT owing to new increased capacity utilization and mine developments. On the other hand, refined copper production in 2008 is forecast to have increased by 1.90% to million tonnes in 2008, with a further increase of 4.32% to million tonnes in Production is likely to expand in China and Chile. In China, refining capacity is expected to increase in 2008 and 2009 as new capacity comes on line. By 2009, China s production of refined copper is forecast to have increased by more than 600,000 tonnes, to around 4 million tonnes. In Chile, refined production is forecast to increase by 500,000 tonnes by end-2009 because of new solvent extraction-electro winning (SX-EW) production. A shortage of concentrates in 2008 and 2009 is expected to restrain the growth of refined production. Meanwhile, inventories monitored by the London Metal Exchange rose by 72.08% in 2008 to 339,775 tonnes, the highest since early February The cancelled warrants ratio, an indicator of spot demand, moved lower sharply to 1.2% of the headline inventory levels, compared to 10% of the inventory levels in early The basis difference (spot futures) also supported the weak demand factor, as the difference moved into contango, an unusual situation for the red metal. P a g e 35

37 Figure 43: LME Copper stocks vs. prices Fundamental outlook In 2008, copper prices plunged sharply to an over four-year low; depreciating by 66% from its peak levels, as global recession and slowdown curbed the demand for the metal. Copper is extensively used in housing and construction sectors, and with short-term borrowing rates surging followed by a record drop in consumer confidence, these sectors have been badly hit. Demand has slowed down significantly in the US, the EU, Japan and China, as the first three entered into a recession while the fourth witnessed a significant slowdown. Prices are well above the average production costs of around $2,400 levels and any production cuts will be seen as a short-term positive factor for the prices. Figure 44: Copper market balance Source: ICSG The economic measures taken by the US, Euro-zone and China are directed towards boosting infrastructural growth and overall economic growth. Taking into consideration the excess supply in the market combined with weak demand, prices are expected to remain range-bound in However, given the production halts and the expectation that major economies will post a recovery in the latter half, prices are expected to move higher from the lows in 2H09. The crucial factor to watch out for will be the impact of the global crisis on China and other emerging nations. P a g e 36

38 Technical review and outlook Copper prices tumbled in the year 2008, erasing gains made in the previous 3 years. The year began on a positive note with prices trading near the historical highs at $8800 levels and briefly breaching in more than one occasion. Though the prices were trading very near to the historical highs, the inability of the markets to sustain above the same after repeatedly testing those levels and posting fresh historical highs at $8940 levels casted some doubts on the continuation of bullish sentiment in the market. The inability of the market to sustain above the highs indicated lack of buying interest at those levels. This, apart from stopping fresh buying entering the markets also helped in the strengthening of bears. The resultant selling that was witnessed in the markets towards the end of July to till date was a one way journey with the magnitude being so big that the fall in the month of October was more than the gains made in the previous 5 years respectively. Though markets are hovering near oversold conditions in monthly charts, there is no sign of a reversal in the charts. At the most markets may take some correction higher in the near term as some positive divergence can be seen in RSI in daily charts and we think the recent higher price action is a result of that. However, looking from broader perspective, markets are still looking weak and may remain so in this fiscal, though the fall may be limited from these levels. The MACD line moving below the 0 or base line in monthly charts augurs well for the bearish sentiment. On the whole we may see sideways to lower price action in copper with the limited targets on the lower side. The probable targets are $2400 and then $1800 levels. Figure 45: LME copper Technical chart Click to go back to index page P a g e 37

39 LEAD This battery metal started 2008 on the higher side as demand from China coupled with increased investment inflows helped maintain the optimism over the prospects of the metal. The 3-month forward LME lead prices reversed the losses made in late 2007 and rose to $3,480 per tonne levels, its peak during the year. However, with a massive increase in stockpiles coupled with lower Chinese exports, the positive sentiment for the metal remained subdued. During H108, the inventories for the metal monitored by London Metal Exchange warehouses rose by 129% to 101,900 tonnes compared to lastyear s figure of 45,475 tonnes, putting pressure on prices to trade lower. With investors turning cautious about the widening credit crisis and economic recession, the metal was sold-off heavily in H208. Prices plunged to its 38-month low of $851 levels due to the global recession and the carnage across financial markets. Concerns about demand destruction originating from a global economic slowdown coupled with an appreciating US dollar resulted in value depreciation for base metals. The bearish tone gained momentum with skepticism on the US treasury plan to inject $700 billion into the financial system to support the economy and prevent the escalating credit crisis. Major global central banks were seen reducing their lending rates by more than 2%, given the liquidity crunch and the economic slowdown worldwide. Economic indicators continued to paint a deteriorating and gloomy picture on demand prospects, as industrial activity, factory orders and home sales fell to several decade lows. A sharp decline in automobile sales across nations reduced the demand for batteries, proving extremely negative for metal prices. With major automakers in the US striving to survive and applying to the Fed for a bail-out, there was further speculation on demand erosion in future. Above all, the slowdown in China, the world s largest metals consumer, exacerbated the negative sentiment for base metals. China s annual GDP growth fell to 9% in the third quarter from 10.1% in the second quarter, while factory output dropped to a six-year low. Figure 46: LME Lead vs. Dollar Index P a g e 38

40 The bearish tone for the lead metal was compounded largely by the strength in the US dollar, which rallied to a high of $ The US dollar holds an inverse relationship with base metals as demand for base metals from overseas buyers is dependent on the performance of the currency. The stronger US dollar makes dollar-denominated assets expensive for overseas buyers and the reverse is true when the dollar declines. The dollar appreciated as banks rushed to maintain reserves in order to protect further defaults and bail-outs. Figure 47: LME Lead stocks vs. prices Interestingly, as prices plunged, inventories also moved lower by the year-end. The stocks in LME warehouses stood at 45,150 tonnes, which is marginally down by 0.71% from last-year s figure. The spot demand did not signal a demand revival, and this, in turn, increased the downside pressure on prices. Winter demand for the metal did not materialize and production cuts were not enough to arrest the price decline. Demand-supply On the demand front, Chinese trade data points towards lesser usage of the metal outside China. In the first eleven months of 2008, Chinese exports of refined lead fell by 85.72%, to 31,878 tonnes, while its imports rose by 32.2%, to 28,672 tonnes. Over the period January to October 2008, global lead mine output increased by 8.2% compared to the same period in The International Lead and Zinc Study Group forecasted demand to rise by 5.7% to 8.65 million tonnes in 2008 and by a further 4% to 8.99 million tonnes in Production is expected to increase by 6.8% to 8.7 million tonnes in 2008 and by 3.8% to 9 million tonnes in On the whole, the metal is expected to enjoy a small surplus of 30,000 tonnes in 2008 and the balance between supply and demand may even move closer in P a g e 39

41 Figure 48: Lead Production & Consumption Fundamental outlook Source: ILZSG With the U.S., Europe and Japan simultaneously entering a recession coupled with a significant slowdown in emerging nations growth rates, demand for lead is likely to see a further slump. The downtrend in the global economy is likely to result in downside movement in lead prices. The economic measures taken by central banks across the world is likely to take time in order to restore investor confidence in the markets and take the economy on the higher growth path. Lower vehicle sales are reducing the usage of batteries, where lead is mostly used, and this can keep lead prices in a narrow range in the short-term period. In the first half of 2009, we expect prices to trade with a downside bias, although production cuts may lead to a short-term pullback in the market. In H209, we expect economies to recover, and, therefore, lead prices are likely to post gains. Given the oversold nature of the metal followed by various demand revival measures, we expect limited downside movement in the coming days with a broad trading range seen between $680 and $1530 levels. Technical review and outlook Lead prices continued the downward march, starting from where they left in the year Prices moved higher initially after the sharp fall in the months of November and December of However the inherent bearish strength in the markets pushed the prices lower pushing them towards the crucial support range around $1000-$920 levels. Markets as such posted the low at $851 levels and settled in the red at $999 levels. The fall has erased almost the entire gains made during the years 07 and 06. The outlook for Lead continues to remain weak as is the case with some other base metals. The RSI (14) is trading around 38 levels in monthly charts and is trending lower, suggesting that the bearish price action may continue further. The MACD line has breached the 0 or base line and is treading in negative P a g e 40

42 zone pointing towards further bearish price action. The widening of gap between the MACD line and signal line also augurs well for the bearishness in the market. A close below $920 levels can push the markets to $630, which is another good support for the market. However, $430 is the level which is most crucial for the market as that forms the trend channel support, breach of which looks less likely though prices can come down to those levels. On the whole we expect prices to trade lower in the first half and consolidate in the latter part of second half of 09. Figure 49: LME Lead Technical Chart Click to go back to index page P a g e 41

43 NICKEL The white metal witnessed a severe downturn in 2008, with prices falling drastically by 55.51%, to $11,700-a-tonne levels. Prices made a peak of $35,150 levels in early March 2008 and then succumbed to $8,850 levels, as the global financial crisis pulled down demand amid lower stainless steel production and rising inventory levels. Prices remained relatively higher in early 2008, taking cues from increased investment demand, supply disruptions and across-the-board gains in the commodity. Investment demand was robust as money flow was diverted towards commodities at a time when inflation was running high and the dollar depreciated strongly against the majors. The movement in the US dollar and metal prices is inversely correlated as the depreciating dollar makes the metal cheaper for overseas buyers, enhancing the real value of the commodity. Although not much supply disruptions were seen in the nickel market until prices plunged nearer to its cost of production in late 2008 production halts by giant BHP Billiton at its Cerro Matoso mine in Columbia and at the Kalgoorlie nickel smelter in Western Australia, cumulatively producing about 83,000 tonnes, or 6% of the world nickel output, led to a sharp rally in prices. However, as uncertainty on the global economic outlook rose and growth weakened, the consumption of stainless steel declined, lowering the demand rapidly for nickel. Moreover, the Chinese stainless steel mills apparently reduced stainless steel output by over 30% in Q208. Performance of the stainless steel sector is very important as it constitutes 65% of the total nickel usage. Besides this, nickel production increased as new mines started producing output, adding to the already growing stockpiles. With major financial companies filing for bankruptcy, governments undertaking bail-outs, banks reluctance to lend, and policymakers decisions to cut interest rates, the US dollar appreciated strongly against the majors. The negative economic growth in the US, Euro-zone, the UK, Germany, and Japan has all added to the global recessionary fears. The slowdown in emerging nations such as China, India, Brazil, etc., coupled with crashing global equity markets, have resulted in extended and wide sell-off in the metal since early August. The metal demand declined and inventories rose sharply as the one monitored by London Metal Exchange grew by 63.5%, or 30,444 tonnes, to 78,390 tonnes, the highest since July P a g e 42

44 Figure 50: LME Nickel stocks vs. prices The slump in prices and demand was so significant in late 2008 that it forced many miners either to delay/reduce their planned production activities. Lower stainless steel demand forced Chinese nickel producers to slash output in a bid to support prices and avoid losses. China consumes one-fifth of the world s nickel to feed its stainless steel industry. China s largest nickel producer, Jinchuan Group, planned to cut refined nickel output by 20,000 tonnes, to 100,000 tonnes. China produced 103,567 tonnes of refined nickel in the first eleven months of 2008, up 12.1% when compared to same period in During the same period, its exports fell by 62.9% to 6,103 tonnes and imports were up by 12.28% at 107,338 tonnes. A knee-jerk movement was seen in the market after the suspension of mining operations at Xstrata, plcowned Falcondo ferronickel mine in the Dominican Republic, producing about 29,000 tonnes. Other major developments on the industry/production front are given below: BHP Billiton Ltd said that it had scrapped a study on developing an integrated nickel project in eastern Indonesia, while Xstrata, plc. announced plans to cease operations at Craig and Thayer- Lindsley nickel mines ahead of schedule. Russian miner, Norilsk Nickel, expects the financial crisis to continue to sap demand for its products this year, but it believe that it would not get any worse in The company official said that demand right now is significantly lower due to unfolding circumstances. Norilsk Nickel said that it will halt production at its Cawse laterite nickel operation in Western Australia because of higher costs and lower metal prices. The facility, which has been on an indefinite care and maintenance, has been operating under increasing cost pressures for some time. P a g e 43

45 Brazil s Vale said that it was reducing production at some high-cost operational units, including a 20% cut in nickel output at its PT Inco unit in Indonesia. The company will also reduce activity by 65% at its Dalian processing unit in China. Cuba s nickel industry was still operating at around 81% capacity six weeks after taking a direct hit from Hurricane Ike. Canada s First Nickel. Inc. said that it suspended output at its Lockerby mine as the company grapples with low prices. Australian miner Mincor Resources NL said that it expects its production of nickel ore to be in a range of 16,000-19,000 tonnes in fiscal 2009, down from an original plan of 19,500-20,500 tonnes. Australia s Minara Resources Ltd said that it had to defer its $273.5-million nickel expansion plan due to high costs. A heap leach expansion, increasing the firm s annual output of nickel by around 8,000-10,000 tonnes per year by the end of 2009, had to be postponed. It was noted that POSCO had cut stainless steel production by 17% to 334,000 tonnes in the third quarter from the previous quarter and would reduce production by 30% or 150,000 tonnes in the fourth quarter. Demand-supply Nickel mine production was forecasted to decline by 3% to 1.55 million tonnes in A number of mines have been recently commissioned or are expected to commence operating in the short term. However, disruptions to existing operations because of industrial disputes and falling nickel prices are expected to more than offset production from new mines, resulting in lower world mine production for 2008 and 2009 as a whole. Due to the slump in prices, high-cost mines are expected to be placed on care and maintenance or to reduce output, while new mines are forecast to start up relatively slowly. P a g e 44

46 Figure 51: Nickel Production & Consumption Source: INSG According to the International Nickel Study Group (INSG), world primary nickel usage (consumption) was 1.31 MT in 2007, and was estimated to increase to 1.38 MT in For 2009, a slow recovery of nickel usage is anticipated, with main increases taking place in Asia and is forecast at 1.44 MT. As in recent years, the key factor in the 2009 forecast remains the increase in demand from China for nickel and nickel-containing products. China s nickel consumption in 2008 was expected to decline from last year due to falling production of stainless steel with high nickel content. China, the world s top stainless steel producer, was expected to produce 7.8 million tonnes of crude stainless steel in 2008, up just 2%, after growth of 38% last year, a government-run research body forecasted in September. In the US and the EU, weak economic growth has reduced spending on consumer durables, growth in industrial production, and growth in construction activity. Moreover, relatively high world nickel prices are encouraging stainless steel producers to curb their use of the metal. Many stainless steel producers are attempting to offset relatively high nickel prices by reducing the nickel content of the steel they produce through substitution with other metals, such as chromium. On the other hand, world primary refined nickel production was 1.43 MT in 2007, and was expected to decline to 1.41 MT in For 2009, a substantial recovery to 1.55 MT is anticipated, given new production facilities in Brazil, South Korea and New Caledonia coming on stream. The 2009 figure does not include any adjustment factor for possible production disruptions. However, ABARE estimates 2009 production figure to be 1.42 MT. Considering the INSG figures, the market balance in 2009 is currently expected to be at 110,000 tonnes. P a g e 45

47 Figure 52: World crude stainless steel production Source: ISSF The preliminary figures released by the International Stainless Steel Forum (ISSF) show that crude stainless steel production has decreased in the first half of 2008 by 1.8% compared to the same period of The decrease was 2.9% in the first quarter but just 0.6% in the second. All major regions such as the US, the EU and China have shown lower production volumes in the first half of The overall production was estimated to be lower at million tonnes in 2008, down by 0.30% from last year. Fundamental outlook After declining by almost 60% in 2008, the potential for nickel prices to fall further cannot be ruled out. Demand from the stainless steel sector is not expected to pick up anytime soon as advanced and emerging nations, especially China goes through a significant downturn. The IMF has forecasted economic growth in China of 8.5% in 2009 compared to 9.7% in The expected production surplus is likely to be offset largely by mine shutdowns and project delays. This can provide support to prices and can result in a short-term pullback in the market. However, higher stockpiles are likely to pressurize prices to trade lower while reduced personal consumption and weakening growth around the globe is expected to curtail demand for stainless steel and nickel. Given the sharp decline in prices and increasing production cuts, we expect the downside risk to prices to remain limited. The losses will be limited by the expected improvement in demand from governments stimulus plans. On the whole, prices are likely to trade sideways with a downside bias in H109 and may see a revival in the latter half of P a g e 46

48 Technical review and outlook Nickel prices settled in red in the year 2008 continuing the fall that started in 07. After the spectacular fall towards the end of 07, prices consolidated for some time before the resumption of the fall. The break out from the consolidation, which took the form of a pennant, induced fresh bearishness in the market taking prices lower to $8850 levels. As with most of the other base metals the magnitude of the fall was quite big indicating the bearish strength that gripped the market. The outlook for Nickel prices continues to be weak, at least in the first half of 09. Though markets breached the crucial supports at $10,000 levels prices didn t sustain below those levels. As such it is important to see if markets are able to breach and sustain below those levels, upon which prices may test $5000 levels. The RSI (14), treading at 32 levels in monthly charts and trending lower, shows some more downward potential in prices in the near term. The MACD as well as the signal line are below 0 or base line, signifying further weakness in prices. As said before the close below $10,000 levels is very crucial for the market and would be the deciding factor as to the further trend of the market. We expect that prices may move below $10000 levels and probably test around $7000-$6000 levels in 09 after which prices may consolidate and slowly start the journey higher. Figure 53: LME Nickel Technical chart Click to go back to index page P a g e 47

49 ZINC Zinc prices have declined substantially in 2008, owing to poor demand from the consuming nations. Prices declined mainly due to increasing world supply associated with the commencement of new mines and refineries. The slowdown in the developed economies have had a negative impact on developing economies, too, especially China, as the Chinese real GDP for Q3 slowed to 9% from its previous quarter growth of 10.1%. The global meltdown along with rising inventories and falling manufacturing activity resulted in strong bearish movement in prices. The mine expansions in Australia, Bolivia, Canada, China, India and Kazakhstan have put additional pressure on prices to trade lower. Spot premiums and cancelled-warrants ratio, indicators of spot demand, declined heavily while inventory rose by over %, to 253,500 tonnes. Declining construction spending, automobile sales, and industrial activity in the US and Europe have lowered the demand for galvanized steel. Moreover, reduced personal spending has lowered demand for the metal from the household appliances segment. China, the key consumer of the metal, has also reported slowdown in demand and this has proved to be quite a negative factor for prices, signaling the declining demand prospects. The forecasts supplied by the member countries of the International Lead and Zinc Study Group suggest that there will be global surplus of refined zinc metal of 150,000 tonnes in 2008 and 330,000 tonnes in 2009, as growth in supply continues to exceed that of demand. Moreover, a strengthening US dollar and the lack of funds in the global financial market have been weighing down on prices. The liquidity crunch has been restricting the access of funds to metal producers and consumers. Figure 54: LME Zinc stocks vs. prices P a g e 48

50 Demand-supply The International Lead & Zinc Study Group forecasts a gain in consumption of 3.83%, to million tonnes, in 2008, and a 3.40% gain to million tonnes in The majority of the increase is being driven by rising consumption in developing countries while consumption growth in the OECD economies is expected to remain flat. In 2008, Chinese demand was forecast to rise by 13.2%, slightly less than in However, in 2009, a significant slowdown in the rate of increase in usage to 7.6% is expected. In the first eleven months of 2008, Chinese exports of refined zinc fell by 74.79% to 66,534 tonnes while its imports rose by 24.4% to 180,078 tonnes. Elsewhere in Asia, further growth is anticipated in India. However, usage in the Republic of Korea is forecast to fall. In Europe and the United States, decline of 2.2% and 3%, respectively, is expected in 2008 with usage in both regions remaining flat in Around 70% of the zinc consumption occurs in the construction and automotive industries in the form of galvanized (zinc-coated) steel or other components such as die-cast parts. Figure 55: Zinc Production & Consumption Source: ILZSG On the supply front, global zinc mine production was expected to increase by 3.9%, to million tonnes in 2008, followed by a 5.2% gain to 12.2 million tonnes in China s zinc mine output was set to rise by around 10% in 2008 with a similar increase in According to ABARE, growth in world zinc-mine supply is forecast to continue in 2009, with the expected commencement of Goldcorp s Penasquito mine in Mexico (189,000 tonnes a year), an expansion of Xstrata s Mt Isa zinc-lead concentrator (an additional 150,000 tonnes of zinc a year), and the start of Iberian Mineral s Aguas Tenidas mine in Spain (44,000 tonnes a year). Hindustan Zinc also completed a 170,000-tonne expansion of its Chanderiya refinery in India in late 2007 and further expansions are planned. P a g e 49