Supplies may trigger metals meltdown

Copper, nickel and lead, the best performing commodities in the past four months, may be the worst by year-end.

On Wall Street, the chorus is getting louder that rising metal supplies are outpacing demand. From Goldman Sachs Group to JPMorgan Chase to Societe Generale, there are warnings of a mania that is showing all the signs of a climax.

“This is a real bubble,’’ says metals trader David Threlkeld, who first got the world’s attention in 1996 when he showed that Sumitomo Corp’s copper hoarding would lead to a market collapse. Once again, “we have an enormous amount of unsold copper,’’ says Threlkeld, president of Resolved Inc. in Scottsdale, Arizona.

The metals bears are convinced that consumption may drop partly because China, the biggest user, is attempting to reduce investment through interest-rate increases and lending curbs after the economy expanded 11.1 per cent in the first quarter.

Demand is also weakening because of a slowing US economy and a consumer-driven pursuit of alternatives to historically expensive copper and nickel, according to Stephen Roach, chief economist at Morgan Stanley, the second largest securities firm by market value.

Copper will decline 30 per cent to an average of $5,650 a metric tonne in the fourth quarter from more than $8,000 today, according to the median of 12 analysts’ forecasts compiled by Bloomberg. Nickel and lead will drop about 50 per cent from record prices reached on May 4 to $24,450 a tonne for nickel and$1,000 for lead, the data shows.

The anticipated slump would depress exports from Australia, Canada and Chile, wipe out more than $22 billion on the London Metal Exchange and squeeze the profits at mining companies from BHP Billiton, the largest in the world, to OAO GMK Norilsk Nickel, the biggest metals producer in Russia.

Bears miss rally

To be sure, many of the bears were wrong so far this year. An investor who acted on the advice of JPMorgan, the third largest US bank, missed gains of 67 per cent for nickel, 30 per cent for copper and 41 per cent for lead, the best-performing commodities in the 26-member UBS Bloomberg CMCI Index. That compares with a 6.2 per cent increase for the Standard & Poor’s 500 Index and 2 per cent for US Treasuries, according to Merrill Lynch & Co. indexes.

“We’re sticking to our guns’’ because “prices are unsustainable,’’ said London-based Jon Bergtheil, head of global metals strategy at the bank, on May 2. Nickel may average $35,328 a tonne in 2007, down from $51,600, because stainless steel makers might buy less in the second half, he said. Bergtheil in February said that nickel would decline 25 per cent in 2007. The metal, used to make stainless steel, has since gained 40 per cent.

Finding alternatives

Nickel may plunge to $30,000 a tonne by the end of 2008, because the current level is “overdone,’’ Goldman Sachs analysts led by James Gutman in London said in an April 2 report. “There is a risk of longer-term demand destruction.’’

Stainless-steel producers are cancelling orders, he said. His colleague in London, Jeffrey Currie, head of global commodities research, was less bearish last week, saying he expects metals prices to be “trading sideways’’ this year.

The record copper price of $8,800 a tonne reached last May was the peak, said ABN’s London-based analyst Nick Moore. He recommended selling copper in December because global supplies were growing.

He declined further comment in a May 3 e-mail, saying he couldn’t discuss changes to price estimates before they were published. Copper for three-month delivery ended at $8,320 a tonne in London on Friday.

Rising output

World supplies of copper outpaced demand by about 50,000 tonnes in the first quarter, Stockholm-based copper producer Boliden AB said on May 3. Global output rose 8 per cent in the period, twice as much as demand, the company said.

Chile, the world’s biggest supplier of the metal, said production jumped 13 per cent in March as high prices encouraged miners to increase supply. Output rose to 502,106 tonnes from 442,410 tonnes a year earlier, the Santiago-based National Statistics Institute said on April 26.

Nickel stockpiles tracked by the London Metal Exchange (LME), the world’s largest metals bourse, rose almost 60 per cent since dropping on February 6 to 2,982 tonnes, their lowest since July 1991 and barely enough to supply the world for a day.

Lead inventories are also rising, gaining by 42 per cent since March 13 on the LME, to 43,825 tonnes. A surplus of 25,000 tonnes of lead may exist next year, from a deficit of 35,000 tonnes forecast this year, Natixis Commodity Markets said in a quarterly report on May 1.

The metal’s record price is likely to trigger more exports from China, said Natixis, one of the 11 companies trading on the floor of the LME. Lead for three-month delivery ended at $2,115 a tonne in London last week.

Consumption cut

Some of the world’s biggest users of metal are finding ways to reduce consumption. Pohang, South Korea-based Posco, the world’s fourth-largest steelmaker, said on April 25 it will increase output of nickel-free stainless-steel five-fold next year. Nickel helps to make steel corrosion-resistant. Morgan Stanley’s Roach, who will soon become the bank’s chairman in Asia, says commodities are poised to crash in the same way they did in May 2006, when a 5.4 per cent weekly decline in the Reuters-Jefferies CRB Index was the biggest tumble since December 1980. “Watch out below for yet another reversal of commodity froth,’’ Roach said on April 26. “It’s deja vu spring of 2006.’’ He correctly predicted the slump in commodities 12 months ago.

China’s rates

Roach anticipates a drop in commodities because China will increase interest rates to slow the economy and inflation, while a slowdown in US housing will rein in consumer spending. China ordered banks on April 29 to set aside more money as reserves for the seventh time in 11 months to try to prevent the world’s fastest-growing major economy from overheating.

Lenders must put aside 11 per cent of deposits starting May 15, up from 10.5 per cent. The increase will draw 170 billion yuan ($22 billion) from the financial system.

China raised borrowing costs three times since April last year, and will increase rates twice more this year, according to a Bloomberg survey of economists.

In the US, the world’s biggest economy, growth slowed to a 1.3 per cent annual pace in the first quarter from 2.5 per cent in the fourth. An index of pending sales of existing homes fell 4.9 per cent to the lowest level in four years in March, the National Association of Realtors said.

‘Boom in Demand’

Bullish metals investors expect China will fail to curb growth, according to Tony Dolphin, director of strategy and economics at Henderson Global Investors in London, which oversees about $125 billion. “The speculative element in commodities hasn’t been affected by the slowdown in the U.S. economy,’’ Dolphin said. “The expansion we’re seeing in China and India has kept the speculators in.’’

Even the largest US pension fund, the California Public Employees Retirement System known as Calpers, is chasing commodity returns after years of holding stocks and bonds. The fund in March invested $450 million in the Goldman Sachs Commodity Index. “Strength in commodity markets will be something we should see generally over the next 10 to 20 years,’’ said Russell Read, the chief investment officer.

‘Crash’ possible

Any further gains will be fleeting, according to Societe Generale’s head of commodities research, Frederic Lasserre. He expects commodities to extend their rally and rise close to near-record levels in the third quarter of this year, before falling back. The gains in metals are “100 per cent-driven by funds,’’ said Resolved’s Threlkeld. “At some point the funds are going to want to take a profit. And when that happens there could be an almighty crash.’’