The Hindu Business Line : Demand-supply factors may prop up metals

Prospect of supply constraints continuing, no let up Chinese demand in addition to positive outlook for western world metals demand, and not the least, prospects of a weaker dollar are all expected to keep the base metals market buoyant.

Dollar depreciation is expected to attract investment money into assets with traditional negative correlation to the currency.

Unlike in 2005, this time consumers are under-hedged and producers are facing upside pressure on costs because of which dollar weakness will have significant positive implications for metals prices, Barclays Capital Research said in its 2006 Outlook for base metals.

Base metals prices have risen for four consecutive years. Copper continues to hit all-time highs, while aluminium and zinc are around their highest levels in about 17 years. Against general expectations, high prices have failed to rapidly attract new production.

At the same time, the global demand environment has remained strong.

"This powerful combination as well as extremely low global metals inventories will generate even higher prices in 2006, in our view," asserted Ms Ingrid Sternby, base metals analyst.

For 2006, in the base metal complex, Barclays Capital is positive on zinc followed by nickel, copper, aluminium, tin and lead.

An aggregate upside potential of a further 10-15 per cent in the first half of the year from the current cash price levels is seen, when the cyclical peak may also occur.

While in zinc, far forward contracts also continue to offer value, nickel may see return of a nearby backwardation as the market starts to tighten from its current surplus.

Dismissing the views of sceptics who cite rising interest rates, downside risk to the US economy and subsequent risk to the Chinese economy as fears overdone, Barclays Capital asserted that China's metals demand would continue to grow strongly even in the event of an external economic slowdown due to domestic infrastructure-led development.

Strong demand from other emerging market, for example India, is also becoming increasingly important, the report pointed out.

In a strong demand and price environment, production should grow; but serious short and long-term supply constraints persist, and production costs are on the rise. Therefore, the risk of a sudden near-term flow of new

production causing a correction in prices is believed to be small.

Fund involvement is also widely regarded as a threat to the sustainability of high base metals prices. However, there is no sign of long-term investment money that is flowing into the commodity market abating, while

short-term fund involvement is generally not excessive on the long side, Barclays Capital pointed out.