Base Metals Disconnected from Fundamentals

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In spite of numerous signs that metals prices have risen too far too fast there is no certainty that production re-starts will be curtailed across a range of non ferrous metals. At current levels some 90%+ of aluminum, zinc and nickel production is making money and while metal continues to flow into inventories, without negatively impacting prices, there is no incentive for producers to rationalize production. In a Reuters article, Julian Kettle of Brook Hunt is reported as saying the aluminum price will drop to $1700 per metric ton next year as the market continues to suffer from rising inventories. Julian was quoted as saying “Aluminium inventories are at 95 days of global demand and are going to continue to rise to 110 days. Nickel is already at 100 days of global demand. Inventories will not fall until production is cut or demand dramatically rises, neither of which is likely while growth remains so elusive in OECD markets and producers can continue to make money at current prices. Historically, as stocks rise, metals prices soften but we have seen a marked disconnect this last year or so driven by speculative demand and the belief there is a rising China demand that will suck in metals and create shortages. In his LME week blog posts Reuters columnist Andy Homes said dollar weakness and investment buying has been a bigger driver of metals prices than fundamentals. Quoting an unnamed lead specialist who said lead should be at $1750 to 1850/ton based on the fundamentals but could be anywhere up to $3000/ton driven by investor demand from hedge funds, ETF’s etc. We have seen this disconnect countless times in the last year and arguably in the run up to last year’s crash the markets were way beyond themselves on the basis of fundamentals alone. In a conversation over dinner this evening with an experienced trader and long time observer of the markets the point was made that only 10-20% of the futures market trades were actually producer or consumer initiated. Under such circumstances is it any wonder the markets are disconnected with fundamentals?

–Stuart Burns

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