Base Metals Stockpiles and Prices
Scott Wright September 29, 2006 2615 Words
The metals markets have sure cooled off in recent months. From precious metals to base metals, corrections and consolidations have taken hold and have many folks wondering whether it could be the end of this incredible multi-year bull market.
The exuberant sentiment that drove the metals up in this latest and massive upleg that peaked in May has quickly waned. Wall Street analysts are even fueling the commodities burn calling for the end to the great commodities bull of the 00’s. Though they are likely gravely mistaken, commodities as a whole have been spiraling down in recent weeks quickly wiping euphoria from commodities investors and speculators while replacing it with fear.
Energy and metals in particular have bled the most in this latest across-the-board correction. And while many struggle to keep their emotions in check, it is increasingly important to keep in mind the strategic nature of this commodities bull. This is not the first correction, nor will it be the last. Technical corrections are absolutely necessary in order to rebalance sentiment. And until the underlying fundamentals driving the core strength of a bull market are strategically reversed, the bull will march forward.
Each time a correction ensues, the question of fundamentals always comes to surface. Have the economics of a given bull market drastically shifted? Has current supply of a given commodity created enough excess now and into the future to balance demand and create a notable surplus warranting a precipitous decline in prices?
Well it seems commonplace within each correction, many people are quick to discount the notion of a commodities super cycle and aim to contort fundamental realities thus ignoring the technical nature of a correction. It is important to understand that corrections are normal within bull markets. In fact speculators should welcome these shifts in sentiment as they create wonderful buying opportunities at the interim lows before the next upleg launches.
Nearly six years into our current secular commodities bull market, I believe there is still as good a fundamental case as ever for this bull to keep its pace for many more years to come. Today I want to focus on the case for the industrial metals, or base metals, that feed the infrastructure of this global economy and take a look at one of the tools that support their continued strong fundamentals.
One of the places we look to gauge the health of the base metals sector is the London Metal Exchange (LME), the largest non-ferrous metals exchange in the world. An important function of the LME is to provide the most reliable source for daily metals prices in the world. But contrary to popular belief, precious metals are not traded on this exchange. The LME covers six primary base metals, two plastic contracts and a metals index based on its primary metals.
Another of the LME’s integral functions includes providing the markets for futures and traded-options contracts. In addition to the speculative nature of these markets, they serve to mitigate risk allowing consumers and producers to lock in prices, also known as hedging.
This hedging function is as important today as it was over 100 years ago which was initially how the LME came about. Metals hedging came in response to the rise of imports into the UK in the 19th century as consumption and demand for the metals skyrocketed. Even back then metals prices were subject to volatility. A lot could happen to these prices during the lengthy shipping voyages that brought in the metals, which is why hedging became necessary in order to appropriately manage transit risks.
Though this type of risk does not exist in the same way it did in the 1800s, many consumer companies, especially those with tight margins, need to manage their costs looking forward. And the producers many times feel the need to manage their cash flows by locking in future prices of the metals they bring to market.
The third function of the LME, which is what I will focus on, is the physical storage of its traded contracts. In order to ensure price convergence, all contracts traded on the LME “assume” physical delivery. Though only a very small percentage of contracts actually result in delivery, the physical side of the game is especially important in the futures markets.
Since hedging and speculation rule the roost in the LME, most contracts are sold or bought back before coming due for settlement. But occasionally LME contracts are redeemed and settled through the delivery of LME warrants. These warrants allow the bearer to obtain lots of a given metal from LME-approved warehouses around the world.
This physical storage is not designed to supersede existing supply chains such as those that exist between refineries and end users. But when physical deliveries do indeed occur via the LME, it helps paint a picture of global supply and demand which in turn can be used as a factor in determining the metals prices.
Since physical delivery is to be presumed for each contract, massive stocks of each of the metals traded on the LME are stored in warehouses around the world. Any of these warehouses are capable of delivering the metals to any party presenting a warrant. Now the LME does not actually own these warehouses but rather approves the inventory housed at each location as acceptable forms of metals appropriate for delivery.
Today there are over 400 LME-approved warehouses globally scattered among 13 countries. These warehouses provide the critical stock data that not only the LME but traders around the world use to gauge the health of the metals markets. This stock data is published daily by the LME and can be very useful as a leading indicator for metals traders.
Last month I wrote an essay on this year’s amazing run in nickel. And interestingly one of the major reasons for nickel’s success was attributed to the action of its LME stock levels. As you can see in the chart below, nickel stock has taken a nosedive this year. Due to increased demand and sluggish supply, warehoused nickel inventory has plummeted by nearly 90% this year alone.
Throughout the year as nickel stock continued to get pilfered by increasing demand, the plunge to the 5k to 7k metric ton range gave catalyst to a sharp rise in nickel’s price. And in this range standing LME nickel stock tallies the equivalent of just over one day worth of global nickel consumption!
Since the beginning of this year the price of nickel has soared 157% to its recent bull-to-date high over $15 per pound. Though this latest push over $12 or so could be attributed to speculative excess, this shows that simple fundamentals, in this case alarmingly low stock levels, have enormous influence on nickel’s tactical price movements.
LME stock charts can also be useful in painting the pictures for the other base metals. Back in early 2004, global zinc stock was up toward the 800k metric ton level before it started its downward spiral. For a variety of reasons zinc demand has risen while supply has lagged causing warehoused stock to drastically fall.
This economic imbalance is apparent in the chart below as the LME warehoused stock for zinc has plunged by over 81% since 2004 and 63% this year alone. Today’s zinc stock levels provide the equivalent of only about five days of global zinc consumption and don’t seem to be stabilizing as they continues to knife downwards.
And of course the price of zinc has taken an inverse direction from its stock level. Zinc is up an impressive 109% this year to its recent bull-to-date high of $1.80 per pound. It is currently consolidating in what can be drawn as either a wedge off its high or a slight uptrend. And if stock levels continue to descend at their current pace, this grind may well be building strong support in anticipation of another powerful upleg.
LME warehoused stock can be telling in the other direction as well. Take lead for example. While the other base metals were enjoying fantastic rallies in the first half of this year, lead was taking a beating. Even though lead stock is down over 60% in the last four years, the near-term trend did not bode well for the price of lead. There were a variety of reasons for this, but in looking at lead’s LME stock chart, it tells a big part of the story.
Contrary to the general base metals trend, lead stock actually rose quite a bit from the beginning of this year. In fact a stock increase of 181% to its June peak led to a 37% drop in the price of the metal. But like clockwork as soon as the stock levels started to decrease, the price of lead started to rise. In the last three months, lead stock has fallen over 45% which has led to a 55% increase in the price of the underlying metal.
Copper is not quite as refined as these first three metals when it comes to LME stock correlation, but there is still a clear picture. From its mid-March high of 135k metric tons, copper stock fell by 33% to its early July low. In this time copper went parabolic with its price nearly doubling in just two months.
Since its high in early May though, copper caught gold fever and followed the metal of kings down even as LME copper stock continued to plummet. And interestingly since July copper stock has rebounded while the price of copper has stayed relatively strong repelling sell-side pressure. With its LME stock rising and commodities deemed the plague of recent, copper has been surprisingly resilient.
One reason for its resiliency is copper has been the king of the base metals in this base metals bull and has quickly become an investor favorite. There are a myriad of fundamental reasons why copper should stay strong for many years to come, including the fact that today’s stock levels are miniscule compared to the nearly one million metric tons in stock as recent as 2002. But from a technical perspective will this developing wedge off its May highs break out to the upside or the downside? If the metals catch a bid this fall/winter, watch for copper to challenge and perhaps exceed its spring highs.
Aluminum is the last of the major base metals. It is a bit on the boring side of the base metals spectrum from a stock market standpoint, but nevertheless it has quietly enjoyed its own spectacular bull market. Aluminum is the most common of the base metals with its production and consumption dwarfing that of the others.
But even with the volume aluminum runs through the markets, global demand has been pinching supply as indicated by its LME stock levels. Aluminum stock is now about half what is was in the beginning of 2004 and as you can see in the chart above it is finally starting to stabilize at these levels. For the most part the price of aluminum has been fluctuating with its stock levels this year. And in the last couple months it seems to be holding its ground waiting to see what the markets have in store for the base metals.
As touched on above, the multi-year trends of LME global warehoused stock for the base metals have spiraled downward as global demand has outpaced supply. This definitely hints at a widespread economic imbalance for these resources. And to paint even more of a fundamental picture, consider that as stocks are being raided, global mined supply of these metals is rising on balance each year.
In the last ten years, global mined production of the base metals has been subject to widespread growth. Since 1995, lead production has risen 21%, zinc +42%, nickel +44%, copper +52% and aluminum +61%. Even with these impressive increases, demand has obviously outpaced the best the producers had to offer.
So with increasing production and decreasing stocks still hardly fulfilling the global appetite for the metals, this indeed stands to serve as powerful ingredients for a strong secular bull market that should be subject to many years of rising prices until the ultimate hunger is satiated and an abundance of leftovers remain.
And a great way to game a continuing bull for these metals is through the stock market. The LME is a haven for futures speculators gaming the markets. But for those investors and speculators not savvy in the futures markets, profits can still be won. By buying the stocks of the companies that bring these metals to market, you are able to obtain quite a bit of leverage to the price activity of the underlying metal.
Base metals stocks in particular have had quite a run thus far in their young bull market. And the explorers and producers alike that are active in supplying today’s and tomorrow’s metals markets should still have a lot of room to grow. This sector’s bull is still relatively young and undiscovered by the greater investor public and the prudent ones that get in early are likely to see legendary gains.
As the base metals have consolidated off their May highs wiping away some of the speculative premiums valued into the metals and the stocks, they look to be grinding in anticipation of another possible upleg. And with the precious metals, led by gold, poised to begin their next upleg after a sobering summer correction, the base metals may indeed follow suit.
And the fundamentals of base metals stocks are simply crying for attention. Unlike the precious metals stocks, base metals stocks still exhibit obscenely low valuations. Most of these stocks are still trading at bear-market multiples and are ripe for the picking. At Zeal we’ve been researching base metals stocks all summer wading through the hundreds that are out there in order to discover the best fundamental plays.
We recently published another of our comprehensive research reports that identifies our favorite 20 base metals stocks. These reports contain detailed fundamental discussions on the individual stocks we believe have a high potential for success in various sectors within the commodities bull market.
The technical buy and sell decisions are timed and discussed within our newsletters based on current market conditions among many factors. But the ongoing stock research for each sector is too detailed and extensive to cover within our newsletters, which is why we publish our research reports. If you are interested in getting an inside look into our favorite base metals stocks, please purchase our latest report today.
The stocks highlighted in this newest report range from small-cap junior explorers to major producers. This inside look at our research provides valuable information on what we deem the best-of-the-best base metals stocks ultimately designed to support future base metals stock trades for our newsletter subscribers.
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The bottom line is the fundamentals of this young base metals bull are still in line as supported by LME warehoused stock data. As the global imbalance for the base metals works to correct itself, prices should continue to stay high for many more years. With this, the suppliers that are bringing these metals to market now and in the future are positioned to achieve vast profits.
And investors and speculators wishing to ride this excellent bull market in the base metals can multiply their capital through the elite companies that discover and extract these various metals from the earth. Base metals stocks are still cheap, and a continuing bull market in these metals should drive them considerably higher.
Scott Wright September 29, 2006 Subscribe at www.zealllc.com/subscribe.htm