Asian turmoil hits base metals.

The demand for base metals in the new year takes a hit as the current Asian financial contagion spreads around the globe. However, the scenario today is less gloomy than previously anticipated.

Concern over the impact of a financial meltdown in the Asian tiger economies, and anaemic economic activity in Japan, is serving to undermine the prices of most industrial raw materials. Merrill Lynch envisages a generally weak base metals market in 1998, largely due to this growth slow-down across Asia.

It would be false therefore to present a bullish scenario for demand and prices of base metals, amid signs of probable deflation spreading among the major metal-consuming countries. Although the first half of 1997 was seen as the beginning of a bull market in base metals, faltering growth in Asia has dampened the outlook during the second half, and this is reflected in the declining physical metal premiums on the London Metal Exchange (LME).

Since the mid-1960s, the Asian region, including Japan and China, has remained a dominant force in the production and consumption of base metals. Before its recent currency turmoils, it was estimated that between 1995 and 2005, a massive $3tr would be spent on infrastructural projects in Asia, hence boosting demand for construction materials.

Recent price weakness, however, reflects the deterioration in supply and demand fundamentals, and also the impact of the hedging mechanism. Investment funds have been selling future contracts heavily on the LME, in order to recoup losses sustained on the global stock markets since late October. Despite this, analysts say that funds might yet increase their weighting later this year, especially in aluminium, zinc, and nickel, where fundamentals are looking positive. Total commercial base metal stocks are presently significantly lower than they were at the end of 1993. Thus analysts believe that metals are strategically placed to generate positive returns on such investments over a period of time.

Towards the end of 1997, a number of leading institutions, including the Standard Bank of South Africa, Merrill Lynch, Rudolf Wolff, HSBC James Capel, Billiton Metals, the Economist Intelligence Unit, and Metal Bulletin Research produced a comprehensive analysis on the outlook for base metals.

In summary, analysts see a manageable medium-term downturn in the copper market. A substantial expansion in mine and refining capacity, and a slow-down in industrial output in countries like Taiwan and South Korea (big consumers of copper) have resulted in downward pressures on prices. The International Copper Study Group reported a global surplus of refined production for the first eight months of 1997 of around 199,000 tonnes. Experts say the copper supply-surplus will continue to accumulate until at least 2000. Billiton Metals predicts that the surplus will rise to 510,000 tonnes in 1998, as new output capacity comes on stream. This will be reflected in higher LME stocks, which are projected to rise to around 5.5 weeks of consumption by the end of 1998, compared with below 3.5 weeks of consumption in 1996.

In response to expectations of sluggish demand and growing supplies, as well as the stock levels of copper, price forecasts for this year range between $1,950 and $2,204 per tonne, as compared with an estimated average of $2,323 per tonne in 1997. SBC Warburg estimates Western mine output in 1997 at 7.7m tonnes, rising to 8.1m tonnes by 2000.

Zinc, used primarily to galvanise steel for the construction and automotive industries, was a star-performer among base metals for much of 1997. Zinc prices rose to a 7-year peak of $1,763 per tonne in July, underpinned by robust demand from the brass and galvanising industries, declining inventories, and technical squeeze. From October onwards, the market lost its momentum, as prices experienced a spectacular correction, largely due to technical selling. The LME stocks have risen, and the market has had to absorb a considerable quantity of metal.

There is, however, a consensus that zinc's fundamentals remain bullish over the medium-term. Rudolf Wolff points out that under-investment in the mid-1990s will lead to a structural deficit at least until 1999. The EIU projects a cumulative supply deficit of 1m tonnes over the period 1995-99. Billiton and EIU expect Western mine output to reach 5.8m tonnes in 1998, as new mining and smelting capacites are brought on stream in the US, Finland and Peru. A strong consumption growth by Western galvanisers is also expected (EIU estimates consumption at around 6.64m tonnes). After net exports from the former Soviet Union, the EIU projects a supply deficit of 220,000 tonnes in 1998. The average zinc price in 1998 is forecast to be between $1,300 and $1,525 per tonne, compared to an estimated $1,336 in 1997.

Aluminium has been quite resilient in 1997, averaging about $1,605 per tonne up from $1,500 in 1996. Billiton Research estimates world production in 1997 to be 16.165m tonnes, and consumption to be growing by 4.6% to around 18.65m tonnes. Billiton sees total production rising to 16.9m tonnes in 1998, up 4.5% over 1997, as a sizable amount of new smelting capacity is brought on stream in the Middle-East, Australasia, South Africa and Iceland. Consumption is expected to rise modestly by 2.5% to 19.115m tonnes. But with bearish demand from Japan, where internal stocks are high, global consumption offtake may be lower. Asia now consumes more aluminium than Europe, and within the next few years, it could exceed North America.

Some analysts anticipate some upside potential for aluminium in 1998. The industry has not invested adequately in new capacity to keep pace with demand, and lower exports from the former Soviet Union, should keep market conditions quite tight. A supply-deficit of about 230,000 tonnes during 1997 was estimated by Metal Bulletin Research, and this shortfall is expected to increase steadily over 1998 and 1999. As a result, prices could be underpinned by falling LME stocks.

Pressures on aluminium could increase, if inventories fall to a critical level of between 4.5-5.5 weeks' consumption. At the end of 1996, LME and producers' stocks were 2.6m tonnes, equivalent to 7.7 weeks' consumption. Price projections for 1998 range between $1,650 and $1,860 per tonne.

The nickel market has been gripped by a bearish mood since the second half of 1997, largely due to higher levels of production to meet robust demand for stainless steel (which accounts for 65% of nickel demand), and from the recent surge in exports from Russia. World steel consumption in 1997 rose by an estimated 4.5% to a record 695m tonnes.

HSBC James Capel analysts estimate the total Western supply (including exports from the former Soviet Union) at 923,000 tonnes in 1997. The metal's performance in 1998 could be undermined by a demand slow-down from stainless mills, and large stainless-steel inventories. The market remains in a state of "near-equilibrium." Analysts estimate a supply-deficit of 17,000 tonnes in 1997, falling to only 3,000 tonnes in 1998. Price forecasts for 1998 range between $7,250 and $7,494 per tonne, compared with an estimated $7,017 per tonne in 1997.

Essentially, the fortunes for base metals are contingent on the pace of industrial output in the major consuming countries. The fall-out from the crisis in SE Asia could have a sustained dampening effect on prices, and is hence likely to derail growth in the short-term. But beyond 1998, the global economic cycle could be favourable for base metals consumption.