The U.S. Federal Reserve reversed course in September and eased monetary policy, cutting the federal funds rate to 4.75 percent from 5.25 percent. Historically, the funds rate and metal prices have been positively correlated, largely because rising interest rates went hand-in-hand with a strong economic performance (and hence metals demand), while an easing in monetary policy usually took place in the environment of a decelerating U.S. economy.
In my view, the current macroeconomic picture in the United States is certainly not bullish and the fundamentals are now not as strong as they were before the economic slowdown.
However, there are some factors that should mitigate the impact of the deceleration in North America, so metal prices are likely to remain relatively well supported from the demand side (for many metals, supply additions are still not massive).
Importantly, the share of U.S. gross domestic product (GDP) in the global economy has been declining over the past few years as other countries, especially in the developing world, have gained in importance. The decreased weighting of the United States is also reflected in the fact that over the past few years world industrial production has outperformed U.S. manufacturing activity after being a laggard for a long time (which is also one reason why the London Metal Exchange price index has risen well above the levels seen historically). This is heavily influenced by the strong growth of many less-developed countries, especially China, whose industrial activity continues to expand at a rapid pace.
My generally strong fundamental view on most base metals has not changed following the cut in U.S. interest rates. Although it is likely that investor sentiment will remain a crucial factor on the financial markets, metal prices should once again move more in line with what physical demand/ supply suggest.
As for individual metals, the nickel market likely will be focused on the stainless sector, where many producers had cut output earlier this year, partly because distributors were de-stocking. The consequent decline in nickel demand has been reflected in the monthly supply and demand balances, with the International Nickel Study Group reporting a sizeable surplus year to date.
Underlying stainless demand is still strong but actual new steel orders will be heavily influenced by steel prices, for which nickel quotations are an important factor. The European alloy surcharge fell by $630 per tonne in October, which fed straight through into stainless transaction prices. October surcharges posted by major U.S. stainless producers on Type 304 sheet fell by about 26.4 cents a pound from September and are down about $1 since their high point in July.
After nickel prices declined sharply earlier this year, they have been relatively steady of late, which means that the scope for further large decreases in alloy surcharges, and hence stainless prices, is likely to be limited. This should give stainless buyers an incentive to place new orders.
The copper market is concentrating on China, where metal users have drawn down some of the inventories built up, especially in the first half of 2007, and any sign of a return of buyers and imports will lend support to copper prices. The negotiations on treatment and refining charges (TC/RCs) also should be interesting (they usually begin during LME Week in October). I forecast a very tight concentrates market in 2008 (and low TC/RCs), which should make it economically difficult for many smelters to operate.
Michael Widmer is head of metals research at Calyon Financial SNC.