- Recent sell-off in commodities was a reality check, says Natixis - Among base metals, copper and tin are believed to have strongest fundamentals - Inflation a key to any further leg-up in prices

By Chris Shaw

Commodity market consultant Natixis Commodity Markets has released its second quarter metals review, the update suggesting the recent correction in commodity prices can be viewed as a reality check as prices had moved away from fundamentals in the early months of 2011.

For many base metals Natixis suggests prices were extrapolating strong fundamentals, this without taking into account the possible negatives of high energy prices, substitution, recycling or other potential efficiency gains from end-users. Continued positive news flow was needed to sustain prices, so as this bullish news flow dried up and then went into reverse, prices fell.

With energy prices falling of late, Natixis sees scope for an eventual peak in year-on-year inflation rates. As investors look beyond the current round of policy tightening, this means scope for a further leg-up in base metal prices.

Most likely to benefit from such a scenario are copper and tin given they offer the strongest fundamentals in Natixis's view. Fundamentals could potentially improve for both lead and zinc, though this depends on a slowdown in supply growth as much as an increase in demand.

Natixis expects nickel's fundamentals will deteriorate in coming years, though it may be a more extended process than had previously been anticipated. The outlook for aluminium prices will depend as much on energy prices as on a likely slowdown in supply growth.

In general, Natixis suggests the demand environment for commodities remains supportive, as any slowdown in economic activity will allow developing countries to moderate recent monetary tightening measures. This would offer scope for an increase in consumer activity.

For the base metals specifically, Natixis expects a gradual return to a deficit position for aluminium, while other factors such as strong demand growth, difficulty accessing metal stockpiles and increasing production costs will remain supportive. Natixis is forecasting annual average prices of US$2,650/t this year, rising to US$2,750/t in 2012.

Given still supportive fundamentals Natixis remains cautiously positive on copper prices, this while accepting the current correction could extend a little further. The group is tempted to buy the metal on any dips as any easing in inflationary pressures should be supportive for industrial demand in emerging economies. Natixis targets average annual prices of US$9,450/t this year and US$9,700/t in 2012.

In lead, Natixis suggests the market is not quite as tight as some had anticipated, a situation that may persist for another few months. This is likely to generate a modest surplus this year before a return to deficit in 2012 due to slowing supply growth. On these expectations Natixis is forecasting average annual prices of US$2,650/t this year and US$2,850/t in 2012.

While expecting a nickel market deficit of around 10,000 tonnes this year the market appears a story of two halves, Natixis noting from a significant deficit in the first half the market should be in surplus in the second part of this year.

This trend should continue, pushing the market into a surplus in 2012 as well. This implies price levels around US$26,000/t will be difficult to sustain, Natixis forecasting average annual prices of US$24,500/t this year and US$24,000/t next year.

An inadequate supply response should keep the tin market in deficit this year predicts Natixis, especially given ongoing strong demand. This trend should also continue into 2012 given a lack of new projects coming on-line, so Natixis is forecasting prices of US$31,500/t this year and around that level in 2012.

Zinc should enjoy a modest deficit in 2012 following five years of surpluses, this due to a slowdown in production. There is also expected to be growing tightness in the zinc concentrate market, which should support prices as it implies tighter conditions for the refined metal as well. Natixis forecasts average annual prices of US$2,350/t this year and US$2,700/t next year.

On the precious metals, Natixis sees reason for caution on gold prices. This reflects the possibility of further interest rate increases around the world, which would raise the opportunity cost of holding low yielding assets such as gold. Such changes in rates should also provide support to the US dollar.

This implies one key driver behind the rapid expansion of high powered money may be coming to an end, which may result in reduced investor appetite for gold. On this basis Natixis is forecasting average annual gold prices of US$1,490/oz for 2011 and US$1,290/oz in 2012, with potential for prices to move towards or even below US$1,000/oz at some point during this period.

Given the recent decline of other commodity prices such as crude oil, there is scope for recent price action in silver to signal the start of a more protracted correction, notes Natixis. This is especially the case as gold also looks likely to suffer a correction during the middle part of this year.

Natixis expects silver prices will continue the recent decline below US$35/oz, though support at US$30/oz is likely to hold in the near-term. For 2011 overall Natixis expects silver will average US$35-$36/oz.

Platinum group metals price support appears stronger than Natixis had expected, the group anticipating palladium will continue to perform better relative to platinum given stronger market fundamentals longer-term. This reflects question marks over Russian supplies and ongoing market deficits.

Platinum in contrast remains in structural oversupply, relying on investors to absorb excess production. The one positive is ongoing electricity supply issues in South Africa, which Natixis expects will limit the extent of any price corrections in the platinum market.

Average annual price forecasts for the PGMs stand at US$1,800/oz and US$1,750/oz for platinum over 2011 and 2012 and US$710/oz and US$800/oz for palladium.

More bullish and bearish scenarios are heavily influenced by the outlook for global growth and inflation, particularly with respect to developing countries. To be more optimistic Natixis suggests an improvement in the inflation outlook is required, as this will allow for a moderation in pressure relative to tighter monetary policy.

The opposite would be the driver of any more bearish scenario, as if inflationary pressures remain elevated and growth slows down, Natixis expects further damage to commodity prices.

The exception will be aluminium, as energy input costs remain a significant factor with respect to production. Natixis sees aluminium outperforming if the more bearish scenario plays out but underperforming assuming more bullish conditions for commodities generally.

In the precious metals Natixis is of the view the difference between bull and bear outcomes is largely a question where the market sits relative to a precious metals bubble. If global high powered money can continue to expand at a rapid pace and US interest rates stay low, price gains can continue for an extended period.

The major risk is the recent corrections in both silver and oil are indicators of things to come, which Natixis suggests could see prices fall further and faster than are currently forecast.

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