Base metals physical premiums stabilise, but at levels that indicate further price weakness

Macquarie Research notes that the latest set of premium data for December 2007 indicate that physical premiums for most base metals have stabilised across the USA, Europe and Japan, after a period of (unexpectedly sharp) decline during the previous six months.

The physical metals premium is the price that metals purchasers are required to pay (in addition to the LME price) to receive delivery of their purchase at a specified location. The physical premium covers costs such as freight, insurance, warehousing and logistical costs. Given the strong increases in freight rates over the previous 12 months (which saw many more than double), the fall in premiums is particularly painful for metals producers and traders, Macquarie Research comments.

Physical metals premiums have tended to be strongly correlated with base metals prices, a phenomenon that is not particularly surprising considering that movements in the metals premiums tend to give a good indication of the physical availability of a metal.

When Macquarie Research last reported on base metals physical premiums in early-November 2007, base metals prices (as measured by the LMEX base metals index) were hovering around their all-time nominal highs reached in May 2006, while average physical premiums had been falling quite sharply since May 2007.

Over the two months since, base metals have declined in line with the softness in physical premia (that had been prevalent for months prior). However, despite the recent declines in prices, the level of overall average premia points to further falls in LMEX in the short term, Macquarie feels. “If we look at copper in particular, the historical relationship between physical copper premiums and copper prices has not been overly strong. However, it is clear that a very large gap has opened between the LME copper price and the level of physical premia, implying that there is considerable downside to copper prices from their current levels.

Macquarie believes the current copper price level “is very high, considering how far copper prices are from the top of the cost curve (at around $4,000-4,500/t)” and the fact that copper exchange stocks are at levels similar to those at this time in 2007, when prices were around 15% lower than they are now. “However, falling Shanghai Futures Exchange (SHFE) copper stocks (which have dropped by 75,000 t since their peak of just under 100,000 t in June 2007), the potential for the Chinese to significantly re-stock (we believe that this may not be as likely as some have suggested), and the ever-present threat of supply disruptions have been very supportive of prices.

“One supportive factor for copper is that Chinese copper premiums have reportedly picked up over the past month, from around $55/t ($0.025/lb) to $70-75/t ($0.033/lb), with some smaller volumes being purchased at levels as high as $120/t ($0.054/lb). The rise follows an increase in the SHFE relative to the LME price late last month, and that has increased the incentive for the Chinese to import refined copper. In fact, the LME/SHFE arbitrage moved in favour of importing refined copper for the first time since early in 2007.

“Nickel premiums continued to fall in the US. However, they appear to have stabilised in Europe and Asia after falling by more than 70% from their peak in May 2007. The European stainless sector was particularly soft in the second and third quarters of 2007, and although the underlying stainless market shows some signs of picking up, there is a large amount of nickel pig iron inventory that has to be worked through, and an abundant supply of nickel pig iron is still finding its way to the market.”

Macquarie Research reports it is hearing “that ferronickel (a product that cannot be delivered onto the LME) is being bid at a discount to the LME price, with no iron credits payable – a significant deterioration from past practice of LME flat plus iron credits.

“The latest lead premium data highlighted the significant effect that the jump in Chinese refined lead exports in November 2007 has had on Asian lead premiums. Chinese refined lead exports rose from 9,883 t in October to 24,352 t in November (their highest level since June) following an increase in the LME/SHFE arbitrage. Largely reflecting this, Asian lead premiums dropped from $170/t to around $120/t.

“The latest zinc and aluminium physical premium data illustrate some stabilisation in premiums over the past one-to-two months, following a sharp decline since the middle of 2007.”