But while prices will remain historically high, the peaks reached earlier this year will not be seen again, analysts say

By Virginia Heffernan | October 2007

The Spring of 2007 may be remembered as the peak of an extraordinary five-year run in base-metals prices that saw some metals reach twice their previous historical highs, then defy projections and continue even higher.

Bank of Nova Scotia’s metal and mineral price index — which tracks the prices of base metals, precious metals and elements such as uranium, molybdenum and cobalt — hit an all-time high in May as nickel skyrocketed to $24.59/lb. from $15/lb. at the beginning of the year. (All figures are in U.S. dollars.)

But the subsequent descent was almost as breathtaking — and much more rapid. On Aug. 16 to 17, zinc, nickel and aluminium dropped to 12-month lows of $1.22/lb., $11.30/lb. and $1.10/lb., respectively, as the metals succumbed to the U.S. credit squeeze. At press time, nickel had lost half its value from its high for the year, while zinc was down about 35% from the beginning of the year.

Copper, meanwhile, has been relatively resilient, managing to hold at slightly more than $3/lb. — although it is well off its all-time high of $3.99/lb. set in May 2006.

And although the subprime mortgage difficulties in the U.S. are not directly related to commodity markets, metals were trounced in late summer as investors pulled money out of profitable positions to cover losses in other areas.

“There was quite a bit of profit-taking on the metals exchanges, particularly in London and New York,” says Patricia Mohr, vice president of economics for Scotiabank, “before the Fed announced the cut in the discount rate. Most of that was not a reflection of any reassessment of the outlook for metals prices, but had more to do with hedge funds that were securitizing subprime mortgages. They had to meet stepped-up bank collateral demands and they had profitable positions in the metals. So, they sold them.”

This hit metals and mining equities hard. Whereas the Dow Jones industrial average fell 7% from its peak during the August rout, mining stocks, on average, lost about a third of their value. Uranium stocks took the biggest hit, falling more than 50%, but nickel equities also plummeted by 31%, along with zinc (29%) and copper (23%).

Will they recover? If Mohr is correct and high metals prices are here to stay for a few more years, there is no reason why they shouldn’t, providing their initial price appreciation was more a reflection of fundamentals than the rampant speculation that took the uranium sector to unprecedented highs.

“These are still extremely profitable prices, from a mining company’s point of view,” Mohr says. “We’re coming off something that was quite spectacular and moving down to quite high levels still.”

The market for most of the metals remains tight, she adds. The lead times on new production are long, while demand from China is expected to remain strong for the foreseeable future.

Cliff Hale-Sanders and Terry Tsui of CIBC World Markets Inc. concur. “We view this correction as another bump in the road — maybe bigger than one would like — and a buying opportunity,” they note in a recent report.

The CIBC analysts expect global demand growth for base metals to exceed 4% in 2007, with limited new supply coming onstream in the next couple of years. But both CIBC and Scotiabank believe that, while prices will remain historically high, the peaks reached earlier this year will not be seen again.

“It is hard to envisage a fundamental need for metals prices to move materially higher on an average annual basis to entice new supply,” says the CIBC report. “Supply additions are more a function of physical time constraints than the availability of projects.”

The bull run was never just about fundamentals, however. Speculation during a period of high liquidity in the capital markets also drove the metals to unprecedented highs. Recent events suggest those conditions may be about to change.

Here’s a closer look at the metals:

> Aluminium. The aluminium market looks the weakest, in terms of fundamentals. But if consolidation in the sector continues — resulting in less new capacity — prices could move upward, according to the CIBC report.

London-based Natixis Commo-dity Markets Ltd. is projecting a relatively balanced aluminium market this year compared with last year’s supply deficit. But continuing strength in non-Western world consumption means the metal could move into a significant supply deficit of 250,000 tonnes in 2008.