This time last year, it was difficult to find a mining analyst who was bearish on base metals. Demand for the metals, mostly by China, was so high and inventories so low that prices seemed to have nowhere to go but up.

The bulls were right. Almost all base metals ended 2004 near their highest levels in years. Copper rose 34%, aluminum 21%, and lead, zinc and tin all had double-digit gains. The only metal that dipped was nickel, but on an average annual price basis, it gained about 44% from 2003 levels.

But what about now? Most analysts are
optimistic that base metals prices will remain robust in the long term, but the crystal ball has become murkier for 2005. As companies scramble to take advantage of high prices by boosting production, new supply could temper the uptrend.

The other wild card is the U.S. dollar. If it continues to decline, metals could have another banner year. But a rise in the US$ — seen as unlikely by most analysts — could have the opposite effect. This happened on a short-term basis in January, when a higher US$ triggered a metals sell-off by investment funds, sending metal prices crashing.

Demand is less of a concern. Double-digit growth in China’s industrial production is expected to continue through 2005, although at a somewhat slower pace, while there are signs of positive growth elsewhere in the world.

“At this stage, most of the evidence points to more of the same for the Chinese economy — high and sustainable economic growth rates that should support the base metals sector in 2005,” London-based GFMS Metals Consulting Ltd. says in a recent report.

Until a few years ago, metal prices had been so low for so long there was little incentive for mining companies to develop new deposits. Exploration and development expenditures plummeted, and few new deposits were added to the pipeline. The results are plainly visible on the London Metal Exchange, on which base metal inventories are plunging on a daily basis and flirting with 15-year lows.

Because it usually takes years to develop a new mine, the supply imbalance could last a long time, especially if strong demand from China continues. But there is fresh evidence, especially in the copper market, that new supply is coming onstream in response to higher prices. That could spell trouble in the short term for mining
investors.

Citing new information about aggressive development and expansion plans in the copper industry, the International Copper Study Group recently raised its projections for copper-mining capacity. For example, Chile-based Codelco, already one of the world’s largest copper producers, increased its budget to expand existing mines and build new operations in its home country by 27%. Worldwide capacity is expected to grow by 3.2 million tonnes over the next three years, turning some analysts bearish despite ongoing supply deficits.

Supplies of nickel will pick up at the end of the year, when Voisey’s Bay in Newfoundland and Labrador, the first of a series of major new mines, starts shipping its first concentrate. Until then, labour disputes are expected to keep nickel inventories tight and prices relatively high.

“The common theme of slowing global demand growth, coupled with recovering production, means many markets will move into surplus in the second half,” says a recent report from London-based Standard Bank. “This means we are close to, or have already seen, the peak of the current price cycle, and annual averages will be lower in 2005.”

The only two metals Standard Bank is bullish on this year are zinc and aluminum, which it says are undervalued and headed for supply deficits in 2005 and 2006.

Analysts at New York-based JPMorgan Chase & Co. are also concerned about new supply. The firm expects copper output to increase 7.5% this year, nickel by 5.8%, and aluminum, lead and zinc by about 4%, while growth in industrial production in China is expected to slow.

The effect the changing fundamentals will have on metal prices is clear. The firm expects copper to average US$1.22 a pound, compared with US$1.30 in 2004, while nickel is expected to drop to an average of US$6 a pound from US$6.24. Not huge drops, but a reversal of the upward trend.

Canaccord Capital Inc.’s Toronto office is looking for a volatile year in the metal markets, as China continues its transition to a market-based financial system. The brokerage has brightened its forecast for 2005 copper to US$1.21 a pound from US$1.16 because of ever-declining LME warehouse stocks, but Canaccord analyst Greg Barnes does not believe demand from China will necessarily result in higher metal prices overall because of the dampening effect of increased supply.