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PRUDENTIAL SECURITIES, INC.
One New York Plaza, New York, New York
(August 11, 1997) METALS: PRECIOUS METALS–Volatility increased in the precious metals complex in response to uncertainties surrounding the availability of platinum and palladium, as well as fluctuations in the U.S. Dollar. Commodity and hedge funds were major participants in otherwise lightly traded markets. At times, their activity exaggerated price moves.
GOLD–The recent surge in the dollar was a primary negative factor for gold. However, the dollar eased toward the end of last week and played a supportive role in gold's moderate recovery. The decline in the bond and equity markets also tended to support gold in its potential role as a safety asset or as an alternative investment. In particular, stock prices of gold- producing companies have rallied during recent sessions and may have contributed to the late-week recovery.
Overhanging the market are the bearish implications of potential central bank gold sales and the banks' presumed reduced commitment to gold. Still, central banks remain major holders of gold and are, at times, reluctant to allow the value of their gold reserves to shrink dramatically. Hence, central bank support buying surfaced when gold recently broke below support at $320 per ounce.
Meanwhile, those gold producers concerned over falling prices have been rushing to sell their output forward to cover their production costs. One recent survey reported average total gold mine costs globally at $315 per ounce. Coming in above this figure were operations in South Africa, Australia and some of the older North American operations. Although a considerable number of high-cost mines are likely to close in the coming months as a result of lower prices, production shortfalls are unlikely to significantly affect the supply outlook or market. However, lower prices may curtail development of new mines and thus constrain output in coming years, possibly developing into a long-term bullish consideration.
SILVER–Commodity funds were particularly focused on silver in broad two-way action. Strong resistance prevailed between $4.50 per ounce and $4.54, basis September, which coupled with the weakness in gold constrained silver. Meantime COMEX silver warehouse stocks continue to erode moderately but steadily, while industrial demand for the metal also remains favorable. However, silver has yet to unshackle itself from the fluctuations in the gold market.
PLATINUM–Platinum futures were volatile, trading in a broad range on the bullish implications of ongoing Russian supply constraints and a labor strike at South Africa's Impala refinery versus the bearish influences of strike settlement talk and a possible resumption of Russian shipments. In the end, Russia announced a resumption of platinum and palladium shipments, which had been delayed seven months, to Japan and the West. However, the quantities sold have been modest and the fabricating industry is concerned that future supplies may remain constrained.
Several uncertainties surround these markets. The reasons for Russia's curtailment of platinum and palladium exports remain unclear and this uncertainty breeds volatility. Some explanations include:
1. A turf battle seems to be taking place to control platinum and palladium sales among Russia's central bank, Almaz (the Russian sales agency that previously had been responsible for such sales) and other government organizations.
2. Policy differences related to this controversy may include either constraining exports to rally prices or retaining moderate, favorable prices to avoid industrial substitution of platinum and palladium with other metals, possibly silver or nickel.
3. Supplies may not be available and Russia may want to retain some stockpiles of platinum and palladium as safety assets.
4. Apropos, the Norilsk mining complex (Russia's major source for these metals) is reportedly operating at 50% of its capacity. In addition, it is experiencing a severely acrimonious partial privatization endeavor, which suggests continued production problems.
The new twist last week was the strike at South Africa's large Impala platinum refinery, which produces about 1 million ounces per year. Rumors that the strike may end shortly resulted in some heavy profit-taking last Wednesday, although earlier indications had suggested that negotiations between the company, Amplats, and the National Union of Mineworkers would take place August 12.
Disruptions in Russia and South Africa are of critical importance to the markets because Russia produces about 70% of the world's palladium and 25% of its platinum; South Africa produces most of the rest, with 25% of palladium and 60% of platinum output, In essence, the world is captive to these two sources of platinum and palladium, and any dislocations in either region can have a sharp impact on prices.
The precious metals markets retain the potential for extreme volatility, as each follows its own path. December gold's range is likely to remain narrow, with $320 marking the downside and $340 the upside; September silver should stay between $4.25 and $4.50; we would be inclined to probe the long side of this contract near the $4.30 level. October platinum is likely to trade in a broad range of $425 per ounce to $470 as the various situations described above come alternatively to the fore. There is an acute shortage of palladium at present, with the unanswered question being whether Russia has supplies and is willing to ship soon. Meantime, our range for September palladium is $185 per ounce to $250.
COPPER–Copper came under downside pressure as London Metal Exchange (LME) warehouse stocks continued to rise sharply. Since the end of June, these stocks have risen by 116,000 tonnes to a total of 249,000. Comex warehouse stocks increased by a modest 2,000 tons during the same period. Although inventory increases are common during the slowdown in seasonal demand, recent increases have been larger than usual, suggesting several possibilities: (1) selling by Chinese sources because of low demand of in efforts to move prices lower for repurchase purposes; (2) selling of physical copper by a South Korean copper-producing organization in order to offset recent losses in other industrial metals; or (3) a decline in demand.
The U.S. economy remains expansionary, a constructive factor for copper demand. However, the recent release of extremely favorable U.S. employment data raised concerns that interest rates might rise in the months ahead. Higher rates tend to decrease demand for interest-fate sensitive copper-consuming products (such as housing, appliances and automobiles) and can be perceived as somewhat bearish.
Arguing against such a bearish factor is the renewed interest by commodity and hedge funds in the industrial metals sector, which has rallied these markets. Some funds may have perceived the likelihood of higher prices on the approach of the high-demand fall season. Because the supply/demand outlook for many of these metals (including copper) is balanced, any rise in consumption or constraints in supply can move prices higher.
We expect copper to trade sideways in the coming weeks, in an initial range of 103.50 cents per pound to 110.00, basis December. We recommend long positions near the lows of these parameters, risking 3.00 cents.
Bette Raptopoulos
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