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PRUDENTIAL SECURITIES, INC.
One New York Plaza, New York, New York
(October 20, 1997) METALS: GOLD–The dollar surged late last week on concerns over a possible interest rate tightening by the Federal Reserve Board, given Friday's favorable economic data for September. The reports included a better-than-expected 7.9% rise in U.S. housing starts, a 0.7% increase in industrial production and a rise of 0.3% in capacity utilization. Although the implications of higher inflation as well as the related sharp sell-off in the stock market were constructive for gold and silver prices, the dollar's rally capped the metals' upside movement.
Earlier in the week, gold and silver had given back their recent, modest gains late last week in response to benign inflation data, including a moderate 0.2% rise in the September Consumer Price Index. The earlier firming in these markets had been attributed to rising concerns over inflation on more favorable economic data. Also, accelerated producer selling pressured gold lower as did sporadic surges in the equities markets, which suggested a diminished role for precious metals in an investment portfolio for the moment.
In essence, both investors and hedge funds have been trading precious metals sporadically, in response to an alternating bullish/bearish scenario. The bullish scenario includes the following factors:
–For September, a better-than-expected retail sales figure, which tends to fuel inflation fears.
–The rising political acrimony in Russia wherein the Dumas (led by the Communist contingent) threatened a no-confidence vote against the government. However, President Yeltsin has requested postponement of the legislative vote, a move that may be signaling a compromise agreement.
–Precious metals' role, as alternative investments on portfolio reallocations, triggered by fluctuating stock and bond markets.
–Long-term uncertainties surrounding implementation of a single European currency, the ECU, which may destabilize some currencies, in the interim at least. Conversely, some countries may sell part of their gold reserves to adjust their finances to conform to European Monetary Union requirements.
The bearish factors include sporadic reports and rumors that central banks are selling gold as well as producer selling that intensifies on modest rallies. As we have been noting in previous reports, some producers now sell in order to lock in production costs whereas forward selling in earlier years had been focused on locking in profits.
SILVER–Silver has been fluctuating on technical fund activity, spurred at times by gold price movements. Meantime, COMEX silver warehouse stocks have ceased declining and now appear to be stabilizing, thus diminishing the bullish incentive.
PLATINUM AND PALLADIUM–Platinum and palladium prices surged, with the latter rallying the $6.00 per ounce limit on rising concerns over supply availability from Russia. The most recent report is that output from one of Russia's Norilsk plants will be cut by half during a five- to six-month period when plant repairs take place. The plant's nickel output will be cut by 33% and copper by 25%. However, Russians do not release data on platinum and palladium and guard these numbers closely. (They are quite liberal in releasing information on other metals, including gold.) One explanation for this secretive policy may be that Russia remains sensitive to potential competition as a major producer of platinum and the world's largest producer of palladium.
Earlier in the week, the Russians remained anxious to convey the impression that supplies were ample and denied production closures (but each government agency has a different story). Therefore, we will not be surprised if production shortfall estimates mentioned earlier, which came from Norilsk's management, would be modified in coming days. Meantime, autocatalyst fabricators and other users remain concerned over supplies. Hence, volatility is likely to continue through year end and probably much longer.
Our view is that Russian platinum and palladium inventories have most likely been drawn down in recent years to offset decreased production at the Norilsk mining operations. Russia's financial requirements have, made it imperative to maximize hard currency income, which also encompassed sales of platinum and palladium.
Thus, we continue to expect higher prices in these markets, with sporadic profit-taking creating strong volatility.
We would be inclined to buy precious metals on setbacks near the lower levels of the following ranges: December gold. $322-$340 per ounce: December silver, $4.80-$5.30 per ounce; and January platinum, $418 to $445.
COPPER–Copper firmed moderately last week in response to several constructive features, the most critical being the stabilization in London Metal Exchange (LME) warehouse stocks and subsequent decline of about 3,000 tonnes last week. Stocks had increased 223,000 tonnes since the end of June.
In mid-week, reports of an earthquake in central and northern Chile, the world's largest copper-producing country, firmed the market. The support faded when Codelco, the state copper agency, reported that copper mines were not damaged and remained fully operative. However, we would not be surprised to see earthquake- related supply constraints develop either via mine obstructions or delivery and shipping problems from the devastated regions.
Another source of supply constraint centers on the inability of the Union Pacific Railroad to provide timely deliveries because of a shortage of railway cars and other structural impediments. This is a broad problem for the company, which may continue for some time. Meantime, copper shipments, particularly from Arizona, are likely to experience considerable, delay, which could create some supply tightness for the balance of the year.
Other supply concerns include weather-related problems experienced by the Ok Tedi copper mine in Papua New Guinea, and the curtailment of output at Russia's Norilsk operations, where 425,000 tonnes of copper are produced annually.
We recommend long positions in copper, expecting an upside move in the months ahead and a range of 94.50 cents per pound to 104.00 cents, basis December.
Bette Raptopoulos
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