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PRUDENTIAL SECURITIES, INC.
One New York Plaza, New York, New York
(September 29, 1997) METALS: GOLD–The potential for higher U.S. inflation lifted the precious metals complex higher as gold prices rallied. Last Thursday, several economic reports caused traders to question the scenario of a slowing U.S. economy. The reports revealed an unexpectedly large rise of 2.7% in August durable goods orders as well as an upward readjustment of the July data. In addition, a decline in jobless claims were reported for the week of September 20. Interestingly, the issue of whether U.S. interest rates would increase on such an expansionary outlook did not arise. It appears an interest rate hike is unlikely given prevailing global currency instabilities and related strength in the U.S. Dollar.
Ironically, a weaker dollar lent support to precious metals prices earlier in the week as the U.S. currency came under pressure versus the Japanese Yen and Deutschemark after Japanese and German leaders indicated they wanted their currencies to remain firm. Similar talk and threats of currency action by other industrial nations may move the dollar lower for the short term, but the reality remains that a strong U.S. economy will inevitably attract investors to the dollar until the economies of other industrialized nations resume their expansion. Therefore, we anticipate a stronger dollar ahead and believe that would likely to keep a lid on gold prices.
Other considerations in the gold market outlook include:
(1) Reports that Australian producer gold selling has resurfaced in a substantive fashion. As a high-cost producer, Australia is anxious to seek price protection, even at current low price levels. A recent report by Gold Fields Mineral Services Ltd. of London put Australia's production costs for gold at $272 per ounce, second only to South Africa's costs of $318 per ounce. The United States and Canada ranked third and fourth at $222 and $221, respectively.
(2) Resurfacing rumors that some central banks are assessing the possibility of gold reserve sales. (Central bank officials in Taiwan denied recent rumors of plans to sell gold from their 400-tonne reserves.)
Clearly, the overhanging bearish issue remains the potential for such gold sales and the related view that central banks have diminished their commitment to gold as a reserve asset. However, we continue to believe that central banks do not want to see gold prices decline sharply because it would diminish the value of the large quantities of the metal they still hold in their reserves.
Two factors may contribute to the market's constructive nature: (1) the resurfacing of inflation concerns, which also were expressed by Federal Reserve Board Governor Susan Phillips in a recent speech; and (2) the likelihood that investors will begin to include precious metals in their portfolios.
SILVER–Silver continues clinging to gold as a price indicator, despite dichotomous fundamentals. Although the threat of central bank gold sales spooks investors, silver supplies appear to be declining in the face of rising U.S. industrial demand for the metals in an expanding economy. However, investor interest in gold and silver is moderate as the primary investment vehicles remain the equity and bond markets.
PLATINUM AND PALLADIUM–Platinum made a six-week high of $442 per ounce on supply concerns and related investor and hedge fund interest. Prices remain volatile due to ongoing uncertainty over future availability. Russia, one of the largest producers had suspended deliveries for the first half of the year, and shipments have been sporadic in the second half due to bureaucratic infighting. Platinum is used in auto catalysts for emission control purposes, jewelry, electronics and other industrial purposes. Likewise, palladium is used in electronics and auto catalysts.
We believe that the quantities of platinum and palladium in Russia have shrunk considerably since the beginning of the year, and that there is little chance that inventories will be replenished in the foreseeable future. Part of the problem is that production of platinum group metals (as well as nickel, of which these metals are a byproduct) has been eroding steadily in recent years, a situation that has not yet run its course. Indeed, supplies of these metals may remain at low levels for several years. The major source of the platinum group metals, the Norilsk mining complex in the Arctic, has been experiencing financial difficulties, severe pollution problems and acrimony between the government and the mine's private owners. These warning signals suggest a possible shuttering of some operations and labor unrest (especially because workers get paid only sporadically).
Several sources, including a major South African producer and a metals-oriented U.K. brokerage firm suggest global demand for platinum could exceed supply by about 200,000 ounces this year. In 1996, total supply and demand were basically in balance. Supplies equaled 4.9 million ounces while demand (including Western sales to China) was 4.88 million ounces, according to Johnson Matthey's Platinum 1997 report.
PRICE OUTLOOK–Gold prices are likely to trade in a range of $325-334 per ounce. basis December. We recommend buying December silver on a possible setback near the lows of the following range: $4.65- $5.10 per ounce. We are sidelined in platinum and palladium, despite our bias to the upside, because we consider the market excessively volatile. Our ranges are: October platinum, $420-$460; and December palladium, $180-$220 per ounce.
COPPER–In a tug-of-war between two opposing forces, copper moved sideways last week. The bearish forces center on increases in warehouse stocks at the London Metal Exchange (LME) and COMEX. Copper inventory levels should have begun to stabilize, if not decrease, on a seasonal basis by now. The rising stocks reflect concerns that there will be a severe slowdown in Southeast Asian economies due to recent currency crises as well as the possibility that the slowdown will adversely impact Japan's economy and its copper consumption. On the bullish side of the equation are weather-related production constraints. Both shipping impediments from Ok Tedi's large copper mine in Papua New Guinea and flooding conditions in some South American mines are likely to support copper prices later this year.
On a broader note, IBM's announcement that copper will replace aluminum in the manufacture of its computer chips should enhance copper's image as an excellent conductor. However the quantities of copper that would be used in IBM's new process likely will be quite modest and not enough to immediately impact copper's supply/demand equation. The announcement, however, encourages increased research into other applications for copper in industry and technology.
Given the countervailing forces at work in the copper market, we remain sidelined and expect copper to continue to trade sideways between 92.50 cents per pound and 102.00 cents, basis December.
Bette Raptopoulos
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