Base Metals: Second Quarter Outlook

NEW YORK (TheStreet) -- Based on fundamental factors of base metals and macroeconomic aspects, we provide the second quarter outlook for base metals -- aluminum, copper, zinc, lead and nickel. Furthermore, we present four base metal stocks which have potential upside based on average analyst consensus estimates.

Global Scenario

According to the International Monetary Fund's (IMF) latest report on the global economy, recovery is underway and global economic growth is likely to be 4.4% during 2011. Advanced economies are seen growing at 2.5%, headed by the US with 3%. However, China's growth projections are unchanged at 9.6%.

Overall, as emerging markets experience moderate growth, developed economies, on the other hand, may continue to witness strong growth. With these two factors combined, demand for base metals is forecasted strong.

Performance of Base Metals

Base metals ended 2011 first quarter on a mixed note with single-digit percentage gains in nickel, lead and aluminum, and modest losses in zinc and copper. Unrest in the Middle East and North Africa, and implications of the catastrophic events in Japan has piled pressure on prices. Heightening demand uncertainty ballooned inventory across the entire base metals complex, except nickel.

On the other hand, the MSCI World Index was marginally up by 0.8%, dented by soaring crude oil prices and the natural calamities in Japan. Gold prices during the quarter increased 0.8% while silver prices were up 21.8%.

Base metals are expected to continue to rally, taking cues from strong economic growth. Additionally, China's buying activity in the second quarter will soar ahead of the construction activity picking up in the third quarter. Besides, supply constraints are foreseen due to unfavorable weather conditions.

A weakening US dollar index could drive base metal prices higher. At the end of the first quarter, the euro and pound strengthened versus the dollar index that shed 4.2%, thereby pushing commodity prices higher. Unlike other central banks, the Federal Reserve is not expected to raise interest rates in 2011 thereby pushing the US dollar index lose ground under pressure.

9. Aluminum

Going forward to the second quarter, in the near term, aluminum prices could dip following the devastation in Japan - Asia's largest importer. However, we expect China's demand to remain strong for the second quarter with term premiums for aluminum shipments set at $113 per ton, unchanged from the first quarter, indicating robust demand levels. Further, European premiums continue to remain high as a chunk of LME stocks are locked in financing deals.

At the end of 2011 first quarter, aluminum prices on the LME ended at $2,560 per ton, 3.6% higher on the back of strong demand and rising stockpiles. LME inventory levels for the same period climbed 7.85% to 335,775 tons, taking total stock level to 4.61 million tons. However, for the same period, China's aluminum warehouse stocks dropped 6.7% to 411, 589 tons.

For the first two months of 2011, world aluminum production stood at 6.67 million tons, an increase of 3.3% from the same period in 2010. China contributed almost 2.59 million tons to the total production. Meanwhile, latest available data show aluminum consumption in January 2011 increased 1.6% to 3.28 million tons from January 2010 levels.

8. Kaiser Aluminum ( KALU), semi-fabricated specialty aluminum products manufacturing company, operates through one reporting segment: Fabricated products. The company's other business units are secondary aluminum, hedging, corporate and other.

For the latest fourth quarter, Kaiser reported sales of $265.8 million against $237 million in the year-ago period. Adjusted consolidated operating income for full year 2010 stood at $65 million, increasing $12 million from the prior levels. The company declared a quarterly cash dividend payment of 24 cents per share, payable May 13, 2011. Kaiser is scheduled to release its first quarter earnings on April 27, 2011 after the market closes.

For full year 2011, capital spending is estimated between $35 and $45 million, mainly directed towards maintenance expenditure and continued investment for quality, operating efficiency, and debottlenecking across the company's operations. The company's efforts to improve top-line and bottom-line growth through purchase of Alexco and Nichols Wire and the launch of a new, world-class remelt and extrusion facility in Michigan, will support it to capitalize on the opportunities in its served markets in 2011.

Of the four analysts covering the stock, 50% recommend a buy on it while the remaining suggest a hold. There are no sell ratings on the stock. Analysts polled by Bloomberg expect the stock to gain an average 28.8% to $61.0 in the upcoming 12 months.

7. Alcoa ( AA) engages in mining, refining, smelting, fabricating, recycling, and the production and management of aluminum, fabricated aluminum, and alumina combined. The company operates in 31 countries and has investments and operating activities in Australia, Brazil, China, Guinea, Iceland, Russia, and Saudi Arabia.

For the first quarter of 2011, Alcoa reported 22% increase in revenue to $5.96 billion, led by rising aluminum and raw material (alumina) prices. In fact, the significant demand arising from the aircraft, automobiles, industrial goods and packaging industries cushioned profit levels. Alcoa swung to a net profit of $308 million or 27 cents per share during the first quarter of 2011, compared to a net loss of $201 million or 20 cents per share in the year-ago quarter.

The company has reaffirmed its guidance of 12% growth in global aluminum demand, although the ongoing uncertainty in many countries and China's efforts to curb inflation could slowdown growth, raising concerns on the metal's outlook. Moreover, the company's latest acquisition of aerospace fastener business TransDigm Group for $240 million is seen to be accretive to the company's earnings and cash flow in the first year itself.

Of the 17 analysts covering the stock, 53% recommend a buy on it while 29% suggest a hold. Analysts polled by Bloomberg expect the stock to gain an average 23.3% to $20.4 in the upcoming 12 months.

6. Copper

Analysts expect the market to experience a supply-demand mismatch as overall mine capacity is seen restricted due to lower ore grades and shortage of mine workers. A report by International Copper Study Group expects copper mine capacity to increase by only 4.9% to reach 24.1 million tons between 2011 and 2014. We believe that a combination of these factors will push copper prices higher.

At the end of the first quarter, LME copper prices ended at $9,510 per ton, down 1% on declining Japanese demand and rising stockpiles. Meanwhile, for the same period, LME monitored inventory levels rose 13.8%, or 52,100 tons, taking total stock to 429,650 tonnes. For the same period, China's warehouse stocks escalated 34.5% to 45,474 tonnes.

For January 2011, world copper production increased 6.8% year-over-year to 1.68 million tons, while consumption for the same period was up 12.4% to 1.62 million tons. However, U.S. production for January 2011 was down 6.3% to 90,100 tons as compared to January 2010, Consumption levels for the same period in the country increased 4.3% to 147, 000 tons.

Refined copper output in 2011 is seen rising by 1% to 19.3 million tons, while consumption is pegged at 4.5% to 19.7 million tons. With a net deficit of 435,000, our base case scenario therefore anticipates copper prices to continue the uptrend. Demand from Japan could cap in the near term, but will pick up once reconstruction activities begin. In fact, a balanced supply-demand scenario in China is crucial, as it contributes almost 40% of total world consumption.

Overall, strong equity markets and base metal prices share a good correlation with favorable economic prospects boosting demand for metals. However, a very strong correlation is marked between the movement of Dow Jones and copper prices. Over a 120-day period, the correlation between Dow Jones and copper stood at 0.94, indicating that the price movements for both followed the same direction.

5. Southern Copper, an integrated copper producer and a subsidiary of Mexican miner Grupo Mexico, also engages in the production of molybdenum, zinc and silver. The company has exploration, mining, smelting, and refining activities through facilities located in Peru, Mexico and Chile. Broadly, the company operates through three segments: Peruvian operations, Mexican open-pit operations, and Mexican underground mining operations.

Southern Copper, one of the world's largest copper producers, expects its production to increase to 600,000 tons in 2011 from 450,000 tons in 2010 as its Buenavista mine in Mexico reopens after being shut down for more than two years. The company is focusing on new operations in South America with copper exploration in Argentina advancing and exploration plans underway in Ecuador. Southern Copper estimates demand to recoup as Japan starts its reconstruction.

For the latest fourth quarter, Southern Copper's profit was up 36% from the same quarter a year ago. While the company foresees China's consumption to remain strong, Brazil's demand is likely to increase by 500,000 tons in 2011 from 2010 levels. The company expects its $1.3 billion Las Chancas project in Peru to start production in 2014 or 2015, pending its feasibility study report. The company's 2011 production guidance for molybdenum is 17,000 tons.

Of the 18 analysts covering the stock, 33% recommend a buy while 50% rate a hold. On average, analysts estimate 30.1% upside to $47.0 from current levels.

4. Nickel

Looking ahead to the second quarter, supply disruptions, in the backdrop of strong demand from large producing countries like China, will support nickel prices. Factoring in the consistent drawdown from LME inventories, we foresee robust demand for the metal. Furthermore, with premiums in the spot market remaining high, nickel prices could continue the uptrend. For full year 2011, the nickel market may face a deficit as declining inventory levels indicate tight market conditions.

At the end of the first quarter, LME nickel prices ended 8.1% higher at $26,750 per ton, outperforming the other metals in the complex as demand for steel remains strong in China and India. LME stockpiles fell 7.8%, or 10,572 tons, taking the total to 125,100 tons, reflecting strong demand for the metal.

Beginning 2011, nickel output levels experienced strong declines indicating that supply disruption would occur in many instances. Vale ( VALE), one of largest producers of nickel, announced that it would lose almost 5% of its 2011 production due to a 16-week shutdown of a Canadian smelter. Moreover, five nickel mines in Caledonia, which contributes almost 4% of the global production, were affected by a cyclone in January 2011.

3. Zinc

At the end of the first quarter, LME zinc prices slipped 5% to close at $2,325 per ton, underperforming the entire base metals complex as supply outpaced demand. Oversupply expanded LME zinc inventories by 5%, or 34,775 tons, taking the total to 736,200 tons. For full year 2010, stockpiles were up by 215,150 tonnes. In addition, China's warehouses grew 15% or 43,801 tons. The combined inventories of the two warehouses are equal to more than a million tons, or one month's global consumption.

For January 2011, zinc slab production increased 10.7% year-over-year to 1.14 million metric tons (all time high), while consumption was up 15% to 1.07 million metric tonnes.

Over the past few months, global zinc production has stabilized at 1% to 2%, while consumption was relatively flat at 1.06 million tons in the past couple of quarters. Thereby, in such a scenario, zinc prices are seen affecting unfavorably. Meanwhile, in January 2011, zinc was in surplus of 36,000 tons.

During 2010, 60% of Japan's zinc capacity was shut down, an incredible amount given that the country accounts for 271,000 tons of global supply. Furthermore, the closure of smelters coupled with an estimated pick up in demand due to an improving economic outlook led to higher premiums in the zinc spot market.

2. Horsehead Holding ( ZINC), a producer of specialty zinc and nickel-based products, primarily sells to customers in the U.S. The company is also engaged in the recycling of electric arc furnace dust in the U.S. and is a recycler of hazardous and non-hazardous waste for the specialty steel industry.

For the latest fourth quarter, the company reported earnings of $14.6 million or 16 cents per share, with $7.7 million recorded as a one-time benefit from insurance recovery related to the blast at its Monaco refining facility. Earnings per share in the year-ago quarter stood at 11 cents. In addition, net sales increased 40% to $96.3 million, led by higher volumes, prices and acquisitions.

During the first quarter of 2011, the company ran at almost full capacity, without any disruptions from the factory incidents that occurred in 2010. The company renewed major contracts, and shipments of zinc oxide are expected to rise through 2011.

Of the six analysts covering the stock, 50% recommend a buy on it while 33% suggest a hold. Analysts polled by Bloomberg expect the stock to gain an average 29.2% to $20.0 in the upcoming 12 months.

1. Lead

Demand for lead is likely to restore as the massive destruction in Japan led to the closure of the country's manufacturing sector. Furthermore, demand for batteries--the best alternative in the short term--will increase and support lead prices to rally higher. Additionally, in the long term, lead could also benefit from the eventual reconstruction demand-side boost from Japan, especially the country's auto sector.

At the end of the first quarter, LME lead prices were 5% higher at $2,677 per ton, outperforming other metals in the complex on the back of strong demand. Meanwhile, for the same period, LME inventory levels rose 38.5%, or 80,375 tons, taking total stock to 288,650 tons.

For January 2011, global refined lead production was up 19.3% year-over-year to 853,010 tons, while consumption for the same period was up 22.6% to 874,543 tons. China contributed 422,300 tons to the total production levels.

Major growth was recorded in global lead production is on the back of China's lead smelters reopening idle capacities that were earlier closed due to irregular power supplies. China is increasing production as battery demand--major end use of the metal--is expanding. Additionally, rapid expansion in global automobile sales is providing room for further growth in the consumption of the metal.

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