COLUMN-Nickel's bull narrative accelerates; too fast?: Andy Home

Thu Apr 10, 2014 9:59am EDT

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(The opinions expressed here are those of the author, a columnist for Reuters.)

By Andy Home

LONDON, April 10 (Reuters) - The nickel market is on a charge.

On the London Metal Exchange (LME) three-month nickel has just hit a one-year high of $17,188 per tonne. The stainless steel input is by some margin the best performer so far this year among the base metals pack, up 22 percent since the start of January.

And for good reason.

This is a market that has just lost almost a third of global mine supply, a bolt of lightning unprecedented in the recent history of commodity trading.

Effective Jan. 12 the Indonesian government banned exports of nickel ore, cutting off a flow of material estimated by analysts at Macquarie Bank at around 670,000 tonnes last year.

The resulting price surge in part represents collective shock that this has actually happened. Although the ban was codified into Indonesian law five years ago, everyone thought the authorities would fudge the issue when the deadline came.

They didn't. The ban is total. Nor does anyone expect anything to change after the double parliamentary and presidential elections in Indonesia this year. There seems to be consensus across the political spectrum that the ban, intended to force the creation of value-added mineral processing in the country, is the right thing to do.

As analysts now work through their nickel supply numbers, there is a hardening consensus that this market is going to switch from chronic oversupply to chronic supply shortfall.

Key questions, however, are how quickly, how far the price might go and is the market already running ahead of itself? ^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^ Graphic on China's imports of nickel ore link.reuters.com/mak48v ^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^

AIMING HIGH

Macquarie Bank's own bullish view is writ large in the title of its most recent research note: "Nickel prices up 25 percent in 2014 - you ain't seen nothing yet" (April 9, 2014).

It forecasts the global market shifting to small supply deficit this year and to stay in deficit for the next four years at least.

That will cause a dramatic run-down of stocks along the supply chain and "we think that by 2016, the market will get tighter than it did in 2006/07."

Gulp! That was a time when LME stocks, at one stage in October 2006, totalled just 3,930 tonnes and the price went on a stratospheric run to over $50,000 per tonne.

Underpinning Macquarie's forecast is a simple calculation that the rest of the world is not going to be able to fill the supply gap left by the Indonesian ban.

Other countries, most notably the Philippines and New Caledonia, can produce nickel ore but not in sufficient quantity or quality to satisfy demand from China's leviathan nickel pig iron (NPI) sector.

Processing plants in Indonesia, in effect off-shoring Chinese NPI production, are not going to be up and running quickly enough. The first, according to Macquarie, will do well to start operations by the end of this year.

The obvious implication is that China's stainless steel sector is going to have to start switching from using NPI to refined nickel for its raw material input.

STARTING SOON

So far, so largely uncontroversial. Macquarie's argument is very much in line with consensus thinking, or the new consensus thinking now everyone's realised Indonesian policymakers are not going to change their minds on the minerals export ban.

Where Macquarie sets itself apart as bull cheerleader is in its contention that this whole process is going to happen a lot sooner than most people expect.

Everyone knows that Chinese NPI producers weren't sitting on their hands as the Indonesian deadline approached. A significant part of last year's imports from Indonesia went into stock-building.

Macquarie itself estimates that such stocks represented around 7-8 months of consumption at the start of the year.

In theory. In practice, though, things are slightly different.

Firstly, those stocks are not evenly distributed among China's NPI producers. Smaller operators have much less inventory on hand and they are already been squeezed by a second development.

The price of nickel ore in China is already accelerating upwards, reducing availability as traders hold onto their stocks in expectation of still higher prices.

That risks bringing forward in time the impact on actual NPI production rates.

Macquarie's view is that Chinese NPI output peaked in the fourth quarter of last year and is now entering a pronounced and steepening downturn. It estimates production of 375,000 tonnes this year, down from 500,000 tonnes in 2013.

BEWARE THE JOHOR SHUFFLE

That still doesn't mean that the price of refined nickel is going to go back to $50,000 any time soon. There are a lot of stocks around, as might be expected in a market that has been notching up cumulative years of production surplus.

Not least on the LME itself, where registered inventory of 278,844 tonnes is just shy of all-time highs.

Bulls can point to the fact that almost half of those stocks, some 133,200 tonnes, are in the form of cancelled warrants, denoting metal earmarked for physical drawdown.

In theory. In practice, though, that high cancelled tonnage figure is a false signal in terms of market balance right now.

Most of the cancelled tonnage, 72,474 tonnes, is located in the Malaysian port of Johor MNI-MYJHB-TOT, a location which has for some time seen an extraordinary amount of cancellation and rewarranting activity, far exceeding actual departure rates.

There have been almost 94,000 tonnes of cancellations and 26,000 tonnes of "reverse" cancellations at Johor this year and those are only the daily net movements. The true total is probably much higher.

Yet actual departures have totalled just over 10,000 tonnes and have been offset by higher arrivals. Johor stocks of nickel are up by a net 15,000 tonnes so far in 2014.

The "Johor Shuffle" is all about using nickel to get letters of credit, a collateral trade that has been overshadowed by the much larger amount of copper that is caught up in China's shadow banking sector.

ACCELERATORS

While LME stocks are sending an overly bullish signal about the market's current as opposed to future need for nickel units, the price rally is being accelerated by two other developments.

The first is the sheer weight of speculative money that has flowed into the nickel market since prices first started moving up in early January.

Market open interest MNI-MOI-TOT has mushroomed from a January low of 231,000 lots to a current 295,700 lots. Quite evidently, given the near $4,000 rise in price over the same timeframe, this hasn't been people rushing to sell.

Market positioning is starting to look extreme and some sort of pause for breath might already have taken place were it not for the second accelerator.

Having lost a major slice of mine supply on Jan. 12, the nickel market is now mulling the possibility of another previously unexpected supply-side hit.

The tense and unpredictable geopolitical stand-off in Ukraine has raised the prospect of harder and more far-reaching sanctions against Russia. U.S. officials have mentioned mining as one area for punitive sanctions if Russia tries to "do a Crimea" in eastern Ukraine.

High on the hit-list would surely be Norilsk Nickel, which last year supplied 232,000 tonnes of refined nickel from its Arctic operations to the rest of the world, first and foremost Europe.

Now, a further escalation of the Ukraine stand-off is not anyone's base case scenario but evidently it isn't a zero-risk possibility either.

It has certainly helped put a bit more fuel on the nickel fire. But maybe just a bit too much.

There is no disputing this market's bull narrative. The implications of the Indonesian ban will be both far-reaching and massively disruptive to China's NPI sector.

But the current rally risks consuming itself in its own heat, the price apparently ignoring the fact that it will take time before NPI production cuts start eating into that stocks overhang.

Moreover, push things too hard and too fast in this market and strange things happen.

The most significant outcome of that 2006-2007 rally to over $50,000 was the commercialisation of a new form of producing nickel in China. It's called nickel pig iron!

(Editing by David Evans)

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