Macquarie Nickel – signs of life after the collapse

PT Inco (INCO IJ) should continue to see share price strength in the near term, following the unexpected strength in the nickel price. Today, Macquarie commodities team acknowledges that when demand turns for nickel, the price turns very sharply (due to speculative over-stocking). Also, tighter scrap supplies in the upturn can lead to a massive rise in primary nickel demand. It is likely that there would be a significant lag before supply taken off-line could be brought back into production (2-6 months). Finally, history tells us that LME stocks are not always readily “available” in an upturn! The stock trades on 2.1x P/Book and Macq rates Underperform.

Some of the factors explaining the recent rally are:
(1) Short-covering: open interest on the LME has fallen over the past week as prices have rallied, indicating that speculative shorts have covered.
(2) Stainless orders on the rise: after collapsing for the past 6-9 months, reports are filtering through in Europe and in parts of Asia (especially Taiwan) of a rise in orders for stainless steel. There are also reports of a small rise in stainless steel base prices in some markets for the first time in a while.
(3) A growing shortage of secondary nickel: In the stainless steel market, almost half the nickel comes from recycled stainless steel scrap and reports from the market indicate that scrap availability will fall by more than 20% this year. In China, we have heard of a mad scramble to buy ferronickel from the import market as a result of tight scrap availability (and also a collapse in nickel pig iron production). This has run down a lot of the non-reported nickel stocks in recent months.
(4) Fear of further supply disruptions: speculation is growing about potential industrial action at Vale Inco’s Canadian nickel operations, where new labour contracts are due for renewal at the end of May. Including half the Voisey’s Bay product (which is processed at Sudbury), this could affect around 100,000tpa of nickel (around 8% of 2009 world output).

Risks: the team thinks it may be too early to be buying nickel and the risks of a short-term pull back are still quite high. But they acknowledge that risks are gradually moving to the upside as the year progresses and being short ahead of a potential Vale Inco strike may be risky. What concerns the team is the enormous stock sitting on the LME (just over a month demand compared with just over a week of demand in copper for example) and the industry is operating at such a low rate of utilisation (around 75% according to our estimates compared with over 90% in copper). Plenty of potential supply hangs over this market.