In the intervening period to almost 5 years’ later, the nickel price has closed at US$4.67/lb on 21 October 2008 after touching a low of US$4.55/lb, with the 27-month LME price at US$11,700/t (US$5.30/lb).

During the past 5 years, nickel rose steadily to peak at almost US$25/lb in May 2007 and fell as China “rattled the sabre” stating in a June 2007 Shanghai conference that stainless steel production was expected to fall and nickel pig-iron production was significantly increasing to fill the supply-demand gap. Although stainless steel production figures actually rose during the 2007, the damage had been done.

The rise of the new commodity hedge funds in early 2008, collectively shorting nickel on a one-month to 3-month time frame is probably one of the main reasons behind the weaker nickel price, since as shown in Figure 1, LME stocks have only risen by ~7,000tNi to 56,000tNi, while the nickel price has fallen US$4/lb in the past 7 weeks. In fact since April 2008, the nickel price has fallen over US$8/lb from almost US$13/lb, while the LME’s stockpiles have only risen by ~4,000tNi.

Alas, looking at LME stockpile comparisons over a longer period does not correlate properly any more because the LME relaxed their holding requirements for nickel twice in mid-2007, both times resulting in higher stockpiled quantities.

However, nickel’s fall was definitely exacerbated by RIO’s recent comments that China is slowing, with RIO curtailing projects (quoting that it is hard to justify building a nickel laterite plant at these prices), and reputedly making major staff and expenditure cut-backs in their international exploration division.

Theoretically of course, RIO’s comments should have partly cancelled each other out as the expected increase in demand was to be offset by new projects coming into production. If exploration is being curtailed in any form then that usually increases the lag in production’s capability to catch up when demand recovers. And if (as usual) the majors have over-reacted with their closures and cut-backs, then their perception of reduced demand may also be overconservative, narrowing the supply-demand gap.

Also in the intervening period, costs have risen significantly in power, labour and consumables, such that at US$4.50/lb up to 60% of the world’s nickel production may be uneconomic. The nickel pig-iron producers became uneconomic at possibly about US$9/lb, followed by the nickel laterite producers at about US$8/lb, and below US$6/lb a number of the lower grade nickel producers that do not have significant by-product credits would have to be feeling the squeeze.

While China is anticipated to slow to an expected growth rate of 7% to 8%pa (for possibly at least another 10 years), that is still quite a healthy rate on top of the unsustainable ~11.5%pa. At the annual China Mining conference in November 2007, growth of 7% to 8%pa was expected under a scenario in which the US fell to zero growth. Although that scenario has occurred and the impact on China appears to be greater than envisaged due to the rolling impact it has had on the rest of the world, it should not result in more than a halving of world nickel demand.

One of the big questions is how much of the annual nickel demand from China is domestic consumption, and of that exported by China, how much goes to Chinese construction projects throughout the world.

Admittedly the Australian producers are cushioned to some degree by the weaker A$ which has recovered to US$0.70 (up from a low of ~US$0.64), although it is well down from the expected near parity it attained at US$0.98. However, the credit markets are expected to remain under pressure until the collapsing risk of the “pyramid of derivative cards” has been reduced.

As for the new nickel laterite mining projects that were going to annually fill the originally expected increased demand for nickel, it is going to be very hard for the major resource companies to justify constructing them at up to US$4bn (Xstrata’s Koniambo) to achieve a viable return, as the current price fall literally “blows apart” any required guarantee of the nickel price remaining above US$8/lb for the long-term – and that is probably a minimum requirement for such nickel project approvals.

In our (ERA) opinion, the nickel price should recover and remain above US$5/lb, in fact we think that it should be at least above US$6/lb long-term.

It has to be recognised that the longer the nickel price remains below US$6/lb, there has to be increasing pressure on the current world nickel producers to close or significantly reduce (albeit temporarily) any loss-making operations. Then there are the majors who have probably overreacted in curtailing projects as China appears to be more robust than they think it is.

And lastly there is the “x” factor of the hedge funds and whether they have shorted nickel and are unable to deliver when the shorts fall due in 1-month to 3-months’ time.

Disclosure and Disclaimer: This article has been written by Keith Goode, the Managing Director of Eagle Research Advisory Pty Ltd, (an independent research company) who is an Authorised Representative with Taylor Collison Ltd, and with his associates, may hold interests in some of the stocks mentioned in this article. The opinions expressed in this article should not be taken as investment advice, but are based on observations by the author. The author does not warrant the accuracy or completeness of any information and is not liable for any loss or damage suffered through any reliance on its contents.

Figure 1. Nickel Price (US$/lb and A$/lb) and LME Stockpile (000tNi) (1 Sept to 21 Oct 2008)