LME zinc, nickel and lead drop; volatility expected

London Metal Exchange zinc, nickel and lead fell sharply Monday driven by follow-through fund selling and activity ahead of the rebalancing of a major index, with traders expecting price volatility to remain a key feature this week.

"We saw a continuation from last week's sell-off" in Monday's drop, said a LME trader, with "sell the rallies" the prevailing sentiment. Three-month nickel, zinc, and lead dropped Monday between 2%-3%, respectively.

Fund-selling triggered stops on the way down, which accelerated the fall, the LME trader said. An increase in stock levels for each of the metals Monday, as well as the smaller liquidity of those markets, exacerbated the impact of the selling pressure, analysts added.

Monday is the first real trading day of 2007, with many market participants returning after the long holiday and this added to liquidity, said Michael Widmer of Calyon.

Moreover, analysts pointed to the rebalancing of the Dow Jones-AIG Commodity Index Fund as adding to price pressure.

The Dow Jones-AIG Commodity Index rebalancing begins after Monday's determination date and will be fully implemented on Jan. 16. The new target weights were approved by the Dow Jones-AIG Commodity Index Oversight Committee in July 2006.

Rebalancing and reweighting means that, in general, the index may reallocate out of commodities that have appreciated in value and into commodities that have underperformed.

LME zinc and nickel are particularly affected by the rebalancing of the DJ-AIGCI Fund as the two metals were particularly strong performers in 2006. Nickel and zinc increased around 135% and 110%, respectively, during 2006.

According to DJ-AIG, zinc's weighting for 2007 is 2.798069%, up from 2006's weighting of 2.702377%, while nickel's 2007 weighting is 2.715318%, up slightly from 2.659153% in 2006.

"Further weakness looks assured this week as the DJ-AIG index is reweighted with heavy selling of nickel and zinc in particular expected," said UBS in a note.

However, the LME trader said the concern is overdone. "I think prices will begin to stabilize and consolidate after the latest shake-out because they are now closer to fairer values," said the trader.

Barclays Capital said in a note that the issue of rebalancing "has been blown up out of all proportion" since the amount of selling is relatively small compared with typical market volumes and the process of reweighting itself is very transparent.

Elsewhere, bargain-hunting and technical buying helped push LME three-month aluminium and copper prices off their earlier lows, another LME trader said. Aluminium is looking to consolidate after falling nearly 10% since the start of 2007, while copper prices are severely oversold after falling over 10% from the start of 2007, the LME trader added.

LME copper pushed up nearly 3% from Monday's low of $5,430/ton to a PM kerb of $5,606/ton, and aluminium traded to a PM kerb of $2,625/ton, up from Friday's close of $2,610/ton.

Prices in dollar a metric ton.
3 Months Metal     Bid-Ask        Change from
                                 Friday PM kerb
Copper           5606.0-5607.0      Dn    4
Lead             1555.0-1557.0      Dn   65
Zinc             3720.0-3725.0      Dn  190
Aluminium        2610.0-2613.0      Up    5
Nickel