Of the six major base metals, nickel has been the most volatile performer over the past several months. As we'll soon explain, that's not such a big surprise. This market is faced with a supply-and-demand dilemma that's making for tricky forecasting and treacherous trading.

The Big Collapse

After surging to highs near $25/pound on the London Metal Exchange in May 2007, nickel prices not only retreated, but went virtually into a free fall, dropping to around $12/pound in a matter of a few months. They spent some time consolidating thereafter, only to sink further this spring and summer, bottoming out at around $8/pound in early August. They've been making a tepid recovery over the past few weeks, still trading below $10/pound.

A major catalyst has been slowing global demand for the metal. The troubled U.S. economy and the collapse in the housing sector can certainly be partly blamed. But also important was that stainless steel producers, who account for about two-thirds of nickel's end market, were finding it just too expensive to purchase nickel, as prices surged to those lofty levels last spring.

Japanese and Chinese stainless steel mills cut production, or at least switched to some product lines of stainless steel that consume lower amounts of nickel. According to a recent Citi report, the ratio of high nickel grade stainless production to low grade fell to 55% in 2007 from 75% the previous year. "A reversion of this trend was expected in 2008 [supporting nickel demand] but this is not occurring," the report said.

According to the International Stainless Steel Forum, stainless steel production in the first quarter of this year was down 3% from a year earlier.

There are some signs of a recovery, as stainless steel production was actually up 6.5% when compared with the last quarter of 2007.

But even given this, the outlook for stainless doesn't appear all that rosy. In addition to the weakness in the Asian market, European stainless demand is sluggish, with distributors delaying restocking until there are perceptions that the market has bottomed out.

Nickel has had another problem to contend with: a rise in exports from China of the low-quality nickel substitute pig iron.

It's quite possible that the lower prices now being seen for nickel could be lessening demand for pig iron, and surging energy costs could also be making pig iron less attractive because of higher ocean freight charges. But pig iron for now is still a factor undermining the nickel market.

A Plethora Of New Mine Supply

The supply side of the nickel world is where things get particularly dicey. A flood of fresh mine production is about to be unleashed, at a time when it appears the market needs it the least. Inventories of nickel in LME warehouses at the end of August were about 47,000 tonnes, down only 1.9% year-to-date and still near their highest levels in eight years. And it could get worse.

Getting a new mining operation up and running takes years. Feasibility studies have to be conducted, capital raised and then there's all the construction work. Given the long lead-up time, it's guesswork as to when the market will actually be crying out for new production. When nickel shot up to $25/pound, miners were tantalized by the prospect of bringing new projects online in such a price environment. Some 16 months later, with several projects about to enter production, the timing has gone from opportune to pretty rotten.

Take BHP Billiton Ltd., for example. Its $2.2-billion Ravensthorpe nickel mine in Western Australia officially opened in May and production rates will be steadily increased until it reaches its 50,000-tonne-per-year capacity in a few years. Meanwhile, Brazilian miner Vale plans first commercial production at its Onça Puma project at the start of next year. It has a capacity of 58,000 tonnes per year of the nickel contained in iron-nickel, and is among several Brazilian operations that are targeted for future start-up.

Over in New Caledonia, two huge new projects are gearing up. Vale Inco's 60,000-tonne-per-year Goro mine will be the first, with production slated to start by December of this year. Xstrata Nickel's Koniambo project is expected to follow in 2011, with a production target of 60,000 tonnes of nickel-in-ferronickel.

A similar-sized project, Ambatovy in Madagascar, operated by Canada's Sherritt International, is expected to begin production in 2010.

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