Base metals markets in limbo – the next leg upwards could be approaching
A broad gauge of base metal price performance, the LME index, a basket of six major base metals traded on the London Metal Exchange, has remained range-bound since early February after one of the strongest starts to the year on record. In our view, the initial rally has stalled due to sluggish demand so far this year from China and despite healthy demand growth from the US manufacturing sector. High oil prices have also raised concerns about slower economic growth, which undoubtedly would hurt demand for metals. Nevertheless, there are various signs that certain metals markets are tightening, notably the industry bellwether copper and aluminium. These metals have seen “available” exchange inventories, including exchange inventories in China (Shanghai Futures Exchange), drop 14% and 18%, respectively so far this year despite the Chinese slowdown. The trend in the ratio of stocks-to-consumption is one of the most important medium-term drivers for metals prices. The trend for these metals has indeed recently been a decline. The opposite is, however, true for both nickel and zinc, which continue to suffer from sluggish demand and improving supplies.
The next leg upwards for both copper and aluminium could be approaching for several reasons, in our view.
First, metals prices tend to be more coincident indicators of economic activity than for instance equity prices and credit spreads, which have improved strongly this year.
Second, “fear” levels as measured by market prices of expected financial market volatility have fallen to levels conducive of increased metals demand, at least in the next two to three months.
Source: Bloomberg, Nordea Markets
Third, global purchasing manager indices have stabilised and could continue to post gains in the coming months, which normally leads industrial production levels and metals demand.
Fourth, copper supply is still struggling as Chilean production was down 7% y/y in January. Primary aluminium production still struggles with poor economics amid elevated energy costs, and we expect further curtailments over the course of the year and a gradual move towards balance for the global aluminium market, which has struggled with surplus the past five years.
The crux for metals prices is the performance of the Chinese economy, which Nordea believes will manage a soft landing and gradual recovery over the course of the year. If our favourite indicator for Chinese manufacturing activity, the HSBC/Markit purchasing manager index, points towards continued stabilising production growth tomorrow morning, we would be strengthened in our view that the next leg upwards in copper and aluminium prices is imminent.