Base metal prices have rallied very strongly lately but are the gains sustainable? Metal Bulletin Research (MBR) has its doubts.
The move started with lead and zinc, and these two are up 28 per cent and 20 per cent, respectively, from mid-March lows. But the rest have joined since late April, with copper and aluminium reaching fresh 2015 highs in recent days.
On the whole, currency markets, more so than the metal markets' own fundamentals, have been the main driving force. Better economic data out of Europe, combined with softer data from the US, has seen the dollar retreat to its weakest level in two months against the euro and other major currencies. Easing concerns about euro zone deflation and a more dovish Federal Reserve have been factors, too.
Fears about economic slowdown in China, which accounts for almost half of global metal demand, have also subsided somewhat, as the government there is taking steps to instil stability and promote more lending. There are even signs among some metal demand indicators that certain markets - most importantly, copper - are beginning to reap the benefits of Beijing's stimulus efforts already, and there is hope that more stimulus might not be far behind.
Another general factor has been the strong recovery in crude oil prices, which has helped draw investor attention back to commodities.
And, there is market positioning. Earlier in the year, base metals were loaded with speculative short positions amid widespread negative sentiment, which dragged many markets down to five to six-year lows. The more positive developments lately and improved sentiment have triggered short-covering. The scale has been sufficient to break technical resistance levels, turn charts more constructive and trigger a cascade of buying from CTA-type funds.
MBR has been forecasting higher base metal prices this quarter, so the rallies are largely in line with expectations but the moves feel excessive in some cases. This is, especially so for the likes of zinc and aluminium, where premiums have been moving in the opposite direction to London Metal Exchange prices, reflecting ample availability of metal and poor demand. Such a disconnect between futures and physical markets is unsustainable and will probably be resolved by a pull-back in LME pricing. Indeed, we are already starting to see some price reversals, as profit-taking and forward hedge selling has emerged. But it might take a rebound in the dollar to trigger more serious corrections and give committed speculative bears the incentive to rebuild short positions.
For copper, MBR has a base case forecast of $6,150 a tonne and high-case scenario of $6,300 a tonne this quarter, allowing for a pull-back and consolidation at lower numbers for a while. Prices should resume their advance towards $7,000 a tonne during the second half of the year.
Aluminium, lead and zinc have become more overstretched and might need a longer period of consolidation and correction, though the latter two are far better placed than oversupplied aluminium to advance later in the year. Nickel and tin overshot on the downside recently but supply cuts are turning the fundamentals around and laying the foundation for strong recoveries in the coming quarters.
The author is principal analyst, Metal Bulletin Research (www.metalbulletinresearch.com)