Base metals in a correction

Base metals are in a severe correction period. This phase could last longer, given the seasonally lower consumer demand during the months to come. However, copper, which is the metal reacting most sensitive to the business cycle, has lost more than 20% since the high in April and is approaching technical support levels. Therefore, favorable opportunities in base metals could soon arise on the buying side for both consumers and speculative market participants.

There are currently two factors weighing strongly on base. For one, this is the fear of a collapse of the global economic recovery. In forecasts that we have given at the beginning of the year in various polls, we had indicated that after an increase in the first quarter, we expect lower base metals prices in the second and third quarter. The main reason for this prediction was that the most important factors in our quantitative fair value models for base metals would not be able to continue their momentum from 2009 and there would be a consolidation.

This also applies to the surveys of purchasing managers, which are an important leading indicator; although in our models only the OECD leading indicator is included as an independent variable. In China, the two surveys of purchasing managers, which were published in the previous week, showed an unexpected decline. This has accelerated fears of an economic downturn, after the less expansionary monetary and credit policy of the Chinese central bank already dampened sentiment. However, China should continue to expand at a double-digit growth rate of GDP. The demand for base metals should therefore remain high.

In the US, the index of purchasing managers in manufacturing has declined in May. However, it is at 59.7 still on a high level, which indicates a further growing economy in the sector. On Friday, the US employment report contributed to a massive slump in metal prices. The number of new jobs outside agriculture has remained with 431K below the consensus forecasts by 90K. Economists have thereby underestimated not only the effect of new temporary jobs for the census in the US, but were also too optimistic for the new jobs in the private sector. Although the labor market is a lagging indicator, it has been interpreted in the markets as a sign the economy were weakening again. Beside the metals markets, also stock markets plunged noticeably. The development of stock markets will remain an essential factor for the industrial metals, because investors regard equity markets as an indicator of future economic activity.

 

The other burden on base metals is the strength of the U.S. dollar. Last Friday, the euro has fallen against the US dollar below the 1.20 mark. The trigger for this was the new government in Hungary, which stated that the previous government had embellished the statistics and the actual debt was much higher than previously indicated. On the markets, the comments were interpreted as an indication of a possible state bankruptcy of Hungary, which triggered massive selling of the euro. But the euro is not only under pressure by the debt of an EU country that does not adopt the euro, but also by the austerity measures. Germany, the largest economy in the euro zone, acts once more in a counterproductive way. The discussion of tax increases and massive spending cuts are poison for the still weak economic recovery. Instead of boosting the domestic economy, the government in Berlin is again on the brakes, thus providing a disservice for the euro zone yet again in 2010. Although the euro zone is not the largest consumer of base metals, however, by a more than a meager GDP growth or even a possible relapse into recession, the US dollar is likely to remain strong against the Euro, despite the structural problems of the US. This is then a much greater burden on industrial metals than the shortfall of demand from the eurozone.

It will depend crucially on whether the stock market and the euro will stabilize soon. If this were the case, then base metals prices should recover. The stock markets are, as a glance at the volatility indices, yet extremely nervous. But precisely in those circumstances, the situation can calm down quickly and could trigger a rebound of stock markets. This would also be positive for the base metals.