Mixed performance of base metals in 2010

The LME index comprising the six non-ferrous metals traded at the London Metal Exchange is down 7.18% since the start of the year, after posting an astonishing surge of 97.2% in 2009. While the tight lifted all boats, the performance of the base metals is rather mixed in 2010 so far. Zinc is the worst performing metal with a loss of 25.4% year-to-date, followed by lead with a minus of 19.1% ytd. The best performing metal is tin, which soared by 13.6% ytd, and nickel posted a gain of 8.4% since the start of the year despite the pressure on steel prices. Copper and aluminum record single-digit losses of 5.1% and 9.4% respectively.

Thus, the question arises, why the base metals are performing so differently this year after all metals ended 2009 in the plus. From our point of view, the answer is a shift in the strength of impulses among the various factors determining the fair value prices of base metals.

In our quantitative models, the fair value of each base metal is explained by five independent variables. However, among these factors, only one is specific to the individual metal whereas the other four factors are common for all six metals. However, each metal might react with a different time lag to the various independent variables. The four general market factors are the US Dollar Index, the price of crude oil as proxy for energy costs, the S&P 500 index as a leading indicator of economic activity and the 10year US Treasury yield as the reference for movements of interest rate costs. The corresponding LME warehouse stocks of the base metals are the only metal specific factor entering our fair value models.

Last year, many metal analysts were puzzled about the strength of the recovery of base metals. Some analysts argued that the purchases of Chinese State Reserve Board were the driving factor behind the surge of metal prices. However, this only one factor and does not explain that the rally lasted even to the first month of 2010. Other factors must have played a crucial role too. Some analysts predicted a reversal of base metals prices in the second half of last year and based their forecasts on rising warehouse stocks and inventories outside the official warehouses. Those analysts also overlooked that other factors could overcompensate the negative impact of rising inventories.

In 2009, the general market factors all rebounded from the crisis levels caused by the global economic collapse in the wake of the Lehman bankruptcy. The stock markets surged and posted strong gains in the yoy-comparison. Also crude oil recovered and prices more than doubled from the low in early 2009. The Fed cut its key interest rate to almost zero, which made the US dollar to a funding currency and the US Dollar index fell. The yield on 10year US Treasuries rose with a recovery of the US economy and investors leaving the safe haven of government bonds and invested again in risky assets. All these factors induced financial investors to buy base metals and prices rose despite increases inventories.

However, in 2010, the situation is different. It should not come as a surprise that the general market factors could not continue move at the same pace as in the year before. The US stock market is in a trading range, as also some other equity markets, which implies that the percentage change yoy is declining. Also crude oil is moving sideways, which has the same impact on the yoy-%-change. The US Dollar has been a save haven in H1 of 2010 as investors left the euro due to the crisis of public finances in some states of the eurozone. Also the US Treasuries served again as a safe haven, in particular as more concerns about a possible double-dip recession emerged in the US and China took measures to slow GDP growth to a sustainable level. Thus, the general market factors had a lower impact on fair value metal prices than in 2009 and at the beginning of this year. As a result, the metal specific factor gained in importance. Thus, it should not come as a surprise that falling inventories contributed to the outperformance of tin, while zinc lost most due to the rise of LME warehouse stocks, which continued in 2010.

Is gold heading towards further losses?

Although the gold price could recover slightly compared to the preceding week, the question arises whether further price losses have to be expected. First, the technical condition has deteriorated. Secondly - and this may be the more essential factor – those arguments for a flight into gold loss in importance. The gold price could therefore tend further down in a period, which in many cases shows seasonal weakness.

Last week gold traded largely sideways and has found some support at the lower Bollinger band. However, the ADX indicator, which measures the strength of a trend, increased significantly. The MACD indicator tends to decline and has moved away from its signal line. Both indicators point out so that a downward trend has established in Gold. A further negative aspect is that gold is below the moving average of the Bollinger band and this average is also decreasing. This gives an indication that gold test could again the low of 21 May at 1,166.5$/oz.

A negative for the further development of the gold price is also the positioning of the large speculators. At the end of June, the net long position of non-commercials was at 244,725 contracts (Comex Gold Futures), which represented the highest level since mid-December 2009. But within a week, the net long position fell by 35,683 contracts and was at only 209 042 contracts according to the latest report of the CFTC on "commitment of traders' on 6 July. The hedge funds and other large institutional market participants exited gold long positions massively. But it was probably not only large speculators selling gold. The decline of gold holdings at the largest gold ETF, the SPDR Gold Trust, by almost 6 tones to 1314.5 tones in the same period suggests that also retail investors sold gold.

Thus the question is, why do investors leave gold, which, at the end of the first half, many experts regarded as a safe haven against all possible threats - whether deflation or inflation. First, the fear of a global slide into a renewed recession has decreased somewhat, as the recent recovery in stock markets shows. Inflation is not in sight near-term, given the still well below normal capacity utilization. The first indications of the stress tests in European banks have also suggested that the banking system is more stable and resistant, as has been painted on the wall by so many prophets of doom. If investors get slightly more confident, then gold loses its luster as a safe haven and the gold price starts to head lower. The many small investors, who bought massive physical gold out of fear of a crisis in recent weeks, are likely to again the famous last one bitten by the dogs.

Fear of double-dip recession weighs on base metals

After being more attracted by the FIFA World Cup the previous two weekends, it is now time again that a new post in this blog is in the foreground. The focus this time is on base metals, which partially have suffered strong losses since the beginning of the year. Even copper, which in the first quarter was trading above 8,000$/t fell from high again by about a quarter and is compared to the beginning of the year in the red. We consider, however, the current concern is exaggerated. The quarter that has just begun is frequently the weakest seasonal phase. It should provide a good opportunity for consumers of base metals to hedge against the risks of rising prices and secure benefit from low prices longer term.

At this point, we have repeatedly stressed the importance of international stock markets as an indicator for base metals. So it should not surprise that some metals, particularly copper could recover from its low of 6,037$/ t on 7 June, as the stock market turned upward. However, as after the announcement of austerity measures in countries of the euro zone, the fear of a renewed slide of the main economies of the West in a new recession is again a drag on the stock and thus also the markets for base metals.

But also in China, easing the peg of the yuan to the U.S. dollar has been able to stimulate in the short run only. Latest with the publication of the indices of the purchasing managers in the previous week, the official index in June fell to 52.1 after 53.2 the previous month, the markets are worried again about the growth in China, which is currently the global economic locomotive. With a growth rate of 11.9% over the previous quarter, however, GDP grew in the first quarter very strongly and the acceleration of the growth rate is of concern. In China, a stabilization of the growth rate is most welcome to prevent overheating of the economy. This is also helped the credit policy, which aims to curb the boom in housing investment. China has learnt its lesson out of the housing crisis in the U.S., which was the starting point for the financial crisis. But a reduction of the expansion rate does not mean that this will lead to lower demand for raw materials. However, the demand for commodities is expected to increase at a lower rate than would be the case without restrictive measures.

The fear of a double-dip recession dominates in the US after the data on the housing market were worse than the economists predicted. It should be noted, however, that government programs have expired. But also in the US, the indices of purchasing managers in the manufacturing industry disappointed expectations. In the Chicago area, the index has fallen from 59.7 to 59.1 and the national ISM index dropped from 59.7 to 56.2. Both indexes are well above the mark of 50 and therefore still signal an expansion in manufacturing in the US. Looking at the history of the ISM index, is also striking that the index does not stay long above the 60 mark. This represents the extreme of a growing economy and that there is normalization without the economy falling into a recession. It should also be noted that economists are initially too cautious with their forecasts at the start of a recovery. their, After the released data exceeds the consensus expectations for several months, then economists generally get too optimistic and adjust their forecasts upwards. However, then they overshoot the target. In this phase, we might find ourselves today. In Europe, the research institutes adjusted upwards forecasts for GDP growth in Germany, the largest economy in the euro zone, for this year and 2011, although the federal government has decided on austerity measures. The weak euro here provides a positive impulse.

Overall, we expect that there will be no double-dip recession. The pessimism in the markets should then decrease, and both shares as well as industrial metals are expected to rise significantly. The current quarter should be used by consumers of base metals to secure the low price level for the longer term.