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.