Improved outlook for base metals in H2

Two factors are probably the catalyst for a strong recovery of base metals last week. And both factors are repeating the history. Like in the summer of 2010, base metals suffered also this year under the debt crisis in Greece and the impact on the euro as well as on talk of a double-dip recession in the US. Developments last week indicate an improvement in both countries. For the base metals, it might set the stage for a trend of higher prices in the second half of this year.

After the Greek PM Papandreou survived a confidence vote in the parliament already the week before, investors were still cautious. Rumors were spread around that the austerity package would not find a majority in the Greek parliament. However, even before the final vote on the austerity package took place, sentiment improved. Strikes and unrests at the Syntagma Place in front of the parliament building could not prevent that lawmakers approved the austerity package. The eurozone finance ministers also agreed in a telephone conference on Saturday to transfer the next installment to the Greek government. Thus, a default is avoided, at least for the time being. The euro rallied above 1.45 versus the US dollar after trading down to 1.41 at the start of last week. The firmer euro and preventing a collapse of Greece, which could send even stronger shock-waves through financial markets than the bankruptcy of Lehman Brothers in 2008, also send base metals prices higher.

The second factor contributing to the strong recovery of base metals was US economic data. We have pointed out in the past, that readings of the purchasing manager indices for the manufacturing sector above 60 are not sustainable for a longer period and that indices retrace back to the mid-50 level. We also stated before that expectations of economists in the City or on Wall Street are not rational in the sense of academic theory but are adaptive. The consensus remains sticky if economic data comes in below consensus for some time but then adjusts after about 3 months and then tends to underestimate the economic figures. This has been also the case this year. However, the economic impact of the earthquake, which caused a tsunami and the nuclear catastrophe in Japan, made forecasting of short-term economic data more difficult then it is already in normal times. This uncertainty had also been expressed by the Fed in the recent FOMC statement and by Fed chairman Bernanke during the press conference.

While the media criticized the Fed for this more cautious stance, the economic data released during the past week indicates that the Fed is still smarter than many journalists and academic scribblers’ comments in news-papers. At the beginning of the week, the Richmond Fed index rebounded from -6 to +3. The pending home sales also posted a far stronger gain than the consensus had expected. However, more important had been the ISM purchasing index for the manufacturing sector in Chicago and the nationwide index. The Chicago PMI rose again above the 60-level and come in at a surprisingly strong reading of 61.1. The consensus expected for the nationwide ISM manufacturing PMI a further decline to 51.9 but the index rose contrary to the forecasts to 55.3. This level is still compatible with strong economic growth. The talk about a possible double dip recession appears to be exaggerated. Also Prof. Doom, Nouriel Roubini, does not always get it right.

Furthermore, the HSBC PMI for China remained unchanged at 50.1. This index has the tendency to be somewhat lower than the official PMI for China. Thus, the central bank was successful in reducing the speed of economic expansion but managed to avoid a too sharp slowdown.

From our point of view, the lower than initially expected US GDP growth was influenced to a large extend in the first quarter by the adverse weather conditions. In the second quarter, the impact of the earthquake in Japan in March played a crucial role by interrupting supply chains. However, both factors have not derailed the US economy as the recent PMI data indicates. Beside the monetary policy of the PBoC, the Chinese economic expansion was also influenced by the events in Japan. It seems that these negative impacts are now digested. We expect a stronger GDP growth in H2 in the two major commodity consuming countries. This should also have a supporting impact on base metal prices. Consumers might be well advised to hedge their exposure.