China lockdowns might have killed the base metals bull

Base metals have experienced outsized price moves this year. What next for these commodities in the light of the negative US GDP print and covid lockdowns in China?

While the majority of market attention is often placed on precious metals (gold and silver), base metals are a highly traded asset class and regularly present a great deal of opportunity. 

Metals such as nickel saw a more than 200% gain before dropping by almost 50%. We’ve also seen wild swings in copper which rallied almost 20% over Q1 before correcting by 13%. 

 

Key Factors Affecting Base Metals

IIn terms of what’s been driving these volatile moves, there a few key factors we can explore: 

  1. Ukraine – Russia conflict 
  2. Inflation & supply-side issues
  3. Fed tightening & USD outlook
  4. China slowdown and growth concerns

 

Ukraine – Russia conflict 

The Russian invasion of Ukraine in the last week of February caused seismic shifts across asset classes. For base metals, the invasion, and ensuing conflict, saw metals such as Zinc, aluminium and copper soaring on expectations of massive supply disruptions. With Russia accounting for 11% of global nickel production and 6% of aluminium production (largest producer outside of China), the conflict, as well as western sanction on Russia, impact supply greatly. 

 

Inflation & supply-side issues

The disruption caused by the invasion of Ukraine came at a time when base metals were already seeing inflating prices as a result of broader and soaring inflation and existing supply issues, linked to COVID. The release of pent-up demand over the pandemic, as well as the bottlenecks and backlogs caused by COVID-related issues, meant that metals prices were already moving higher ahead of the Ukraine conflict emerging, with the conflict then exacerbating these issues subsequently. 

 

Fed tightening & USD outlook

Following the price spikes we saw across late Q1, base metals prices have since corrected sharply lower. Part of this is the natural reversal of the knee-jerk reaction seen in response to news of the invasion. However, a larger factor has been the aggressive uptick in hawkishness from the Fed. 

With inflation soaring and US employment still rising strongly, the Fed became significantly more hawkish across Q1. The 0.25% rate hike in March has since been followed by the Fed upgrading its rates outlook to include larger 0.5% hikes to come imminently and across the remainder of the year. With USD rallying subsequently, this has weighed heavily on base metals prices, along with prices of other commodities and the broader risk complex, including equities and higher-yielding currencies. 

 

China slowdown and growth concerns

Finally, the rise in USD has come alongside fresh concerns over Chinese economic health and broader global growth. Recent economic data highlighted a slow-down in China over Q1 with the world’s second largest economy introducing fresh regional lockdowns as a result of resurgent COVID cases. 

Additionally, rising inflation alongside a wave of central bank tightening within the G10 bloc, is raising concerns over the growth outlook over the remainder of the year.

The shock -1.4% drop in US Q1 GDP according to the first estimate from the US Commerce department shows the damage already being done. At the same time the brief inversion of the 2s-10s yield curve implies a recession is around the corner.

With traders anticipating that supply issues, higher input costs and steeper borrowing costs will weigh on business activity into the back end of 2022, dragging down demand for base metals. 

 

DBB Invesco Base Metals Fund 

One method of tracking the broader performance of the base metals sector is to track the Invesco base metals fund. The fund is composed as an index tracking changes in a broad range of key industrial metals, including zinc, copper, aluminium and nickel and more. When these assets are trading positively, the fund’s price will increase and vice versa when these assets are falling in price. As such, this represents an efficient means for evaluating - and trading - broader moves within the sector as well as forecasting coming moves. 

 

Monthly Chart of DBB 

Source: FlowBank / TradingView

 

Looking at the monthly chart in DBB (Invesco base metals fund), we can see that price has been trending higher since 2020, recently taking out the 2011 highs (around 26.20), to hit new highs of 26.96. While we are currently seeing some correction lower, the outlook for the fund remains positive while prices hold above the 23.92 level, keeping the focus on a breakout above 26.96 in coming months. Should price close beneath the 23.92 level on a monthly basis, focus will instead shift to deeper support at the 21.80 level.

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