METALS INSIDER: Recession ? What recession ?

-- Andy Home is a Reuters columnist. The opinions expressed are
his own. For more Metals Insider columns, top Reuters metals
stories and third party content, please visit the free Base
Metals Community website at (www.metalsinsider.com) --

By Andy Home

LONDON, April 20 (Reuters) - You might be forgiven for
thinking the world is still in the throes of the worst recession
since the 1930s.

You may, for example, have heeded the words of Dominique
Strauss-Kahn, managing director of the International Monetary
Fund, who said last week that the global economy would "enter
deeply negative territory" this year before showing signs of
recovery next year. [ID:nN16293353]

Or maybe you have been dispirited by the latest slew of
macro-economic data, showing the Chinese economy expanding at
its slowest pace since records began in 1992, and U.S.
industrial production contracting by 20 percent year-on-year in
the first quarter of 2009.

Or maybe you're worrying about the pending results of the
"stress tests" of the biggest U.S. banks and whether U.S.
industrial icon General Motors can avoid bankruptcy.

But then look at the LME industrial metals complex and you
might equally be forgiven for thinking that the worst is now
over and the good times are here again.

Prices surged pretty much across the board last week and
metals such as copper and lead are now showing remarkable
year-to-date price gains in excess of 55 percent.

LME three-month valuations on Friday with percentage changes
for the week, the quarter- and the year-to-date:

Close Wk Chg Qt Chg YTD Chg
Aluminium $1,486 -3.2 +6.8 -3.5
Copper $4,805 +5.4 +18.9 +56.6
Lead $1,555 +10.8 +22.4 +55.7
Nickel $12,825 +16.2 +30.2 +9.6
Steel FE $325 +1.6 -3.0 -3.0
Steel Med $330 +8.2 +1.5 -13.2
Tin $12,250 +11.4 +17.8 +14.5
Zinc $1,557 +11.6 +18.0 +28.9
Moreover, three of the LME metals, copper, lead and tin, are in
front-month backwardation, a sign of cash-date tightness and
normally a classic hall-mark of bull markets.

You may therefore be asking yourself, what on earth is going
on ?

PHYSICAL ATTRACTION

What first and foremost is going on is the physical movement
of global metal surplus to China ?

This process is most advanced in the copper market, where
Chinese buying kicked in as early as the fourth quarter of last
year.

The country's appetite for the red metal is apparently
insatiable, imports hitting fresh all-time highs with each
passing month.

The same is now starting to happen in other base metals. The
full trade figures for March out later this month are expected
to show the country absorbing growing amounts of physical
aluminium, zinc, lead and nickel as well.

This swelling flow of physical metal into China has stalled
the uptrend in LME inventories in most metals.

In the case of copper, exchange stocks are now dwindling
again, down by almost 80,000 tonnes from their February
mini-cycle peak with another 68,000 tonnes waiting in the
cancelled warrant "departure lounge."

China seems to be in the midst of a multi-faceted restocking
programme.

The government's State Reserve Bureau is rebuilding its
strategic stocks. Here the primary focus is on copper.

Simultaneously the state is buying up stocks to help support
its metals production sector, a big employer and generator of
tax earnings at both national and regional level. This support
scheme takes in just about all the base metals and could last as
long as three years, according to Jia Mingxing, president of
state research house Antaike. [ID:nPEK316487]

Chinese investors are also getting in on the act, using
physical metal stocks as a speculative tool both to ride the
current price upswing and as a hedge against the expected
resulting inflationary surge.

Nickel, for example, seems to be flavour of the month in
Shanghai, maybe because of its relatively expensive price-tag,
which gives private investors "bang for their buck."
[ID:nSP351465]

FUTURE(S) ATTRACTION

China's impact on the physical market and, via the LME's
global warehouse system, on international prices is creating a
positive feedback loop with existing shifts in investment flows.

The rise in LME prices has coincided with a strong rally in
global equity markets, a sign, in the media shorthand, that risk
appetite is returning.

A better way of describing it, however, might be "the
capitulation trade", meaning prices had fallen so hard and so
fast at the end of 2008 that the risk-reward ratio had shifted
full-circle to the upside.

Predators placed their bets early on the likes of tin, which
never fitted neatly into "the recession trade" because of the
market's low stocks and known supply issues. That's why cash tin
has been in the grips of a dominant long position for several
weeks now.

It has just been joined by lead, a contrarian play with a
lot in common with tin in terms of recession-proofing
(replacement batteries), low visible surplus and problematic
supply. [ID:nL6396824]

The flip side to the capitulation trade is the wholesale
roll-back of legacy short positions held by other parts of the
fund community, particularly the momentum-tracking CTA herd,
which had sold the metals heavily on the way down.

As downwards momentum first stalled and then started to
reverse, the "black-box brethren" have been buying back ever
increasing tonnages. The process is complete in both copper and
zinc, half-way there in others such as lead and tin (for those
that can escape the short-dated squeezes) and still only
gradually building momentum in the "dog with fleas" aluminium
market.

BOOM OR BUBBLE ?

Is the rise in LME metals prices sustainable or are we
witnessing a dual Shanghai-London bubble of irrational
exuberance ?

Can "bellwether" copper's stellar 57-percent price rise this
year be a true gauge of the global manufacturing sector? Or is
the market being hoodwinked by the large-volume shift of surplus
metal from the visible (LME) sphere to the invisible (off-market
in China) sphere ?

It's noticeable that neither of the LME's steel contracts is
joining in the bull party. They are too small and too new to
attract investment money, meaning they have been immune from the
predatory plays and shifts in investment flow taking place
elsewhere in the complex.

They are also symptomatic of the broader
(non-exchange-traded) steel and ferroalloy sector, which remains
in severe distress mode.

Bears (and realists) can take some heart from this widening
split between futures and real-economy worlds.

But the simple truth is that the current positive feedback
loop will continue as long as China sucks up surplus metal at
its current pace.

Copper is the one to watch. China has imported around
750,000 tonnes of copper so far this year. Yet the Shanghai
market is still as tight as a drum. Exchange stocks are
ultra-low, the futures market is heavily backwardated and
physical premiums for imported metal are soaring, suggesting the
feeding frenzy is by no means yet over.