(The opinions expressed here are those of the author, a columnist for Reuters)
* Graphic on 2017 price performance: tmsnrt.rs/2Dg2rGY
* Graphic on fund positioning in copper: tmsnrt.rs/2DIHntK
By Andy Home
LONDON, Jan 18 (Reuters) - After the party must come the hangover.
Industrial metals went on something of a bull bender over the course of December and have done no more than stagger into the New Year.
Copper went on an 11-day binge of consecutive highs as London Metal Exchange (LME) three-month metal powered through the $7,000 a tonne barrier to a four-year peak of $7,312.50 on Dec. 28.
It’s now back below $7,100, with another New Year just around the corner.
The Chinese Year of the Dog starts on Feb. 16 and the onshore Chinese markets are chilling the bull party even further with long liquidation across the metallic board.
But the analyst consensus is that this is no more than a pause in the two-year, 60 percent rally in the LME index of core contracts.
There is more to come and the party is still open to newcomers.
“It pays to be late and enter commodity markets as the business cycle matures,” according to Goldman Sachs. (“Commodity Watch: It pays to be late”, Dec. 11, 2017)
The bank maintains its recommendation of being overweight commodities on a 12-month basis, citing “strong global demand across the commodity complex” and “a positive carry in key commodity markets”, which means “backwardation” to those of us not running investment portfolios.
So what makes them and the other many bulls so confident?
Graphic on LME metals relative price performance in 2017:
A key feature of last year’s LME price action was growing convergence in performance between individual metals from July onwards.
In June there was a wide gap between the weakest LME performer, nickel, down by more than 10 percent on January, and the strongest performer, aluminium, which was up almost 15 percent.
By the end of December all the major LME-traded metals were moving in tandem and notched annual gains of between 23 percent (lead) and 34 percent (aluminium).
Only tin was left behind as a bearish outlier, which may have as much to do with the LME contract’s dwindling liquidity as the tin market’s underlying supply-demand dynamics.
Among the others, differing supply-side dynamics were subsumed by the broader demand story.
The global manufacturing sector has been experiencing an unusual period of strong synchronised growth.
The United States has apparently shrugged off any disappointment about President Trump’s non-delivery of a promised infrastructure programme. National factory activity last month was the second-highest in six years, according to the Institute for Supply Management.
Euro zone activity is running even stronger. Manufacturing activity at the end of last year was the most robust for more than two decades.
China dwarfs everywhere else, though, when it comes to metals demand growth and it’s the continued strength in the country’s construction sector that is underpinning prices.
Real estate investment last year grew by 7.0 percent, the fastest pace since 2014.
If you don’t fancy the official figures, consider the steel sector. China’s steel production has been booming, exports have been falling and there has been no significant build in stocks. Where else has it all gone but into the ground?
But how long can it last?
There are bearish voices out there. UBS, for example, expects “commodity demand growth to soften as China’s growth slows and economic activity in the developed world plateaus”.
UBS is forecasting base metal prices to peak over 2018 to provide total return losses in the mid-single digits (“2018 Commodity Outlook”, Jan. 9, 2018).
Even UBS, though, expects the rally to continue in the short term as a rising tide of demand continues to lift all metals.
Graphic on fund positioning in the copper market:
And the money men seem to agree.
You know you’re in a bull market when older, wiser voices start warning that the price has got ahead of fundamentals.
It’s not that they disagree with the trend, it’s just that those pesky speculators have been pushing it too hard.
The combination of globally robust industrial activity and rising prices has sucked a growing amount of investment money into the complex, even if the Chinese onshore tide is seasonally ebbing right now.
Analysts at Barclays Capital estimate that total funds in the commodity sector hit a four-year high of $311 billion at the end of 2017 (“The Commodity Investor - Flows Analysis”, Jan. 11, 2018).
Much of the institutional money flow into commodities gravitates towards the precious metals and energy sectors.
But, largely via allocations to broad-based indices, the base metals sub-sector saw a third straight year of net inflows, bringing the cumulative tally to $13.8 billion, Barclays said.
Such buying is difficult to spot day to day, but Barclays’ assessment tallies with historically elevated long positioning on the LME LME-CA-MNET and CME copper contracts.
Fund long positioning on both the LME’s aluminium LME-AH-MNET and zinc LME-ZS-MNET contracts also moved a structural leg higher over 2016 and held that elevated level over 2017, notwithstanding the usual chop.
Such speculative length brings dangers of volatile reversals, but that may be what the older, wiser heads are waiting for.
The only way may be up in the short term, but that doesn’t mean all metals will keep moving in lock-step.
Individual metal dynamics are expected to reassert themselves this year.
Zinc, for example, has this week hit another 10-year high of $3,440 a tonne. How much higher can it go relative to, say, nickel, which at a current $12,510 is a lot closer to its 2016 low of $7,550 than its 2007 peak of $51,800?
Divergent supply dynamics will become ever more apparent if universal demand drivers start to fade, as argued by bears such as UBS.
For what it’s worth, Goldman Sachs still likes zinc for a short-term spike, while UBS likes to be long aluminium over the first quarter.
There are as many picks as there are analysts, but right now the consensus is that this party is temporarily closed for cleaning but will resume shortly.
And even if those bears are right about this one ending some time in 2018, I’ve heard there’s another planned by some battery guys.
Did I forget to mention the electric vehicle thing? Not to worry, you’ll be hearing a lot more about that particular party this year.
Editing by David Goodman