Base Metals Say “Buy Me!”

Eric Fry By Eric Fry
Macro Strategist

Metals

Usually when the supplies of a particular commodity fall, the price of that commodity rises. It’s unusual that the opposite happens… but that’s exactly what we’re seeing now in several commodity markets.

The zinc price has been plummeting, for example, despite the fact that supplies of the metal at the London Metal Exchange (LME) are close to their lowest levels of the last two decades.

Similarly, the copper price has been tumbling since January, even though copper supplies at the LME are close to 20-year lows.

The LME inventories provide only one part of the supply-demand picture for metals like zinc and copper. But that picture is usually a reliable reflection of global trends. That’s why a metal’s price tends to rise when LME inventories are falling, and vice versa.

But during the last few months, metals prices have been falling, despite low and/or falling LME supplies.

This anomaly is not a complete mystery. The metals markets have been bullied by dire headlines about a looming trade war and a slowing Chinese economy. Together, this news has created a great deal of anxiety about the future demand for base metals and other commodities.

Clearly, if the Chinese economy were to weaken enough to cause a significant global slowdown, demand for most metals would weaken as well.

The risk of such an outcome is very real, but it hasn’t happened yet. The global economy continues to hum along at a healthy clip. And most measures of commodity demand remain very robust.

The LME inventory levels, for example, show no major slackening of demand for zinc, copper, nickel or aluminum.

 

Meanwhile, the prices of most heavy-industry products like steel and rebar remain conspicuously strong. Presumably, prices for products like these would not be strong if the global economy were weakening.

But that’s not the case, which suggests the recent weakness in the base metals markets appears to be nothing more than a “financial thing.”

In other words, short-term trading – not long-term economic trends – is whipping these markets around.

What we’re witnessing in the base metals markets is the type of sharp, severe correction that rolls through from time to time. This correction is also affecting stocks throughout the natural resource sector.

Many companies in this group are reporting their strongest earnings in many years. And yet their stocks are struggling to advance, as I’ve written about before.

On July 25, Brazilian iron ore producer Vale (NYSE: VALE) reported quarterly earnings of $0.27 per share – up 41% year over year. The company also announced a $1 billion share buyback.

But the stock has dropped 8% since the earnings report.

Two weeks later, Glencore PLC (OTC: GLCNF) reported semiannual earnings of $0.22 per share – up 35% from the first half of last year. That result lifted Glencore’s one-year earnings to $0.42 – the company’s largest annual profit in six years. Prior to this announcement, the company also announced a $1 billion share buyback.

But the stock has fallen 5% since the earnings report.

Despite the poor price action of many resource stocks – and the awful price action in many base metals markets – the underlying fundamentals remain very favorable. Supplies are tight, and demand is strong.

That’s why I consider the current weakness in these markets to be buying opportunities.

But make no mistake: These markets could continue to slide for a while longer. A sell-off that’s set in motion tends to stay in motion.

If the trade war continues to gather steam and/or if the global economy slows down significantly, the prices of base metals could continue to slide.

That’s the fear. Though I believe it’s overblown.

But don’t take just my word for it… One contrarian indicator is signaling loud and clear that the base metals are a better buy than sell.

This indicator tracks the net investment position of “managed money” in specific commodity markets. Whenever this group of traders is leaning hard in the same direction, that market tends to move in the opposite direction.

For example, whenever “managed money” amasses a large net long (i.e., bullish) position in copper, the copper price tends to fall shortly thereafter. The inverse is also true.

And that’s what we have today.

“Managed money” has established its largest-ever net short (i.e., bearish) position in copper.

Many commodity traders refer to “managed money” as “dumb money” – not so much because professional money managers are stupid but because they tend to behave like sheep at market extremes.

As a group, these investors tend to crowd into the same trades at the same time… just before those trades move in the opposite direction.

So if past is prologue, a copper rally should be coming our way.

Keep an eye on the unloved metals markets. They may be attracting widespread affection from investors very soon.

Good investing,

Eric