Supply and Demand in Industrial Metals
Nowhere is supply and demand more obvious right now than in the industrial metals sector.
When demand for copper is high, the price goes up. Copper mines then go into overdrive to satisfy the hunger. When the demand shrinks, you’re left with a surplus of metal flooding the market. And so the price drops.
This is the boom and bust cycle of commodities. Wall Street calls it the “commodity super-cycle.”
The Decade-long Slump and Signs of Recovery
Over the last decade, we’ve watched a sated bear market drag the cycle down. A creation of global oversupply and a slump demand in China.
The result? Base metals like aluminum, zinc, copper, and tin hit multi-year lows a year ago. But have we yet hit “the bottom”? Indeed, there are hints that the “bust” is over and the “boom” has begun.
On the demand side, President Donald Trump has pledged to kick-start infrastructure investment, and China has doubled down on construction. These are both obvious gains for industrial metals.
On the supply side, miners have finally come to terms with the oversupply problem. Commodity producers have begun to close mines and limit production.
The Pendulum Swings Back
In the last two months, we’ve monitored base metals carefully. The explosive price growth is impossible to ignore.
Industrial metals outperformed gold and silver by the most in 26 years. It seems some investors are spreading their funds between the safe havens of precious metals and the active metals. There’s a sense of anticipation here.
And industrial and energy stocks just notched up their best performance since 1999.
The super-cycle is shifting back into gear. There are at least three triggers causing the turnaround.
Trigger 1: Infrastructure and Construction Boost
President Trump is the most high-profile catalyst for this uptick. His pledge to deliver a trillion dollar infrastructure plan has spurred the rise.
One index that tracks base metals jumped 12% after his election in November. It was the index’s biggest upward movement in six years.
Trump isn’t the only trigger here, though. If you look at the numbers, China is by far the world’s largest commodities influencer. The country devours almost half of all industrial metals.
After a long period of slowdown, China has ramped up demand again. They’ve committed to moving 250 million people to urban areas in the next decade. That means building the infrastructure to support it. Steel consumption rocketed in China in late 2016. Meanwhile, investment in transport and utilities will support copper and aluminum.
Trigger 2: Growth in Automotive and Consumer Products
It’s not just construction that’s driving the price. Base metals are used heavily by the auto industry. Indeed, car makers consumed a record amount of aluminum in 2016.
Why? Because it’s lighter, more pliable, and more energy efficient than steel. It’s also easier to recycle. In the race to make cars that are more efficient, auto makers will boost their reliance on aluminum. Additionally, the metal is used in batteries that are fast becoming standard in modern vehicles.
The demand for aluminum in the auto industry looks set to double by 2025. A similar shift is taking place in the airline industry.
Meanwhile, the global middle class is swelling, particularly in China and India. Here, the demand for refrigerators and air conditioning units is soaring. This might sound unrelated, but these appliances demand copper.
Trigger 3: Supply-side Adjustments
Of course, demand is just one side of the coin. The supply of commodities has been left unchecked for too long. We’re swimming in surplus metals.
The high-profile OPEC agreement to limit oil production is a signal to the commodity world. Expect others to follow. A number of zinc mines have already closed down over the last five years. In part, that’s why zinc was among the best performing metals in 2016.
RUSAL and Arconic (two of the world’s largest aluminum producers) have also pledged to lower their production. We may even see a deficit of aluminum in 2017.
Challenges and Considerations
Of course, you should make any and all investments with your eyes wide open. And remember, The Nestmann Group does not offer investment advice. Nothing written here should be construed as such.
Despite the positive signs, there is no guarantee this acceleration will continue.
The current rally is held up on promise. The promise of infrastructure and construction at home and abroad. The promise of supply cuts and the anticipation of growth in the auto sector. Until we see firm assurances, any future turnaround is pure speculation.
There’s another factor at play here: the strong dollar.
Traditionally, a strong dollar drags down the price of commodities. Industrial metals are priced in dollars. And that makes them more expensive for foreign companies to purchase.
Right now, there’s a break in tradition. Both the dollar and base metals are rising. It’s a trend that appears only a handful of times in the past decade. Is this sustainable?
If the dollar continues its upward movement, it may suffocate metal prices. On the other hand, if the dollar weakens, it may light a fire under all commodities.
One final note to consider. The traditional metals trading post, the London Metal Exchange (LME), is under pressure. Two competing forums in China and the US are causing disruption to price formation. It remains to be seen how this will affect real prices. But it’s worth watching, just in case.
Investment Insights
Commodities are a useful addition to your portfolio. They have an intrinsic value, and they offer diversification. But be aware of entering at the wrong moment in the “super-cycle.”
Those with a high-risk appetite may see this as the perfect time to invest. Others may want to sit on the sidelines until Trump’s infrastructure plan gets the go-ahead. Or at least until the supply taps are well and truly turned off.
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