- Base metals rose 12.88% in Q2.
- Copper- The leader of the pack leads the way on the upside.
- All members of the sector post gains- Double-digit percentage increases in copper, nickel, and tin.
- Iron ore rallies almost 20%
- The BDI explodes to the upside
Base metal prices fell by 23.43% in 2015, but in 2016 they appreciated by 26.77%. In 2017, the nonferrous industrial metals sector was the best-performing commodities sector posting a 21.99% gain for the year. In 2018, the industrial commodities shed 15.78% of their value. In 2019, the six LME metals were 1.74% higher from the closing level at the end of December 2018. In Q1 2020, the sector plunged 17.09%. In Q2, it came back and was 12.88% higher. Over the first six months of this year, base metals were 6.58% lower. The best performing commodity in the base metals sector in Q2 was LME copper, which rose 25.61%. COMEX copper was 21.79% higher for the quarter, and the nearby COMEX futures contract fell 20.34%. Tin moved 16.83% higher during the quarter, while the price of nickel gained 13.62%. Zinc recovered by 9.98%, and aluminum was 6.40% higher. The price of lead gained 4.83% in Q2.
Meanwhile, the price of iron ore moved 19.06% higher in Q2. The Baltic Dry Index exploded 227.37% to the upside over the period after substantial losses of over 40% each in Q4 2019 and Q1 2020.
Industrial commodity prices experienced a perfect bearish storm as economic activity around the world ground to a halt as the Coronavirus spread across the globe in Q1. When OPEC and Russia abandoned production quotas on March 6, the price of crude oil dropped to the lowest levels in almost two decades. Falling energy prices cause production costs to decline, allowing producers to sell at far lower levels. At the same time, wild currency volatility and uncertainty in markets across all asset classes weighed on the sector. Moreover, a deflationary spiral that began in China and spread across the world over the past three months created the most bearish conditions in the stock market and all other asset classes since the 1930s.
2020 started with optimism over trade as the US and China signed a “phase one” deal that de-escalated the trade war that had hung over industrial commodities and other markets throughout 2019. At the same time, the December 12 election in the UK paved the way for a Brexit with a deal with the EU that removed another level of uncertainty from markets. Many commodities, including base metals, hit their highs for the first quarter and the first six months of this year during the early days of 2020. As the Coronavirus spread began to impact the Chinese economy, prices fell. China is the demand side of the equation for base metals, industrial commodities, and most raw materials. When the virus spread beyond China’s borders in February, prices slumped, at the end of the month and into March, the slump turned into price carnage. Prices reached lows with the stock market in mid-March, before the end of the first quarter.
Central banks around the world slashed interest rates. Monetary and fiscal stimulus programs rose to unprecedented levels throughout March. Short-term interest rates in the US fell to zero percent, and both the US Fed and ECB fired bazookas of liquidity at markets. Typically, falling interest rates are supportive of base metals and commodities prices as they lower the cost of carrying inventories. However, Q1 2020 was anything but an ordinary time in markets. The quarter ended with the number of cases of Coronaviruses and fatalities rising. Central Banks and government policies have aimed at stabilizing economies worldwide, while scientists scramble to find effective treatments and a vaccine. Healthcare systems across the globe reached the brink as professionals cared for the sick, and leaders looked to slow the spread of infections. Scientific progress is slow compared to the spread of COVID-19 and the reaction in markets. The deflationary spiral has been a symptom of the global pandemic, which is the worst since the 1918 Spanish flu that claimed fifty to one-hundred million victims. As we head into the second quarter of 2020, the world remains on edge, and markets faced the world financial crisis since the Great Depression in the 1930s. The environment in February and March was highly bearish for the prices of base metals and all industrial commodities.
In Q2, prices rebounded as some optimism returned to the industrial commodity markets. Chinese demand began to rise, crude oil made a comeback, and base metals and other raw material prices rose. If the impact of central bank and government stimulus in the aftermath of the 2008 financial crisis is an example for industrial commodities, we could see prices move a lot higher over the coming months and years. The amount of stimulus in 2020 is far higher than in 2008. From June through September 2008, the US Treasury borrowed a record $530 billion. In May, the Treasury borrowed $3 trillion to fund stimulus. The long-term effect of liquidity, low interest rates, and quantitative easing are bullish for commodity prices. At the same time, the value of the US dollar index declined by 1.76% in Q2, which is also supportive of base metals, industrial raw materials, and other commodity prices. The bottom line is that the response of governments around the world supported the industrial sector of the commodities market in the second quarter.
The Invesco DB Base Metals product (DBB) reflects the price action in copper, zinc, and aluminum on the London Metals Exchange. The base metals tend to move together when it comes to macroeconomic issues and risk-off environments. In Q2, the global economic contraction will be the leading factor facing markets as the world looks to contain the spread of the virus. The economic legacy of Q1 2020 is likely to be a dark financial cloud hanging over the markets for years to come causing wide price variance.
The red metal posted a gain of just over 18% gain on the COMEX and 17.4% gain on the LME in 2016. In 2017, COMEX and LME copper gained 31.57% and 30.25%, respectively. Copper was trading at the highest price since 2014 at the end of 2017. Copper on the COMEX futures market moved 20.38% lower in 2018. LME copper three-month forwards lost 16.83% in 2018. In 2019, the red metal was 6.43% higher in the futures market in the US and 3.38% higher on the three-month forward market at the LME in London. Copper is the leader of the base metals sector, and it led it lower in Q1 with a loss of 20.34% on COMEX and 22.17% on the London Metals Exchange. In Q2, LME copper was 25.61% higher, and the red metal moved 21.79% higher in the futures market on COMEX.
Copper rose to the highest level since January 2014 when COMEX futures traded $3.3220 per pound on December 28, 2017. Copper started 2019 on a bearish note as it dropped to a new low at $2.5430 per pound on the second trading session of the year on January 3. After failing to reach the $3 per pound level in April, copper fell below the late 2018 low to $2.4675 during the week of September 3, 2019, when it put in a bullish reversal on the weekly chart. The low came after the US and Chinese trade war escalated in August. In Q4 2019, progress on trade that led to a “phase one” trade agreement pushed the price back to the $2.80 per pound level on the nearby futures contract. In early Q1, copper traded to a peak of $2.8930 when the global pandemic began to take hold of markets and worsened throughout the quarter. The price fell to a low of $2.0595 on the continuous contract in mid-March when a V-shaped recovery began and carried the price higher throughout Q2.
As the weekly chart highlights, copper had made lower highs and lower lows since June 2018 until Q1 when it broke to the downside and moved towards the $2 level on the continuous futures contract. The recovery took the price back over the $2.70 level by the end of Q2. Copper was in overbought territory on the weekly chart at the end of Q2 as the price was working its way towards the 2020 continuous contract high at $2.8860 per pound.
As the daily chart shows, the now active month September COMEX copper futures contract has made higher lows and higher highs since the March bottom. Both price momentum and relative strength indicators were at overbought readings during the final month of the quarter as the price continued to climb. Daily historical volatility declined to below 11% as the price of the nonferrous metal recovered.
As the monthly chart illustrates, copper fell in March on the back of the escalation of Coronavirus as it spread to Europe, the United States, and over 150 countries around the world. During Q2, the red metal posted a gain in each month. From a technical perspective, the volume has been steady, but open interest declined as the price rose. Risk-off conditions sent the price of copper from $4.2160 to $1.2475 in 2008, which is a red flag for the price of the red metal. In 2020, the low has been at just below the $2.06 per pound level. If the 2020 low turns out to be a bottom like in 2008, the upside prospects for the price of the leader of the base metals sector could be significant. Stimulus and a falling dollar are highly supportive of the price of copper.
Open interest in the COMEX futures market moved from 182,253 contracts at the end of Q1 to 193,194 contracts at the end of Q2, an increase of 10,941contracts, or 6.00% higher over the past three months. Rising price and increasing open interest tend to be a technical validation of a bullish trend in a futures market. The open interest metric remains far below the highs of the year when it rose to over 287,000 contracts in January, but risk-off conditions caused many market participants to move to the sidelines in copper and most other assets over the first six months of this year.
A significant indicator of the short-term price direction of the base metal tends to be the level of LME stocks. LME stocks rose to a high of over 388,000 tons in March 2018. At the end of 2018, they stood at the 130,025-ton level. After falling to a low at 111,175 tons in mid-March 2019, stock levels were volatile and stood at the 145,700-ton level at the end of Q4 at the end of December 2019. At the end of Q1, inventories on the LME stood at 222,225 metric tons, which was a 52.52% increase on a quarter-by-quarter basis.
At the end of Q2 2020, they stood at 216,600 tons, a decline of 5,625 tons or 2.53% on a quarter-to-quarter basis. The falling stockpiles were a positive sign for the copper market.
Meanwhile, stocks on COMEX were at the 31,651 tons at the end of Q1 and rose significantly to 80,373 tons at the end of Q2 2020, an increase of 48,722 tons or 153.94%. The shift of stock from the LME to the COMEX warehouses could be the result of Chinese ownership of the London Metals Exchange. The shift was significant, and we should keep an eye on the movement of inventories over the third quarter to see if the trend continues. Meanwhile, production of copper has suffered in Q2 as mine closures because of the global pandemic has weighed on output and mining operations throughout South America and other copper-producing countries worldwide.
US interest short-term interest rates declined to the levels seen in the aftermath of the 2008 global financial crisis during Q1 and Q2 at zero percent. Fiscal and monetary policy stimulus rose to unprecedented levels in March, but the flood of liquidity to stabilize markets is a symptom of the global pandemic and its impact on the worldwide economy. Copper is likely to continue to reflect the risk-off conditions and halt in business activity around the globe of the pandemic continues to claim victims. However, a slowdown in output has provided support for the price along with weakness in the dollar and unprecedented levels of central bank and government stimulus.
Volatility increased dramatically in the currency markets with wide swings in the US dollar versus euro currency pair in Q1. The dollar index traded in a wide range as the crisis unfolded, but the greenback index moved higher over the first three months of 2020. The dollar index reversed and retreated in Q2. Meanwhile, the strength of the price of gold in Q2 continues to be a flashing sign that all currencies are moving lower even though the dollar continues to be the strongest foreign exchange instrument. The dollar may be the king of currencies, but gold is the monarch of money. Lower rates tend to be bullish for commodities prices over time, but these are anything but ordinary times in our lives. Gold reached the $1800 level at the end of Q2, the highest price for the precious metal since 2011.
The European Central Bank remains highly accommodative when it comes to monetary policy. Under President, Christine Lagarde, the ECB fired a liquidity cannon at the financial system in an attempt to provide stability in March. Additional monetary and fiscal policy moves are on the horizon in Q3 as the continent continues to deal with the economic and human toll of the virus. At the end of Q2, Europe seemed to be in better shape when it comes to the virus than the US.
The UK and EU parted ways at the end of January as the December election of Prime Minister Boris Johnson paved the way for the divorce that fulfilled the will of the British people from the June 2016 referendum. The December 12 general election stood as a do-over of the referendum. The number of cases of Coronavirus in the UK continued to rise at the end of Q1, with both Prime Minister Johnson and Prince Charles, the current heir to the throne, testing positive. London is the home to the London Metals Exchange and hub of international trading for base metals and many other markets. The LME stopped all ring or floor trading in March and moved to a wholly electronic model. The move of inventories from the LME to COMEX is a significant event for the copper market and could be a commentary on the attitudes towards China. The coronavirus came from Wuhan Province in China and the US and Europe believe that the Chinese government is responsible for the spread of the pandemic and the extraordinary toll it has taken on lives and the overall economy.
Copper traded to lows of under $1.25 in 2008 in the wake of the world financial crisis. In 2000, the price of the red metal was 85 cents per pound. Before the mid-2000s, copper never traded above $1.60 per pound. Copper traded to a low of $1.9355 in January 2016, which is a level of critical support below the mid-March bottom at $2.0595. Copper has recovered to a level where it was closer to the technical resistance is at the mid-January high of $2.8860 per pound at the end of Q2.
Copper was in a bear market from 2011 through the beginning of 2016. After ten months of consolidation, the metal broke out to the upside, and the bear of past years had turned into a raging bull in 2017. The first half of 2018 had been a year of consolidation, but during Q3 of last year, copper broke to the downside, and the price fell to a marginally lower low in Q3 2019. Copper reversed higher on the daily chart in September and followed through on the upside in Q4 as optimism rose over a de-escalation of the trade war between the US and China. The global pandemic dealt copper and markets across all assets a dramatic blow in Q1. Since mid-March, the copper market experienced a V-shaped recovery. The path of least resistance for the price of the red metal at the end of Q2 is higher. The economic fallout from the unprecedented halt in business activity weighed on the prices of industrial commodities and base metals over the coming months and years. The cure for low prices in commodities markets is low prices as production tends to decline. The initial decline in energy prices pushed production costs lower, but crude oil recovered to the $40 per barrel level at the end of Q2. The virus caused labor shortages and mine closures that are weighing on output. Wide price variance in the copper futures and forward market, as well as all other markets, is likely to continue in Q3 and beyond. If 2008 is an example for the copper market, we could see far higher prices for the red metal in the coming months and years.
Nearby copper futures on COMEX settled at $2.7135 on June 30, and three-month forwards on the LME were at $6043.50 per ton. Copper was only 2.99% lower on COMEX and 2.24% lower on the LME over the first six months of 2020.
Copper Prospects for Q3 2020
Copper’s bull market that commenced in January 2016 had been almost picture-perfect as it has never violated a technical support level on the weekly chart. The pattern held over the first six months of 2018, but in Q3, the price fell significantly, destroying the bullish trend from a technical perspective. In Q4 2018 and Q1 2019, copper worked its way to a marginal new low, which triggered a relief rally on the back of optimism over a trade agreement between the US and China. In Q2 2019, the red metal remained above the Q1 low. In Q3, the price fell to a lower low. In Q4, progress on trade lifted the price of the red metal. In Q1 2020, after rising to a marginal new high at just under $2.90 per pound, the price fell sharply on the back of the global pandemic and halt in business activity. The V-shaped recovery in Q2 took the price towards the high for the year. Production declines, a weaker US dollar, and central bank stimulus are all bullish for the price of copper.
The path of least resistance for copper will depend on the progress of the virus. New outbreaks, rising cases, and increased mortality over the coming months could put a roadblock in front of the recovery in the copper market. It is more than a challenge to predict the future at the end of Q2, but the uncertainty of the virus and the unprecedented economic fallout could weigh on the red metal for a prolonged period. However, stimulus eats away at the value of currencies, which is bullish for copper and all commodities in the long run.
Typically, interest rates, the level of the US dollar, and Chinese economic growth are leading factors that drive the price of copper higher. We are facing anything but ordinary times as we head into Q3. During the worst risk-off period since the 1930s in February and March, we witnessed wide price ranges. The V-shaped recovery in the copper market is a sign that the metal remains an essential building block of infrastructure worldwide, and China’s appetite for the red metal is robust.
Copper traded in a range from $4626.50 to $6325 per ton on the LME and from $1.9725 to $2.90 on COMEX over the first six months of 2020. Copper finished the quarter close to the top end of the range for the year on both the forward and futures markets.
2020 began on an optimistic note, but the black swan event in Q1 changed the copper, base metals, all other markets, and the world in ways we will feel for years if not decades. The price action in Q2 is likely a result of the stimulative measures to address the crisis. We face a new reality in the commodities market, and copper is a barometer for the asset class. That barometer was pointing towards inflationary pressures at the end of Q2.
As I wrote at the end of Q1, “If Coronavirus impacts production and inventories decline when business activity begins to come back online, we could wild swings on the back of the mountains of liquidity that will have a depressive effect on currencies. Fasten your seatbelts in all markets but keep an eye on copper because it could provide signals for other asset classes. In a world gripped by illness, Doctor Copper could provide clues.” Copper is telling us that 2020 could turn out to be a lot like 2008. After falling to a low of $1.2475 in the aftermath of the global financial crisis, copper recovered and rose to a new all-time high in 2011 at $4.6495 per pound. I expect a wild ride in the copper market. Technical resistance on the COMEX futures stands at $3.3220 per pound, the late 2017 high in the red metal. I am cautiously bullish on the prospects for the copper market during the second half of 2020.
The price of aluminum moved 12.43% higher in 2016 after falling by 18.35% in 2015. In 2017, aluminum moved 32.33% higher, but the base metal fell by 17.99% in 2018. Three-month LME aluminum forwards moved 0.92% lower over in 2019. In Q1, aluminum forwards fell 16.68%, but in Q2, the market recovered by 6.40%. Aluminum forwards on the LME were 11.35% lower over the first six months of 2020.
While trade was the critical issue for the aluminum market in 2018 and 2019, like all other markets, the halt of the global economy on the back of the worldwide pandemic weighed on the price of the nonferrous metal leading to an almost 11.35% decline over the first half of 2020.
Aluminum inventories on the London Metals Exchange rose from 1,148,750 metric tons at the end of Q1 to 1,642,600 tons at the end of Q2 2020, a significant rise of 493,850 tons or 43.00% over the past three months.
As the one-year chart highlights, aluminum stocks rose steadily since the virus spread around the world in March 2020.
Shares of Alcoa (AA) rebounded with the recovery in the price of aluminum and the stock market in Q2. AA shares closed Q1 at $6.16 per share and rallied to $11.24 at the end of Q2, a rise of 82.5%. Meanwhile, AA shares closed 2019 at $21.51 per share and remained at almost half that price level at the beginning of Q3. AA outperformed the price action in aluminum and the stock market in Q2 after a significant underperformance in Q1. At the end of Q2, the US was poised to slap a 10% tariff on aluminum from Canada, which could cause increased volatility in the market over the coming weeks and months.
Aluminum Prospects for Q3 2020
2020 began on a note of optimism as the US and China agreed on a “phase one” trade deal. However, Coronavirus and its toll on humanity and the global economy caused the price to move 11.35% lower over the first six months of 2020. The price recovery during Q2 was not enough to erase the double-digit percentage loss so far this year. Aluminum will likely follow the lead of copper and the other base metals, but tariffs on Canada and other aluminum-producing countries could cause price distortions over the coming weeks and months.
As the chart shows, despite the rise in Q2, aluminum stocks on the LME declined significantly over the past five years, which had been a supportive factor for the price of the metal. However, risk-off conditions have changed everything in all markets, and aluminum is no exception. The world’s economy ground to an unprecedented halt in March. While the price of the nonferrous metal made a bit of a comeback in Q2, it remains weak going into the second half of 2020. Coronavirus, trade issues, and the overall path of commodities prices over the coming months and years will dictate the path of least resistance for the price of aluminum. I am a better buyer of aluminum at its price level at the end of Q2, but I am cautious.
Three-month aluminum forwards on the LME traded in a range from $1459.50 to $1826 in Q1 and closed at the end of June just below the midpoint of the trading band for 2020. Aluminum made a lower low during Q3 and three-month forwards closed Q2 at $1621.50 per ton. The price action in AA shares was encouraging during Q2, but they have a lot of ground to make up before reaching the closing level from the end of 2019.
As the chart shows, AA shares may have almost doubled from the low at the end of Q2, but they remain at nearly half the price at the end of 2019. Any long positions in aluminum or AA shares require tight stops given the potential for wide volatility over the coming months. Another move below the $10 level in the stock would be a bearish sign for the aluminum producer.
The price of three-month LME nickel, a highly volatile metal, plunged by an astonishing 42.57% in 2015 and then rallied by 15.98% in 2016. In 2017, nickel posted a gain of 21.90%. Nickel posted a 13.17% loss in 2018. Nickel moved 31.79% higher in 2019 as the market prepared for Indonesia’s export ban that started on January 1, 2020. In Q1, the price of nickel forwards on the LME posted a 19.73% decline as risk-off conditions trumped all other fundamental and technical factors. In Q2, nickel came storming back with a 13.85% gain and was 8.80% lower through the first six months of 2020 in an unusually challenging environment for all industrial commodities. Nickel moved higher over the three months on the back of increased demand for stainless steel and batteries.
Indonesia is a leading nickel producer. The market had expected a mineral export ban to begin in 2022. However, the government accelerated the ban, which started on January 1, 2020. The price of nickel exploded higher on the back of the export ban in Indonesia in 2019. The trend towards electric automobiles continues to underpin the nickel market. Nickel was the best-performing base metal in 2019 and the only metal to post a double-digit percentage gain for the year. Coronavirus in Q1 caused the price of nickel to implode, but the price held the $11,000 per ton level and moved higher over the second quarter.
On the LME, nickel inventories rose from 150,690 at the end of Q4 2019 to 229,812 tons at the end of Q1 2020, 79,122 tons, or 52.5% higher than at the end of 2019. At the end of Q2, stockpiles stood at 233,898 tons, 4,086, or 1.78% higher for the past three months. Nickel stocks were 27.53% lower in 2019. In 2018, LME stocks fell by over 150,000 metric tons, but the trend of falling inventories ended in Q1 2020. The Indonesian export ban and rising demand from electric vehicle batteries provide some support for the price of nickel, but the worldwide pandemic was the overriding factor for the price path of the metal in Q1. In Q2, nickel rose with the rest of the base metals sector, following copper’s lead.
Exchange stocks of nickel tend to be a higher grade suitable for battery production, while nickel for steelmaking requires a lower grade. These days, only around 5% of annual nickel production goes into batteries, while 1% is needed for EV power plants, but that percentage fell, particularly with the significant decline in the price of crude oil and petroleum-based fuels in Q1. Crude oil rose to the $40 per barrel level in Q2, which was supportive of the price of nickel. The rise in Tesla shares, and the company’s increasing production is a supportive factor for the demand for nickel.
When it comes to nickel, iron ore and steel demand are substantial factors for the price of the nonferrous metal. Nickel is highly sensitive to changes in global economic conditions, as we witnessed in Q1 and Q2. Nickel is a very volatile metal, and we could see a wide price range for the metal in Q3, but the bias is now to the upside as copper has led the sector higher. Stimulus and weakness in the US dollar underpin the price of nickel as we head into the second half of 2020.
The decline in the value of currencies could cause some inflationary pressures that could boost the price of nickel. Three-month nickel forwards closed Q2 at $12,837 per ton, at just above the midpoint of the trading range in 2020, which was from $11,142 to $14,360 per ton. Nickel did not venture outside of the trading band in Q2. Demand from electric cars is supportive of the price of the nonferrous metal, but the global pandemic will continue to be the most significant issue facing all markets. Nickel is likely to continue to follow copper’s lead.
Nickel Prospects for Q3 2020
Nickel tends to be one of the most volatile metals that trade on the London Metals Exchange. Over 2017, nickel ran into selling each time the price moved above the $12,000 per ton level, which had been critical technical resistance for the base metal. $12,000 was critical resistance, but in 2018 and 2019, it had made great strides above that level. Nickel was back above $12,000 at the end of Q2 2020 as the price recovered and was only 8.8% lower over the first half of 2020.
Nickel is a thinly traded metal on the LME, and the price can swing from contango to backwardation. At the end of Q2, the cash to three-month nickel prices was at a contango of around $47 per ton, which decreased by $16 from the contango at the end of Q1 2020. Contango is a sign of supply and demand equilibrium or oversupply in a market. The Coronavirus trumped the Indonesian export ban in Q1 and Q2, and the price of nickel plunged with all of the other members of the base metals sector and markets across all asset classes. However, the recovery on the back of demand for stainless steel and batteries is a positive sign for the metal as we head into Q3. Moreover, the virus has caused production problems around the globe, which could be another supportive factor for nickel over the coming months and years.
Keep an eye on nickel inventories as significant changes can cause the price to move higher or lower over the coming weeks. Technical support is now at the $12,000 per ton level once again as we head into Q3.
LME nickel traded from lows of $11,142 to highs of $14,360 per ton in 2020 and closed the quarter above the midpoint of the range. A slowdown in production could cause inventories to decline, which could cause a significant rally in the price of the thinly traded metal. At the end of Q2, the path of least resistance was higher, but we should expect lots of volatility over the second half of this year.
Lead, the worst-performing nonferrous metal in 2014, falling by 17.65%, and then it was the best performing nonferrous metal in 2015, declining by only 3.36% in 2015. In 2016 lead gained 11.14%. Lead appreciated by an incredible 25.31% in 2017. The price of lead fell 19.32% in 2018 and was 4.02% lower in 2019. In Q1, lead forwards were the best performing metal on the LME with an 11.23% loss. In Q2, three-month LME lead forwards moved 4.83% higher and closed on June 30, 2020, at $1,801.50 per ton. Lead was 6.95% lower over the first six months of 2020.
Lead is a thinly traded metal, and it is always a possibility that there are both price and stockpile manipulation in the lead market. Lead stocks on the LME were at the 71,125 level at the end of Q1 and moved to 67,425 tons at the end of Q2, 3,700 tons, or 5.20% lower over the second quarter. The stocks had declined by 38.29% in 2019.
Demand for batteries around the world is supportive of the price of the toxic base metal. China is, by far, the world’s largest producer and consumer of lead and the biggest player in the market, which lends the price of the metal to price manipulation. The Chinese anti-pollution policies have increased the demand for electric automobiles, which is supportive of the price of lead. There is some degree of correlation between the price of oil and lead as higher oil prices increase the demand for electric vehicles and falling oil prices do the opposite. Crude oil tanked in Q1, which weighed on lead as the virus and risk-off conditions were overwhelming. The energy commodity rebounded to the $40 per barrel level at the end of Q2, which helped lead to post a gain for the quarter. Economic expansion or contraction around the globe will be the most significant factor for the price of lead in Q3 and beyond. On a longer-term basis, lead is a promising metal because of its consumption in batteries, a global market that continues to grow.
Lead Prospects for Q3 2020
The growth in the battery market around the world, and China’s intention to increase the number of electric automobiles are supportive of demand for and the price of lead. While the “phase one” trade deal between the US and China provided some optimism going into this year, the pandemic and economic contraction along with the breakdown in relations between the US and China could pose problems for the price of the base metal. Lead traded in a range from $1598 to $2026 over the first half of 2020. Lead closed just below the midpoint of its 2020 trading range at the end of June.
Liquidity in the lead market is thin, but the metal has had an expanding addressable market. The price carnage in the oil market and deflationary spiral weighed on the price of lead forwards on the LME in Q1, but the rebound in Q2 is promising as we head into the second half of this year. Production declines from oil producers that lifted the price of the energy commodity back to the $40 per barrel level could be supportive of gains in lead as the demand for electric vehicles increases.
The price of zinc dropped by 25.8% lower in 2015. Zinc was the best-performing metal on the LME in 2016, gaining 59.53%. Zinc added to those gains as it rallied by 27.54% in 2017. Zinc moved 25.49% lower in 2018 and was 6.53% lower in 2019. In Q1, the price of zinc declined by 17.93%. In Q2, the price rebounded by 9.98% and was 9.74% lower over the first half of 2020. Three-month zinc forwards on the LME closed at $2067.00 per ton on June 30, 2020. After achieving a multiyear high in February 2018, the price of zinc moved steadily lower on the back of increasing stockpiles, and weak Chinese demand. Supplies of zinc concentrates have been rising because of high prices last year. New production from China and Peru weighed on the price of zinc, and lower demand because of escalating trade tensions had sent prices significantly lower. The zinc market had been tight because of depleted mine supply, but higher prices brought new production to the market, and the $2500 per ton level, which has become a significant pivot point for the metal gave way. In Q1, the global pandemic sent the price below $2000 per ton, which was a level of technical and psychological support. In Q2, zinc traded on either side of the $2000 per ton level, which has become the new pivot point for the nonferrous metal. LME stocks moved significantly higher in Q2. LME inventories rose from 73,125 at the end of Q1 to 122,575 tons on June 30, an increase of 49,450 tons, or 67.62%. Zinc inventories have been rising significantly in 2020. The fundamentals for zinc shifted with new production at higher prices, and we witnessed a shift in the production and pricing cycles in the zinc market. Coronavirus hit all of the base metals in Q1, and the zinc market was no exception. In Q2, zinc followed copper and the other metals as they recovered as it cut its loss for the year to under 10%.
Zinc Prospects for Q3 2020
As the production cycle for the zinc market shifted because of higher prices, more zinc concentrates came onto the market, which depressed the price of the metal before the global pandemic dealt all of the base metals a bearish blow. We witnessed the first significant increases in stockpiles in Q2 2019 as they almost doubled in the on a quarter-to-quarter basis. In Q1 and Q2 2020, inventories rose significantly. Zinc traded in a range from $1793 to $2449 so far in 2020 and did not move outside the range in Q2. The price closed Q2 slightly below the middle of the range for this year. Global economic conditions, the value of the US dollar, and the impact of stimulus will dictate the path of least resistance for the zinc market in Q3 and the second half of 2020. The increase in production and high level of stocks could limit the upside over the coming weeks and months.
Tin is the most volatile and illiquid metal traded on the LME. Tin declined 25.13% in 2015. In 2016, tin was the second-best performing base metal, rising by 44.10%. In 2017, tin was the only loser in the base metals sector posting a 5.4% loss. Tin fell 1.89% in 2018, making it the best performer of the six base metals that trade on the LME. In 2019, the price of tin moved 13.26% lower. In Q1, tin added to the losses with a decline of 14.78%, but in Q2, the price moved 16.93% higher and was only 0.43% lower since the end of 2019. Tin was the second-best performing base metal on the LME in Q2.
China is the world’s largest producer and consumer of tin. Indonesian output is on the decline, but in other areas of the world, it has risen. Above $20,000 per ton, things got dicey for tin throughout 2017, but economic growth in China provided stability and support for the price. The $20,000 had become the pivot point for the price of three-month tin forwards. In 2019, the price moved away from the level on the downside. In Q1, tin dropped below the $15,000 level, but it recovered in Q2. Stocks on the LME moved significantly lower in Q2; they were at the 3,605-ton level, down 2,640 tons as of June 30. Three-month tin forwards on the LME closed at $16,777 per ton on the final day of June.
Tin Prospects for Q3 2020
Tin is a thin market that makes the metal susceptible to wide price swings. When it comes to tin, it tends to move on supply and demand fundamentals because of the lack of speculative interest. Tin was in a small backwardation of $70 per ton when it comes to cash to three-month forwards on the LME. The back widened by $29 per ton since the end of Q1. I suggest monitoring the supply and demand situation in the tin market by watching and paying close attention to the tin spreads. Tin can swing back and forth between contango and backwardation, and those moves tend to impact the path of least resistance for three-month prices. Tin can be a heavily manipulated market on the LME because of the limited liquidity. Tin traded in a range from $13,375 to $17,775 so far in 2020 and closed above the midpoint of the trading band this year. The price of tin remained within the range in Q2.
The bottom line: Outlook for Q3 2020
Base metals and industrial commodities are heading into the second half of 2020 after recovering from the worst period since 2008 and perhaps the 1930s when it comes to the overall economy. The world remains at war with an invisible and microscopic enemy at the end of Q2. The virus does not discriminate because of nationality and borders, race, religion, wealth, sexual orientation, or political ideology. Coronavirus is a reminder that all of the people on the planet are in the same boat when it comes to battling a health emergency. The impact on markets has been dramatic, but it is only a symptom of the global pandemic. Central banks and leaders can treat the effects of the virus, but the answer to the crisis is in the hands of scientists looking for effective treatments and a cure and the health professionals who are selflessly treating the ill. The global supply chain continues to provide essentials to people around the globe, but the economic fallout will be substantial. The longer the virus remains out of control and spreads around the planet like wildfire, the higher the financial cost. However, life comes first, and the economic factors a distant second. The stimulus stabilized the situation in Q2 and led to recoveries in all of the base metals, which posted across the board gains. If 2008 is a model for 2020, prices could continue to move higher over the coming months and years.
At the end of Q4 2019, I wrote, “Any risk-off period during 2020 has the potential to cause selling in this sector of the commodities market.” No one expected a risk-off period caused by a virus, which has become the most significant black swan event of our lifetime. Fundamentals and technical factors will continue to take a backseat to the progression of the virus in the short-term. However, price cycles will eventually lead to price bottoms. As production grinds to a halt in an environment of collapsing prices, inventories will begin to fall, leading to price bottoms. The world will emerge from the ashes of Coronavirus, and base metals are the building blocks of infrastructure. The cure for low prices in commodities is low prices.
Keep a critical eye on LME stock movements as the trend in inventories can provide some clues about the path of least resistance of prices. Throughout the years, we witnessed many examples where stocks pushed prices around. However, always view inventories with a grain of salt as they can create a mirage when it comes to the path of least resistance of prices. The LME is working towards a plan that would increase transparency when it comes to stockpile data over the coming months. However, as a Chinese entity owns the exchange, the potential for manipulation is always a danger.
Each non-ferrous metal traded on the London Metal Exchange has different supply and demand fundamentals. Some of the metals were in deficit, and some had surplus inventories when the pandemic emerged.
The price of iron ore, the main ingredient in steel, moved 3.55% lower in 2018, after a 10.02% loss in 2017. In 2019, the price of iron ore jumped 32.27% higher on the back of supply shortages from Brazil. In Q1, nearby iron ore futures fell 9.66%. In Q2, they rallied by 19.05% and were 7.56% higher over the first six months of 2020. Nearby iron ore futures finished Q2 at $98.45 per ton. Iron ore is the primary ingredient in the production of steel. U.S. Steel (NYSE: X) stock was trading at $7.22 per share compared to $6.31 at the end Q1; the stock almost halved in value in Q1 and made a marginal recovery in Q2. X shares had lagged the stock market in 2019 and continued to underperform the leading indices during the price carnage in late February and March 2020 and throughout Q2.
The Baltic Dry Index moved 42.14% higher in 2017. In 2018, the BDI experienced a 6.95% loss compared to its closing price at the end of 2017 and was 14.24% lower in 2019. In Q1, the BDI fell 49.72%. In Q2, it exploded 227.37% higher. Even though the BDI experienced seasonal weakness during the winter months, the deflationary spiral and halt of economic activity weighed on the BDI and freight rates at the end of Q1. The index that represents the freight rates for shipping dry bulk commodities around the world is often a sign of demand for commodities. China is the most influential factor when it comes to moves in the BDI as it is the 800-pound gorilla when it comes to the demand side of the fundamental equation in the raw materials market. New restrictions on cleaner fuels boosted shipping rates and the BDI in 2019. The BDI closed Q2 at the 1794 level. The level of the BDI is a promising sign of emerging demand for the commodities asset class.
The global pandemic has changed the world from a short-term perspective, but the impact will last long after scientists discover effective treatments and a vaccine. The bottom line for base metals and other commodities is that we will feel the effect for years to come. While the deflationary spiral was bearish for prices, unprecedented levels of fiscal and monetary policy stimulus could cause inflationary pressures. At the same time, as the contraction leads to lower levels of output of all of the base metals, inventories will decline, and prices should find bottoms. We could be in for very volatile price action for the foreseeable future. As we head into Q3, the downward spiral took a pause, and prices recovered. I continue to expect volatility in this sector throughout the rest of 2020 and over 2021 and 2022.
DBB is the ETF product that tracks the base metals sector. DBB moved from $12.35 at the end of Q1 to $13.61 at the end of Q2 2020. DBB rose by 10.20%. The product tracks the price action in the copper, aluminum, and zinc markets. DBB does not list lead, nickel, or tin LME forwards in its top holdings, as the prospectus says, “The index Commodities consists of aluminum, zinc, and copper-Grade A.”
DBB has net assets of $87.62 million, trades an average of 80,787 shares each day, and charges a 0.75% expense ratio. The net assets and average trading volume fell from the level at the end of Q1 2020.
Expect lots of price volatility in the base metals and industrial commodity sector of the commodity market over the coming quarter and beyond. While economic contraction was bearish for prices earlier this year, inflationary policies to combat the financial symptoms of the pandemic and a significant decline in production could give way to lots of two-way price volatility. Keep those stops tight and take profits when they are on the table. Markets rarely move in a straight line, which creates an environment where trading opportunities to increase. The current market conditions continue to favor trading rather than any medium or long-term positions. The trend at the end of Q2 was mostly bullish for the sector.
Any investment involves substantial risks, including, but not limited to, pricing volatility, inadequate liquidity, and the potential complete loss of principal. This document does not in any way constitute an offer or solicitation of an offer to buy or sell any investment, security, or commodity discussed herein, or any security in any jurisdiction in which such an offer would be unlawful under the securities laws of such jurisdiction.