With demand from China expected to slow, the outlook for metals, once dominated by the omnipotent force of one of the world’s largest and fastest growing economies, is likely to see cyclical pressures impact pricing. With the recent rally across the metals complex now in the rear view mirror, is it time for investors to take money off the table? While certain markets have begun to mean revert – copper is one example – a UBS report out Monday observes that investors they speak with are looking to buy the dips.

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Copper UBS report
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UBS report Asks - Copper is up near 20% over 4 months, is mean reversion expected?

The 2017 rally in copper, from a May double bottom near $5,500 per ton on the London Metal Exchange to just below $6,970 last week, was a strong 20% rally over four months. Analysts had generally attributed the run higher to a weaker US dollar and China’s threat to ban imports of scrap copper as part of the fundamental explanation. Technical analysts, meanwhile, have noted a momentum effect where price-based speculators received buy signals and their demand pushed futures higher. Goldman Sachs, for its part, had advised clients to buy copper in July.

But since then the price has backed off in a sharp mean reversion to near $6,600 on the spot market, with some analysts watching a potential move to $6,400 or $6,000.

“We view the metal as being increasingly detached from fundamentals with traders looking more at the bullish momentum than specific drivers to justify a 27 per cent rally since the low point in May,” Ole Hansen, head of commodity strategy at Saxo Bank, told the Financial Times.

The UBS report notes a degree of skepticism. “Many investors were sounding a little unconvinced given copper prices now likely sit towards the top of or above the mine cost curve and most of the scrap cost curve,” they wrote in a September 11 Global Mining Strategy piece.

But with a historically strong 20% having already occurred, where can the price of copper go from here? UBS, looking at speculative positioning, searched for meaning. “Record high net long futures positions are curious; what do metal investors know that the rest of us don't?”

While some view the record net long futures position as seen through the CFTC’s Commitment of Traders (COT) report a sign of validation, others disagree. Carly Garner, a commodity analyst at DeCarley Trading, notes that when speculative positions reach above 51,000, an exhaustive impact takes place where speculators have little dry powder left to push the metal higher. Last week that number was at 41,000 with a push to 50,000 this week expected.

The UBS report, for its part, is looking at fundamental demand and is “constructive” in the medium and long term, but thinks prices may have moved a little too far and too fast in the short term. “Now that more projects are being given the go-ahead, and still others fast tracked; how will the market balance change when these projects come to market?” While future projects might boost demand, UBS points out the recent price rise may warrant fund managers buying on a dip. “From current spot prices in the low US$3/lb level, we are effectively neutral price delta from here.”
Where are metals demand going to come from?

With China deleveraging and growth in the US, Europe and Japan reasonably tepid, watching the market equilibrium with a focus on fundamentals, is the UBS focus, as it might determine the long-term staying power of a rally.

“There is emerging evidence of the market asking where the next phase of growth will come from,” the UBS report opined, pointing to investors sentiment and market cycles that may take a few years to pick up. UBS notes this sentiment when speaking with their clients:

The prevailing view was to buy commodity price dips. The rationale here is that demand isn't going to collapse and a cycle shifts away from balance sheet repair & returns to owners, and toward growth; will take 1-2 years. It seems investors are wary buying these names at current spot prices but would be more comfortable if prices eased 10%-20%. No one has aggressive sell or short positions at the moment; no one argued aggressively bearish commodity price views to us.

 

In the aluminum market, the UBS report is watching tight demand that may be disrupted by unregulated supply hitting the market. Zinc is experiencing high demand, but that could change if supply comes on line from producers such as Glencore expanding their mining capacity. With China, a focus on demand and Asian exports slowing, watching the tea leaves for metals means watching how the nation's deleveraging and regulation impacts markets to various degrees.