Base metals can still shine in an uncertain environment

THE global economy is at an important crossroads; economic data from the US has been patchy and signs of a slowdown in China are causing bouts of volatility in risky assets. However, base metal prices have held up well. The question is, will they continue to do so?

The recent surge in base metal prices was fuelled by steady physical demand in the first half of this year as well as supply constraints, such as the closure of several metal plants. Although economic data has moderated in the US and China, it hasn’t fallen off a cliff. In fact, some analysts in the City say that despite downward revisions of China’s GDP forecasts and softening in manufacturing indices, the Chinese authorities’ policy response – to increase stimulus measures to ensure the economy does not enter a protracted slowdown – could have a positive impact on China’s construction sector. This is positive news for base metals prices since China is a main force for the market for raw materials.

Last week the Reuters-Jefferies CRB index, which represents a basket of commodities, rose by 278 points, reaching its highest level since early May. The Royal Bank of Scotland (RBS) base metal index rallied 20 per cent after hitting an eight-month low in June. Technical indicators have also pointed to a bullish trend. Copper and aluminium have led the way, both breaking their 100-day and 200-day moving averages.

If trading base metals themselves is not for you, then you can get exposure through mining companies. The sector was given a boost last week following Xstrata’s and Rio Tinto’s healthy first-half results. Rio’s pre-tax first-half profits rose almost 150 per cent from $3.3bn to $8.8bn, 70 per cent of which came from iron ore sales. Similar results are expected from BHP Billiton when it reports later in the month.

Spread betters should also watch out for any more news about changes to Australian mining taxes, especially after the election later this month.

Spread betters should look to take advantage of continued price swings as a result of merger activity in the sector. Last Monday’s announcement by Glencore, the world’s largest commodities trader, that it was acquiring the metal warehousing business Pecorini, added to upward pressure on base metal prices. Copper three-month futures jumped 2.7 per cent to $7,485 a tonne on the London Stock Exchange following the news.

But watch out – Frédéric Lasserre from Societe Generale says that the base metal rally could be short-lived. Analysts at RBS downgraded China’s growth for 2010 from 11 to 10 per cent. Furthermore China stockpiled base metals when they were low in 2008 and 2009, meaning it has to use these imports before going on another shopping spree. But spread betters can use any weakness to take a long position.

Rio Tinto’s CEO Tom Albanese says that the outlook for commodity prices will be volatile this year, echoing statements made by Xstrata and Anglo American, two other mining giants. If you are unsure which base metal to choose, just remember they tend to move together, with copper leading the pack.

The base metals rally has not run out of steam yet, so spread betters should take advantage, but be nimble.