Recovery hopes are pushing smart traders towards metals contracts

BELOW me, dozens of men in dark suits are standing in a ring, yelling at each other and making special hand signals. Around the ring clerks are sitting, often with a telephone held to each ear and giving a running commentary down the line on the events unfolding in front of them. In the cacophony of noise, it is hard to imagine that anything productive is getting done, let alone that a significant proportion of the world&rsquo;s non-ferrous metals contracts &ndash; the London Metal Exchange trades 95 per cent of the global non-ferrous metals markets &ndash; are traded in the intense five-minute sessions and that this is where the global benchmark price for all metals is set. <br /><br />It might all seem like a throwback to the Gordon Gekko-esque 1980s, and indeed the 133-year-old London Metal Exchange is the last place in the City where they still have open-outcry trading. While it is traditional, it is also at the cutting edge of the modern economy. The biggest forward contracts traded are copper and aluminium: the average daily volume for copper in April was 3m tonnes and for aluminium, 4.2m tonnes was traded daily. Last year the LME introduced steel contracts and it is intending to launch two minor metals &ndash; cobalt and molybdenum &ndash; in the second half of 2009.<br /><br /><strong>RING TRADING</strong><br />While the excitement of ring trading is reserved exclusively to the LME&rsquo;s 12 Category 1 members &ndash; which include major banks such as RBS and Societe Generale as well as metal brokers such as Triland and MF Global UK &ndash; metals are big business across the investment spectrum and a growing range of trading and investment products give the private investor exposure to the metals market.<br /><br />Private investors typically consider just precious metals as a trading possibility, but industrial metals &ndash; which normally use the LME&rsquo;s contract as the underlying asset &ndash; are growing in popularity as their prices have risen on the back of hopes for a global economic recovery start to look more founded in reality. And the increasing presence of spread betting, contracts for difference (CFDs) and exchange-traded-funds (ETFs) make metals trading a possibility for the private investor. <br /><br />If you are interested in getting involved in metals, what are the facts? Among the attention-grabbing statistics are that over the past month the LME copper price has risen by about 16 per cent, aluminium by more than 20 per cent and nickel by as much as 26 per cent. The recent strong rally in markets and the depreciating US dollar have helped move base metal prices higher. Demand for industrial metals tends to indicate a recovery is on its way because firms increase production and therefore step up their orders of metals. <br /><br />Industrial metals bulls believe that emerging markets will bounce back faster than the industrialised economies and that their growth will provide support to base metal prices. This recovery is expected to be led by China, especially after recent figures showed accelerating growth in fixed asset investment, industrial production and retail sales. <br /><br />So should you go long on metals? Well, things are not quite that clear-cut. Although China is gung-ho about its own recovery prospects, some analysts are more cautious. Electricity usage &ndash; often considered a more reliable indicator of GDP growth &ndash; has not been in line with official data. Earlier this week the Chinese statistics agency defended its data showing that industrial output grew 8.9 per cent in May on a year earlier, while electricity production fell by an annual 2.7 per cent. This discrepancy prompted some to say that the actual figure must have been lower because the two figures have generally moved in tandem.<br /><br />And while Chinese restocking has been driving prices higher, surplus metal &ndash; particularly copper &ndash; is still flowing into the country. Restocking is not the same as a recovery in demand, it is only one step along the way. <br /><br />Remember too that Chinese industrial production is determined predominantly by demand for manufactured goods from industrialised countries. With unemployment in the major developed economies still increasing and expected to rise into 2010 consumption is likely to remain constrained, which will depress demand for Chinese goods. <br /><br /><strong>OVERPRICED SECTOR</strong><br />Metals, then, could well be overpriced. UBS analyst Peter Hickson says that spot copper, nickel, zinc and oil are now over 40 per cent ahead of his forecasts in 2009. &ldquo;Commodity prices continue to trade in line with macro indicators, including currency, with little attention on fundamentals; stronger commodity currencies &ndash;&nbsp;for example the Australian dollar and South African rand &ndash; are lowering the company earnings in the mining sector by 16-18 per cent,&rdquo; he says. This suggests that we may see a correction in the current industrial metals rally in the near-term as it runs out of steam. <br /><br />Over the next three months or so it may be worth shorting metals using structured derivatives products such as spread bets or ETFs, in the long term investors should look to buy into the growing emerging market metal demand, where the prospects are still looking good. The World Bank has forecasted that emerging market infrastructure spending will be $21.7 trillion over the next decade. This should easily offset the anticipated drop-off in global demand for Chinese products arising from the financial crisis.<br /><br /><strong>LME METALS </strong> THEIR USES<br /><strong>&9679; Aluminium</strong> &ndash; transport, construction, paint, electrical transmission lines, heat sinks.<br /><br /><strong>&9679; Copper</strong> &ndash; electrics, shipbuilding when alloyed with nickel, biomedical applications.<br /><br /><strong>&9679; Lead</strong> &ndash; car batteries, radiation shields, electrodes, high voltage power cables.<br /><br /><strong>&9679; Zinc</strong> &ndash; galvanisation, batteries, rubber manufacturing, agricultural fungicides.<br /><br /><strong>&9679; Nickel</strong> &ndash; stainless steel production, plating, many alloys. <br /><br /><strong>&9679; Tin</strong> &ndash; pewter, food preservation tins, superconductors, solder.<br /><br /><strong>&9679; Steel</strong> &ndash; transport, bridges, buildings, wires.