LONDON, Dec 15 (Reuters) - Funds have returned to the base metals complex in a big way as investors buy into the COVID-19 recovery story.
Speculative long-positioning is at or near multi-year highs across the board, the collective pivot back to a previously out-of-favour sector acting as a major price driver in its own right.
The main beneficiary of this investment wave is no surprise: Doctor Copper is widely traded as a proxy for global economic health, making it a perennial favourite with the money men and women.
But the bullish exuberance has also spread to other metals, such as aluminium, a market largely shunned by investors in recent years because of its tendency towards excess production and huge inventories.
The question is whether this new money love for metals is just a cyclical recovery play or the start of a structural change in investor behaviour.
BUYING THE BOUNCE
Industrial metal prices have crashed and boomed over the course of 2020.
The London Metal Exchange (LME) Index, a weighted basket of the major base metals, slumped by 22% over the first quarter of 2020 as first China, then the rest of the world went into lockdown. The index is up by 21% on the start of the year, an extraordinary turnaround even by the standards of a notoriously volatile sector.
The super-charged metallic rally has drawn in increasing numbers of investors on the long side. The collective weight of money, much of it chasing price momentum, has itself helped to drive prices to multi-year highs.
This symbiotic relationship between money and price has been apparent in the CME copper contract. Money managers have turned from a collective net short of 59,000 contracts in February to a net long of 90,434 contracts.
The first part of the shift was the close-out of short positions in the second quarter as the copper price bounced from its March low of $4,371 per tonne. Bear bets fell below 30,000 contracts in June and they have stayed low ever since, last at 26,405 contracts.
Since June there has been a steady build in bull bets, both driven by and driving copper’s extended rally to a current $7,825 per tonne.
The same pattern is visible in the LME’s Commitments of Traders Reports, which show bull positioning at the highest since the exchange started publishing the report in the current format in 2018.
Zinc and nickel have both been sucked into a Chinese investor play in the ferrous markets - they are both used as alloying agents for steel - which has spilled over to the London market.
Aluminium is showing the highest level of outright fund long positions. In part, this reflects that it is the biggest, most liquid of the LME contracts, but aluminium may offer some clues as to what is attracting so much investor attention.
A RECOVERY PLAY?
Aluminium is trading above the $2,000 level for the first time since November 2018.
The strength of the demand recovery in China has defied all expectations. The world’s largest producer turned into a net importer of aluminium in all forms in July and August for the first time since the Global Financial Crisis of 2008-2009.
Then as now China has turned on the stimulus taps with investment surging down the twin metals-intensive channels of construction and infrastructure. A sharp recovery in automotive output is acting as a further accelerator.
In many ways, this year looks like a re-run of the last crisis, when China came to the rescue of metal markets and propelled prices higher.
Against this backdrop, the funds’ return to the base metals complex can be seen as a simple economic recovery play, led of course by the world’s largest manufacturer.
If so, funds can be expected to stay in metals for as long as Chinese stimulus lasts, which may not be long.
Indeed analysts at Macquarie Bank say “the pace of credit growth already appears to have peaked in Q2 and the ramp-up of government bond issuance that contributed financing to this year’s investment surge has also slowed.” (“Commodities Compendium”, Dec. 4, 2020).
A dial-back in Chinese government largesse and a simultaneous refocus on the services sector could see metal prices struggle next year. Or, as Citi analysts put it: “We are wary that 1Q 2021 may be tricky for bullish investors, especially for copper.” (“Metals Weekly,” Dec. 15, 2020)
A (DE-)CARBON PLAY?
But there may be more to the aluminium rally than Chinese-led demand recovery.
Physical stocks accumulated in the United States and Europe during the last crisis. This time, they are mostly in Asian locations, because traders are betting that China is going to tap the international market for aluminium more frequently than in the past.
China’s massive smelter sector is fast approaching Beijing’s capacity cap just as demand from green technology applications such as solar power ramps up.
Decarbonisation is a double-edged sword for China’s aluminium producers, promising robust future demand but a major problem for a sector that relies heavily on coal for its power.
The coming green revolution has also excited copper bulls because the metal is used in every low-carbon application from wind farms to electric vehicles.
True, the physical demand impact from decarbonisation is still muted but fund managers are not known for hanging around when they see a structural opportunity, especially when they are part of the decarbonisation trend as growing amounts of money migrate into “green” investment vehicles.
This process may have a way to run, given that some of the world’s largest investment funds have exposure to commodities via baskets, such as the Bloomberg Commodity Index, in which fossil fuels still account for the largest single component at around 30%.
It’s possible that some funds are entering the metals arena with their eye on this longer-term story, in which case they could be here to stay.
But we won’t know the answer until the inevitable correction to this year’s rallies comes. The fund money may flee the complex again or it might just double down.
Editing by Barbara Lewis