since its secular bull kicked off in 2003, the once-boring base-metals sector
took on an aura of excitement. What trader wasn't excited when copper, zinc,
nickel, lead, and aluminum put together respective gains of 475%, 523%, 650%,
829%, and 163% from their 2003 lows to their interim bull-market highs?
structural shift in base metals' core fundamentals sent prices skyrocketing,
as supply simply wasn't able to keep up with fast-growing demand. The age of
consumption extended well beyond the Western economies that normally drove
commodities prices, and an Asian monster was aggressively feeding its
voracious appetite for the metals. A new group of developing economies had
finally joined the modern era, initiating colossal infrastructure buildouts.
as is apparent today, base metals prices were rising too far, too fast. And
as any knowledgeable trader understands, such a blistering pace is
unsustainable. Either supply would catch up to demand, demand would soften,
or crazy-high prices would enable a convergence of these two scenarios. And
this would balance prices at levels that are fundamentally justified.
Base metals prices coming off their lofty highs wouldn't damage the integrity
of their secular bulls, but instead bring order to a bit of speculative
prices did come off their highs. Zinc saw its high in 2006, nickel and lead
in 2007, and copper and aluminum in 2008. Whether consolidation or
correction, base metals prices retreated in search of that balance. But
thanks to the global economic crisis, downward-moving base metals prices were
pushed to the other extreme. As with all assets at the time, they careened
into the depths of despair.
traders that have tried to game the base metals markets have gotten crushed
on both the upside and downside over the last several years. It really has
been challenging to find that balance for these wild and wacky base metals.
And it seemed like no chart, tool, or model could predict what they were
going to do next.
there has been one tool that has been helpful to traders over the years. And
at Zeal we've had great success navigating the base metals markets thanks to
its unique presentation of fundamental attributes. Technicals alone
can only get traders so far, which is why it is always important to stay
abreast of what's happening on the fundamental scene.
London Metal Exchange (LME), the world's premier non-ferrous metals exchange,
is host to this excellent fundamental data. In addition to being the most
reliable source for prices, futures, and options, the LME operates a
warehousing and delivery system. It manages over 500 approved warehouses
around the world to physically store the base metals. And it is the tracking
of this storage, or stockpiles, that feeds us our data.
LME calls this network of warehouses a market of "last resort"
since physical delivery is a very small percentage of its metals trading
activity. As described by the LME, its warehouses are utilized to deliver
excess stock to in times of oversupply, and as a source of material in times
of extreme shortage. And it points out that this delivery system plays
a vital role in creating price convergence.
these stockpile levels updated on a daily basis, traders can integrate the
data with daily price activity, plot it on charts, and come away with a
hybrid fundamental and technical trading tool. And the resulting charts have
been very useful in assisting with trading decisions.
price convergence acknowledged by the LME really plays off the notions of
surplus and scarcity. If stockpiles are rising, it can be implied that supply
is outpacing demand. And if such a trend persists, it is natural that a
recognized surplus will lead to lower prices. Inversely, if stockpiles are
declining it can be implied that supply is falling short of meeting demand.
If this trend persists then prices should naturally rise as more capital is
chasing after scarcer goods.
the last 4 years I've chronicled this LME stockpile and price relationship in
a series of essays that have analyzed the 5 primary base
metals. And this normally reliable tool has been consistent in its reads. But
over the last year or so the extreme conditions spawned by the bond and stock
panics have really thrown base metals traders off balance. As you can see in
these updated charts, a fundamental disconnect is glaringly apparent.
the most mainstream of the base metals, paints a beautiful picture of what
the inverse relationship between LME stockpiles and prices can look like.
Over the first 3 years of this chart we can see prices rise and fall based on
the tides of LME stockpile levels.
meteoric rise in 2006 was a result of rapidly dwindling stockpiles, as demand
was well-outpacing what the refiners were able to bring to market. With most
mine and scrap supply gobbled up via direct channels, consumers were forced
to tap the world's aboveground inventories to meet their needs.
recent as 2002 LME copper stockpiles were at 1m metric tons, but rounding the
corner into 2005 they had gotten as low as about 50k metric tons. Considering
this is the equivalent of only about one day of daily global usage,
the markets reacted strongly. With a 90%+ stockpile plunge prices had nowhere
to go but up. And up they went! With such alarmingly-low stockpile levels a huge
speculative risk premium was placed on copper's price.
copper stockpiles slowly built off their 2004/2005 lows, but for years they
levitated in the 100k- to 200k-metric-ton range. At these low levels the risk
premium was still affixed to copper's price. As you can see each time LME
stockpiles retreated to support, prices would pop into the upper $3
that copper had never even seen $2 prior to this bull, these new high prices
were exceptional. But with a low-inventory reality, this was the balance
where traders were comfortable, and thus what buyers had to pay. It would be
interesting to see where prices balanced once the supply/demand gap
tightened. And when copper stockpiles commenced a build in the second half of
2008, we would begin to get a feel for this new balance.
stockpiles headed towards resistance copper's risk premium was quick to fade.
And the subsequent correction, which was very healthy, took copper back under
$3. But just as LME stockpile levels were stabilizing at resistance leading
into October 2008, the global-economic-crisis-spawned stock panic took the
driver's seat. Copper, along with all commodities, entered into a
death-defying downward spiral.
major crisis, that at the time many thought was the beginning of a neo-Great
Depression, froze copper consumption. And this was immediately reflected via
rising LME stockpile levels. Copper stockpiles soared at a rapid pace, rising
over 400% from 2008's low to the panic high. And by the time all was
said and done, its price had shed 69% off its 2008 high.
was of course violently oversold, and its price recovery commenced in early
2009 even before LME stockpile levels turned the corner. This
pre-stockpile-shift recovery was generally accepted by the markets since
copper was at 2004 prices. But interestingly, can you guess when copper stockpiles
were last above 300k metric tons? Yep, 2004.
March LME stockpiles began a steady fall off the panic highs, with copper's
price steadily rising off its panic lows. But this renewed inverse
relationship we've come to know was short-lived, as in July LME stockpiles
took an about-face and commenced another sharp build. If this longstanding
relationship held true the price of copper would have at least taken a break
to consolidate, and given the sharp rise in stockpile levels it should have
the price of copper kept on rising, and has risen ever since. Since July
copper stockpiles have more than doubled and are nearly back to panic
levels. And provocatively, the price of copper has soared by 59% over
this same period of time. This is a huge fundamental disconnect from the
precedent set forth in this coherent relationship. How could the price of
copper be back to pre-panic levels with LME stockpiles at panic levels? Has
this conundrum thrown a wrench into this once-reliable metric?
development has indeed added a number of question marks to say the least. And
this is no small disconnect on the duration front, now running 7 months. With
LME copper stockpiles at 500k+ metric tons, it is obvious that copper is
exhibiting interim fundamental weakness and is extremely overbought. But with
prices hardly exhibiting weakness, are we seeing a strategic shift in the
balance of these markets?
now take copper out of isolation and see if the other major base metals
subscribe to this same trend. And looking at zinc, so far they're on the same
page. Like copper, zinc's bull gained momentum as rapidly falling stockpiles
exposed a structural supply deficit.
inverse relationship with LME stockpiles isn't as visually-compelling as
copper's, but it was a strong force in the early going. From 2004 levels
around 800k metric tons, LME zinc stockpiles plunged by over 90% in a virtual
freefall before finally stabilizing in 2007. This of course sent zinc prices
through the roof. In 2006 zinc blasted through $1 and then $2 for the first
the equivalent of only about 3 days worth of global zinc usage, futures
traders affixed a huge risk premium to its price. But upon stockpile
stabilization zinc fell off the right shoulder of a classic
head-and-shoulders pattern and entered into a vicious downtrend that didn't
end until the panic had its way with this metal. And like copper, LME zinc
stockpiles mounted a rapid build during this panic period.
the panic high, LME stockpiles retreated for a few months while at the same
time zinc's price commenced a recovery. The inverse relationship was on. But
this stockpile retreat was short-lived as warehoused inventories again
mounted a build. And this build has taken LME zinc stockpiles well past
levels seen at the panic peak.
did zinc prices respond? Like copper they continued to rise right along with
stockpile levels. Now zinc was so oversold, down 77% from its 2006 high, that
it did deserve a little wiggle room in its recovery path. But an 80% gain
during a span where stockpiles rose 56% is again a major disconnect. The last
time LME zinc stockpiles were at 500k metric tons, the price of zinc was well
less than what it is today.
story starts the same as copper and zinc, except on steroids. From its 2006
high LME nickel stockpiles fell by over 90% in quick fashion. The result of
this pilfering was the equivalent of only about one day worth of
global usage. And staying at the 5k-metric-ton level for nearly a year
allowed futures traders to have a field day with nickel's price.
huge risk premium took it past $10 and then $20 for the first time ever. And
when LME stockpiles finally commenced a build in 2007, much of this premium
was quick to come off. The price of nickel stabilized rounding the corner
into 2008 as stockpiles settled around the 50k-metric-ton level. But nickel
got sucked into the global commodities correction as 2008 progressed, and its
price started to fade even before the stockpiles started to build in the
second half of the year.
the time selling was exhausted, nickel had fallen by a staggering 84%. Like
the other base metals LME nickel stockpiles were way up over the course of
the panic, and the build didn't take a breather until April. With stockpile
levels stabilizing at this point nickel commenced its recovery, and by August
its price had more than doubled. But at this same time in August LME
stockpiles changed direction and again mounted a rapid build. But unlike
copper and zinc, nickel would heed the call of this fundamental shift.
traders played the inverse relationship to form and started selling the
metal. While the prices of the other base metals continued to rise in
parallel with their ongoing stockpile builds, nickel took a different course
over the last 5 or so months. As you can see a downtrend has been carved and
prices have retreated down to the $8 level.
this activity should not be all that surprising given nickel's stockpile
history. LME nickel stockpiles are currently more than double the
previous high point since 1998, when the LME started logging daily data. This
big nickel oversupply has righteously suppressed its price.
took a bit of a different path in the beginning of its bull. And this path
was dictated by its interim fundamentals. LME lead stockpiles had an initial
sharp fall from 2002 highs near 200k metric tons, sending its price from
bear-market lows of $0.20 to more than a double. But in 2005 and early 2006
when the stockpiles for the other base metals were still falling or
flat-lining at lows, lead stockpiles mounted a build.
you can see this move higher to about 120k metric tons gave futures traders
little reason to boost lead's price, and it actually fell in the first half
of 2006. But with global average daily usage of about 22k metric tons, even
this 120k level (5 days worth) was on shaky ground. And when stockpiles
started to fall in the second half of 2006, that low-stockpile risk premium
shot lead's price way higher.
LME stockpiles falling dangerously low to only a day or two's worth of usage,
and staying there for over a year, lead shattered its all-time highs
and climbed well above the $1 mark. Lead stockpiles eventually gained ground
in Q2 2008, thus leading to an inverse price movement.
following this brief stockpile move higher, an uncharacteristic drop in the
second half of 2008 occurred. And instead of lead responding with rising
prices, it continued to fall into the panic. Lead traders ignored the
fundamentals and joined the global selloff.
lead stockpiles turned higher to follow the rest of the herd, and in 2009
they more than tripled. And what happened with lead's price is the
same old story. A persistent rally defied logic and displayed yet another
major disconnect from fundamentals. Even though LME lead stockpiles are at
their highest levels since early 2003, traders are unwilling to sell the
metal and have been propping up its price as though stockpile levels were much
story is similar to that of the other base metals. Historically-low stockpile
levels led to higher prices. But for a variety of reasons these levels never
got as low as the others, which is why aluminum's gains were not as
substantial. One reason for this is aluminum is not as scarce as the other
base metals. And its pipeline of development projects is more robust than all
the beginning of aluminum's bull its LME stockpiles got down to only about 3
to 4 days worth of global usage, which boosted its prices above the $1 level.
But when these stockpiles started to mount a material build in the second
half of 2008, aluminum's price was doomed. Aluminum consumption fell so fast
into and after the panic that the producers couldn't throttle back supply
stockpile build had been incredibly sharp, hardly taking a breather until the
second half of 2009. LME warehouses are now teeming with aluminum, at record
levels. And how did prices respond? With a rally that has completely ignored
fundamentals. Since aluminum bottomed in February 2009, it had a
well-deserved initial recovery off its oversold lows. But it kept on going,
rising 85%. Over this same exact span LME aluminum stockpiles rose 46%, again
a major disconnect.
how are we supposed to read these fundamental disconnects? There is no doubt
that LME stockpile levels are exceptionally high. These very material rises
indicate that there is an oversupply, however temporary it may be, and that
consumers should not have a problem going to the market to buy base metals.
Are we to just assume that these base metals are wildly overbought and all
due for sharp corrections once the interim fundamental picture becomes clear
to traders? Perhaps, but perhaps not.
valid argument for a delay in corrections is that fundamentals are still out
the door thanks to the stock panic. With everything so oversold as a result
of the first stock panic in over 100 years, everything seems to
be recovering in lockstep with the world's premier stock index. My business
partner Adam Hamilton wrote an essay earlier this month that included a
copper price chart overlaying the S&P 500. It is quite stunning to see
the correlation, I encourage you to check it out!
must also consider that these prices may be factoring in future supply
deficits and thus lower stockpile levels. The global credit crisis has
seriously hampered the infrastructure buildout of the mining industry. Miners
are responsible for the lion's share of supply, and they need to continually
renew reserves and build new mines to grow production and replace depleted
deposits. But the lack of credit has shut down a lot of development projects
and throttled back exploration efforts. This will likely lead to future
another factor to consider is that base metals are still priced in US
dollars. Today's nominal prices aren't actually as high as they seem if the
true value of today's dollar is taken into account. With the money supply
continuing to grow at a staggering pace, adjusting for inflation would show a
much lower real value for these metals. And if I was running a country
that was stuck with a lot of US dollars, I'd certainly diversify some of them
into say copper or aluminum rather than keep everything in a currency that is
in the midst of a secular bear. Perhaps foreign investment, diversification,
and dollar hedging will play a bigger role on the consumption front from
with these possible disconnect explanations, based on what we are seeing with
LME stockpile levels it is painfully obvious that base metals prices have
disconnected from fundamentals. While a new balance may be developing, I
still believe there is a higher probability for a correction than not.
Current copper, zinc, nickel, lead, and aluminum prices are still 367%, 211%,
154%, 406%, and 75% above their respective 2003 lows. Even a decent-sized
correction from these levels will not challenge the integrity of their
whether a correction, consolidation, or ongoing upward momentum, base metals
prices will in all likelihood continue to move higher over the long term. And
the best way for investors to leverage these gains is by owning the mining
companies that bring these metals to market. There are a number of quality
miners that are making money hand-over-fist at today's prices, can still do
so at lower prices, and are well-positioned for future growth. There is also
an elite group of junior explorers that are finding and developing the
deposits that represent the next generation of base metals mines.
you are interested in base metals stocks but don't want to go through the
hassles of painstaking fundamental research, at Zeal we can make the job
easier for you. We do all the research, sifting through hundreds of stocks,
and publish reports that profile the best-of-the-best in a given
sector. And our two most-recent reports happen to focus on base metals. Arm
yourself with the knowledge of which stocks to buy, by purchasing a
Zeal Report today!
base metals corrections may have near-term adverse effects on the mining
stocks, investors should embrace such scenarios as buying opportunities. In
our acclaimed weekly and monthly newsletters we'll be gearing up for buying once the
timing is right. Join us today, as opportunities abound for those who
stay on top of these exciting markets.
bottom line is the relationship between LME stockpile data and prices offers
traders a unique insight into the explosive base metals markets. LME
stockpile fluctuations occur on a near-real-time basis, which gives us
measurable and meaningful intelligence on the flux of this sector. And
ultimately the LME's intent on creating price convergence has played out
since the panic a fundamental disconnect has disrupted the balance of the
base metals markets. Prices are rising even though stockpiles are building at
a torrid pace. Normally stockpile builds put selling pressure on the base
metals, but this hasn't been the case of recent. Is there a new balance being
created in this post-panic economy, or is there an imminent correction right
around the corner? Either way investors need to be ready to buy the miners
when opportunities arise. This secular bull has yet to run its
So how can you profit from this information? We publish an
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