China, More Than Trump, Fuels Commodity ETF Surge

November 29, 2016

It's no secret that base metals have done well in the month of November. Copper is up 20% month-to-date, its best monthly showing in a decade, according to Bloomberg. Everything from lead to zinc to nickel is up double-digit percentages also.

The PowerShares DB Base Metals Fund (DBB)―which holds futures on copper, aluminum and zinc―now has a gain of more than 33% for the year.

 

YTD Returns For DBB

 

These monster moves come despite a surge in the U.S. dollar during November, a factor that normally weighs on commodity prices. Some analysts attribute the sudden jump in base metals to speculation that U.S. President-elect Donald Trump's infrastructure spending plan will provide a big lift to demand.

But it's not just a Trump-fueled rally. Metals were already doing well this year amid signs of stabilization in China's demand and faltering supply.

"It is tempting to blame the sharp post-election rally in industrial metals prices on President-elect Trump's platform of lower taxation and higher public spending on infrastructure," wrote analysts at Goldman Sachs. "We would argue this rally was a continuation of a reflation trend put in place at the start of 2016 by the Chinese through credit stimulus aimed at infrastructure projects and policy-driven supply curtailments."

China's Coal Gambit

As Goldman suggests, China might have more to do with the rally in base metals and other commodities than any potential infrastructure plans in the U.S.

The case of coal starkly illustrates the affect that the Asian giant has had on commodity prices this year. In an effort to reduce the glut of coal, increase prices and bail out indebted Chinese coal miners, the government of China ordered cutbacks in production.

However, those cutbacks have proven to be much more severe than expected, prompting a rally in coal prices beyond what anyone had imagined. At one point this year, global prices for metallurgical coal (used to make steel) tripled, while prices for thermal coal (used to generate electricity) doubled.

Now China is reversing course and determining how to bring prices back down without harming the country's struggling coal industry. Even so, coal prices remain stubbornly high, helping fuel a 115% year-to-date gain in the Van Eck Vectors Coal ETF (KOL).

 

YTD Returns For KOL

 

More recently, KOL got a boost from Trump's election victory. The president-elect is a vocal supporter of the U.S. coal industry, but Trump is secondary to the China-driven bullish trend already in place for the ETF.

Triple-Digit Gains In Steel ETF

Another industry where the China-Trump effect has been on full display is steel. Strong Chinese demand and supply fundamentals pushed steel prices sharply higher through the start of November. Then after Trump's victory, steel shot even higher to a 2 1/2-year high.

Trump's promise of massive infrastructure spending and trade policies that protect U.S. manufacturers―including steel producers―has been a boon for ETFs such as the VanEck Vectors Steel ETF (SLX). The ETF was already up big before the election, but November's rally of 23% pushed year-to-date gains to an eye-popping 109%.

Similarly, the SPDR S&P Metals & Mining ETF (XME), which holds steel companies, miners and coal producers, rose 24% in November and has risen 112% year-to-date.

YTD Returns For SLX, XME

 

Whether these eye-popping gains in commodities and related ETFs can be maintained is an open question. Some analysts seem to think so. The aforementioned Goldman Sachs recently upgraded commodities to an "overweight" for the first time in four years, saying that markets were entering a "cyclically stronger environment."

Goldman's analysts believe that coking coal and nickel will be two near-term beneficiaries of this environment.

Meanwhile, analysts at Morgan Stanley recently released a bullish report on steel stocks, remarking that "Trump’s $550 billion stimulus plan would increase steel demand by 20% annually for five years.”

The analysts added that "for the first time in a decade, we see a credible long-term investment case for steel equities."

Contact Sumit Roy at [email protected]

 

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