Let’s talk metal. No, not Van Halen or Black Sabbath.
Metal as in the Invesco DB Base Metals Fund (DBB), which may be set to put on a good show for investors.
DBB owns long positions in the three most liquidly traded metals on the London Metals Exchange: aluminum, copper and zinc.
Aluminum attracts the most volume, while copper is a barometer for industrial commodities. Sometimes called Dr. Copper, with a Ph.D. in economics, copper prices reflect the global economy’s state. Copper tends to rally during expansion and decline during contraction.
Lead, nickel and tin round out the LME metals, but they don’t have the liquidity required for inclusion in DBB’s portfolio.
Base metals have traditionally been the building blocks of infrastructure, making China the world’s leading consumer. However, in 2022, growing worldwide green initiatives have increased the addressable market for base metals, as they are critical inputs in electric vehicles, wind turbines and other green energy products.
‘The New Oil’?
Goldman Sachs analysts have called copper “the new oil,” noting that without it, we don’t decarbonize. In 2021, they forecasted the price would rise to $15,000 per ton by 2025. At that level, the nearby COMEX futures contract would be at the $6.80 per pound level. On Nov. 28, the December COMEX futures settled at $3.6115 per pound, so we’re more than halfway there.
Also figuring into supply and demand, the better part of a decade is needed to bring new copper mines into full production. Furthermore, LME copper inventories have decreased over the past five years.
Goldman Sachs believes copper fundamentals support a continuation of higher lows and higher highs. In March, copper reached a record $5.01 per pound before correcting. The price fell to $3.15 in July and has been consolidating over the past months.
As the chart highlights, LME copper stocks have declined to 90,750 metric tons from more than 380,000 in 2018. Obviously, a bullish sign for copper.
Aluminum and the Ukraine War
Aluminum is one of the most environmentally friendly metals due to its sustainability. Aluminum can be recycled indefinitely to produce the same level, and recycling saves 95% of the energy used in its production from raw materials.
China leads the world in aluminum production and consumption. Last year it manufactured 39 million metric tons, more than half of the global output. India was second, at 3.9 million metric tons, and Russia was third, with 3.7 million. In 2021, 6% of U.S. aluminum imports came from Russia, but in 2022, sanctions have limited Russian exports to the U.S. and Europe.
Meanwhile, the dramatic decline in LME aluminum stocks has supported the metal’s price.
The above chart shows the drop from nearly 2 million tons last year to below 510,000 metric tons on Nov. 25. The drop isn’t bearish for prices.
Tight Zinc Fundamentals
Zinc’s primary function is to galvanize metals: Adding a coating to steel or iron protects it from rusting.
Zinc demand currently outstrips supply. The Lead and Zinc Study Group says zinc should be in a 297,000 ton deficit this year and a 150,000 ton deficit in 2023. Physical zinc buyers are paying record premiums for the metal because of falling warehouse stocks, and LME stocks have declined from nearly 300,000 tons in early 2021 to the 41,450 metric ton level on Nov. 25.
Base metal prices have declined since reaching highs in early 2022. Rising U.S. interest rates have increased the cost of carrying inventories, weighing on prices. Moreover, increasing rates put upward pressure on the U.S. dollar versus other world currencies. Since the U.S. dollar is the world’s reserve currency and the pricing mechanism for the LME metals, a strong dollar puts downward pressure on prices.
China, home to the world’s biggest population and its No. 2 economy, consumes the most nonferrous metals as it builds its infrastructure. COVID-19 lockdowns have weighed on economic growth, cutting into demand.
Meanwhile, low stockpiles could lead to a sudden spike in demand when China emerges from its COVID-19 protocols over the coming months. Base metals prices may soar on news that China’s economy is recovering.
DBB Exposure to Liquid Base Metals
Liquidity is critical when considering any investment, as tight bid/offer spreads allow buyers and sellers efficient execution. In the LME nonferrous metals world, the aluminum, copper and zinc markets offer the most significant liquidity.
While the most direct route for a risk position in the three metals is via the futures, forwards and options on the LME, DBB provides an alternative. At $19.28 per share on Nov. 28, DBB had $257.45 million in assets under management. DBB trades an average of 233,841 shares daily and charges a 0.77% expense ratio.
Copper, aluminum and zinc prices have declined from the early 2022 highs.
The above chart shows that DBB fell from $27.01 in March 2022 to $19.28, a 28.6% correction.
The supply and demand fundamentals for aluminum, copper and zinc support higher prices, but rising rates, a strong U.S. dollar and Chinese economic weakness have weighed on prices.
I favor buying DBB below the $20 per share level, leaving plenty of room to add on further price weakness. Picking bottoms in any market is a dangerous venture, but the supply and demand picture for base metals remains a compelling reason to consider adding DBB to your portfolio.