Base metals boom

Lead is not supposed to fly, but late last week the heavy metal did exactly that. It soared to a five-year high of $US1.13 a pound on the London Metal Exchange, before easing back this week to $US1.06/lb, which is still 25 per cent up on the price of 12 months ago.

And lead didn't fly alone, which is perhaps more significant than the sudden revival of interest in an otherwise boring industrial metal. Most other industrial metals – commonly called base metals – including copper, zinc, nickel and aluminium also rose strongly.

The widespread industrial metal recovery is driven by four forces:

• Production cutbacks introduced after the commodity sector downturn in 2012.
• Mine closures as ore reserves deplete without new mines replacing old.
• What appears to be synchronised economic growth in the world's major economies, and
• Speculative trading which could disappear as quickly as it arrived.

One view of the industrials metals sector is that a price recovery was inevitable, and perhaps overdue, after a round of severe production cutbacks that followed sharp price falls in 2012.

Take copper, which dropped from $US3.75/lb in mid-2012 to less than $US2/lb in late-2015, forcing the closure of mines around the world.

A strong recovery in demand for copper, especially from China which has launched a fresh round of economic stimulation, has changed the outlook with the price back to $US2.97/lb. That's enough to encourage fresh capital such as BHP's proposed $US2.5 billion investment in extending the life of the Spence mine in Chile.

Nickel is another example of excess supply and sluggish demand over the past five years leading to production cutbacks. A classic example is Canada's First Quantum Minerals' decision earlier this month to mothball the Ravensthorpe mine in WA.

Losing Ravensthorpe, for the second time, is having a positive effect on the nickel price, which this week rose back above the $US5/lb mark for the first time in 10 months.

Aluminium is a third example of supply cuts doing their work on the price, with China enforcing environmental clean-up laws which has seen aluminium smelting capacity close and a supply shortage start to emerge. This is why the price has risen by 35 per cent to $US95c/lb over the past 12 months.

The base metal revival is being reflected in the share prices of miners. South 32, one of the most exposed stocks to the sector, is up 17 per cent since mid-June from $2.51 to $2.92, a useful rise but one that does not reflect the sharp increase in its underlying metal prices.

Independence Group, which is more heavily exposed to nickel, has also been heading higher. It has added 40c, or 13 per cent, to $3.50 since mid-June, a welcome move but one which is well short of the 25 per cent recovery in the nickel price to $US5.09/lb over the same time.

The failure of Independence and South 32 to match the rise in the nickel price is telling a story of investors being wary of what's happening in base metals.

Production cuts, which have boosted prices, can just as easily become production restarts, which can reduce prices.

Among investors with an interest in mining there is a desire to believe that a sustainable recovery has started thanks to strong economic growth in China, the US and Europe. But there is also concern that the latest bounce will encourage the restart of mothballed mines, the expansion of existing mines (such as Spence), and the development of new mines.

Another metal, gold, is also signalling concern about the global outlook with its recent rise that's within sight of $US1300 an ounce. The move reflects concern about political and economic stability.

Domestic political issues in the US and the threat of conflict at the Korean Peninsula are positive for the gold price – and negative for the base metals.

If there is a base metal which stands out, it's zinc. That's because mine closures and production cutbacks have been more severe than most other metals. Demand is also rising at a stronger rate thanks to zinc's primary use in galvanising steel, which is enjoying a surge in demand as China undergoes an infrastructure investment boom.

Since hitting a multi-year low of US65c/lb in late 2015, the zinc price has more than doubled to $US1.40/lb, with US15c of that rise coming in the past three weeks.

The biggest winner from the zinc revival is London-listed Glencore, the world's biggest zinc miner, and the company that did the most to curtail supply during the price slump.

Locally, the biggest winner has been New Century Resources, the company planning to redevelop the mothballed Century mine in Queensland, once the world's biggest single source of the metal.

Since raising $5 million through an issue of shares priced at 15c, New Century has been one of the top performers on the Australian stock market, reaching a high of $1 last Friday before slipping back to 88.5c.

If, as some seasoned observers suspect, the base metal revival has been a case of too much too soon, then a correction seems likely – but not a crash.

What's happened over the past two weeks is the start of what should be a long recovery in demand for metals, especially if the global economy has entered a period of synchronised growth.

Investment bank Morgan Stanley is cautiously optimistic about the outlook but also reckons that zinc is the only base metal with fundamentals that can sustain the recent upward price surge.

“The sharp lift in base metal prices this past week is really just an extension of a two-month rally,” Morgan Stanley said in a note circulated to clients on Tuesday, 22 August.

“For most of them [the base metals] last week's moves were largely speculative, since corresponding fundamental signals [such as inventories of metal] failed to report supportive shifts.”

Morgan Stanley said the fundamentals of copper and aluminium were subdued or, in the case of nickel and lead, weakening.

Zinc, however, was the exception.

“Unlike other base metals, all of zinc's fundamental market signals confirm its price performance,” the bank said.

For investors with an interest in metals and mining the good news is the recovery which started early last year is continuing. The bad news? The recent sharp upward price moves are unlikely to be sustained and a retreat to the long-term uptrend is looking more likely.