China's strong GDP pushes metal prices higher

Prices keep pushing higher, despite fears about sovereign debt In the past week base metal prices have rallied without exception. While some modest USD weakness helped, this performance was nevertheless impressive, given the wider backdrop of a rallying gold price, weaker equity markets and increased fears about sovereign-debt downgrades in both Europe and the US.

Investors appear to be retreating from currency risk and looking for alternative homes in both the base and precious metals space. GDP data from China was also strong, with a 9.6% y/y increase in Q2, following a strong CPI print for June, which is bullish for most metal markets.

Copper is currently up 1.7% w/w, with aluminium up 0.8% w/w, as a weak oil price capped the upside. Lead, nickel and tin rose by 1-2% w/w. The USD weakened by 2% against the EUR during this period.

Zinc – which has underperformed for months – became the star performer this week, rising 5.5% w/w and 13.3% m/m. We believe this was largely driven by short-covering and has little to do with fundamentals, which remain very weak. The International Lead Zinc Study Group announced this week that the market remains oversupplied, with global production at 1.07 million tonnes in May, while consumption was at 1.04mt. Production outpaced demand by 204 thousand tonnes in the first five months of this year. Moreover, LME stocks continue to rise and are up 16kt m/m to 884kt. This month they reached their highest level in 16 years, equivalent to 29 days of global consumption.

The rebound in prices was also helped by a rise in LME cancelled warrants, which indicates an intention to withdraw metal. These reached a five-year high of 75kt. We remain mildly bullish on zinc, as tightly held inventory can push prices higher, despite the weak fundamental backdrop.

However, we expect the rally to run out of steam soon. The latest statistics for China were bullish for base metals, with fixed asset investment up 25% y/y in the first half of the year. Steel consumption remained strong in June – apparent demand was up 15% y/y – which implies robust construction activity and normally indicates firm demand for zinc, as a good proportion of steel is galvanised. Figures for copper were similarly robust. Production of copper semis rose by 18% y/y in June - up 16% in first six months, outpacing the increase in local production, which was up 12% y/y in June. This reinforced the bullish story on copper that came from the recent upturn in imports.

Overall, we maintain our mildly bullish view on the base metals sector, despite the latest problems in Europe and the US. Sentiment around China has continued to improve as inflation is likely to peak soon and the market anticipates the end of monetary tightening there. With Japan also benefiting from a return to normality, the next six months should see demand for industrial metals accelerate from its soft patch.