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Portfolio > Portfolio Construction

What’s More Precious Than Gold? Industrial Metals

By Ginger Szala

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Talk about metals always seems to surround the most precious of them:  gold. But when it comes to real trading, it’s the baser cousins that can truly shine. This is even truer now as China spends itself out of the doldrums and the non-precious metals — copper, aluminum, nickel, aluminum, lead and zinc, and their alloy brother, steel — have come to life. These are the metals closely aligned with economic booms and busts.

“We like to call it Dr. Copper because [copper prices are] an economic indicator along with crude oil,” says George Gero, managing director of RBC Wealth Management.

Copper seems to have shaken off some bearishness, reacting to positive financial news across the world, mainly in China, Gero adds. He notes that open interest in the futures contract has jumped 8% since January, a sure indicator that hedgers are selling against inventories.

Even fundamentals bear this out with the auto industry in recovery, both in the U.S. and China, and each new car uses roughly 40 pounds of copper wiring. In addition, with increasing strength in the housing market and energy complex, demand for copper used in structures is growing. That said, the road to higher prices will likely be bumpy, as noted by the chief executive of the world’s largest copper producer, Codelco, who told one newspaper that he believes copper prices will go lower before they go higher.

Copper may be still gaining strength, but other base metals’ behavior is stronger. For example, since the beginning of 2016, the S&P Metals & Mining index has outperformed the S&P 500 by 43%, according to the Daily Shot.

Iron ore seems to be leading this rally, and in fact its futures contract traded at the Dalian Commodity exchange volume grew by 161% in 2015 and is the second largest volume metals contract in the world. Likewise, steel futures prices have risen 53% on the Shanghai Futures exchange since their low in December 2015.

Zinc has continued its rally like other industrial metals as inventories in warehouses tracked by the London Metal Exchange “declined the most in more than eight years,” which signals improved demand, notes a RBC Capital Markets report, adding that inventories are the lowest in almost seven years. One London trading company analyst noted that zinc price levels would now be attractive to “physical or investment buyers.”

Despite these positives, insiders believe it will be a long and winding road before they see a full-blown recovery in the base metals markets. For example, BHP Billiton Ltd (BHP), one of the largest mining companies in the world, recently cut its dividend for the first time in 15 years. That aside, its chief executive told an Australian newspaper that “the fall has stopped,” and he believes the rebound in raw materials prices will be “gradual, and bumpy.”

Likewise, the Rio Tinto (RIO)’s chief executive recently told his company’s annual shareholders’ meeting that he believed iron ore prices would fall in the second half of year and prices would continue to be volatile.

Despite these cautious signals, global fiscal stimulus, especially in China, is a positive for the industrial metals. Further, base metals may be a cheaper way to get exposure to an improving global economy, or at least the U.S. economy, without picking stocks. Of course there are many precious metal ETFs, but base metals have a showing as well. Some of these include:

  • PowerShares DB Base Metals Fund (DBB): One of the more liquid funds, this ETF tracks the Deutsche Bank Liquid Commodity Index-Optimum Yield Industrial Metals Excess Return. The fund, which has just over $100 million in AUM, invests in aluminum, copper-grade A and zinc futures contracts. 
  • Rogers International Commodity Metal ETN (RJZ): This lighter traded exchange-traded note (ETN) is based on Rogers International Commodity Index-Total Returns. It’s comprised of 10 metals futures contracts and is thus more diversified, and it has just over $8 million in AUM.
  • DB Base Metals Double Short ETN (BOM): Don’t feel positive about the economy? This is a way to short metals by taking a long position in this ETN as it moves in the opposite direction of the daily price movements of the Deutsche Bank Liquid Commodity Index–Optimum Yield Industrial Metals Excess Return. If you expect the price of aluminum, zinc and copper to collectively decline, you would buy this product.

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