Metals: A fundamental story

April 30, 2014 07:00 PM

Crisis, quantitative easing and manufacturing all affect the metals markets—but the key is to understand why. Knowing what fundamental drivers move these markets will help you understand what is making them move today and in the coming years.

Even long held distinctions between base and precious metals are coming under question as new uses are being developed for all types of metals. 

While fundamentals have shifted somewhat there are still distinctions. Base metals are malleable, ductile and corrode relatively easily. They are common metals that are not considered precious, such as copper, tin or zinc.

A precious metal is a rare, naturally occurring metallic chemical element of high economic value. Chemically, the precious metals are less reactive than most elements and are usually ductile. 

The best-known precious metals are the coinage metals, gold (COMEX:GCM14) and silver (COMEX:SIM14). While both straddle the commodity/currency space, they are better known for their uses in jewelry and coinage.

More important is that historically precious metals were used as currencies and many investors feel they still act that way and can be used as a store of value—a more resilient currency than the fiat paper we carry around today. Gold and silver, particularly gold, are viewed as an investment that won’t lose value in inflationary times. 


Gold’s place as king

Although gold has industrial applications, gold is a monetary asset and its prime driver is investment demand.  

The value of gold is determined by the market 24 hours a day, nearly seven days a week. Gold trades predominantly as a function of sentiment; its price is less affected by the laws of supply and demand. 

Blu Putnam, chief economist for CME Group says people buy gold when they are scared of a financial disaster or if they’re afraid of inflation. 

He notes that China and India are the two main countries that buy gold for jewelry and India has raised tariffs on gold imports three times during the last year affecting price. 

While more traditional supply/demand factors of gold as a commodity can affect price, it is the supply/demand of gold as a currency that drives larger long-term moves. 

“Gold prices corrected sharply last year and there were a number of factors for this,” says Patricia Mohr, vice-president economics and commodities specialist at Scotiabank. 

“The all-time record high in gold was $1,921 per ounce on Sept.  9, 2011, and what drove gold prices to that level was quantitative easing by the U.S. Federal Reserve board and by the bank of Japan and the possibility that QE might be applied in the Eurozone as well,” says Mohr. QE in that regard is essentially printing money by the central bank and injecting cash into the economy to keep interest rates very low to try to kick-start economic growth.

Gold traders thought that Fed-led QE would ultimately prove inflationary— however that never happened. 


Silver

Silver (COMEX:SIM14) is an industrial metal as well as a precious metal. Some of the industrial demands for silver, such as for film and electronics, have declined in recent years, which has caused demand to decline. 

While some think silver is no longer a precious metal because of its many industrial uses, it is still very much both. Despite the more industrial uses for silver it is still highly correlated to gold (see, “A shiny pair,” below). “Silver moves in lockstep with gold and will continue to do so the next 18 months,” says Mohr who adds that silver is the most volatile metal, so new investors should be cautious.

Copper (COMEX:HGM14)

Most of copper’s recent action has been from the supply side. In the last decade copper has been very profitable for mining companies around the world.

Demand has been driven by industrialization in China and the incredible growth in its manufacturing industry, and automobile sales in China and the rest of the emerging world, according to Mohr. (Automobile manufacturing uses a lot of copper for wiring.)

Mohr says copper has performed well because for the five years leading up to 2012 there was very little new supply, but in the past 18 months there has been a wave of new mine supplies causing copper prices to fade.

In regards to supply for copper, the major refining nations include the United States, Japan, Chile and the European Union. Chile, Indonesia, Canada and Australia are the major exporters, while Japan, China, the European Union and Philippines are the major importers. World copper mine production through exploration of new mines and expansion of existing mines also is a major factor that effects copper supply and pricing.

Supply disruptions should also be taken into consideration for those interested in copper trading. Strike periods that occur with expiration of labor contracts have a significant effect on copper prices. Additionally, earthquakes and shipping problems, as well as political unrest in Chile, Peru and South Africa, can cause a decrease in supplies of copper and cause copper futures to rally.

The main report for copper futures is the Copper - High Grade Warehouse Stocks. This report indicates whether copper supplies are increasing or decreasing.

Perhaps there is no better measure of global economic health than the price of copper because it is used to build things. Big things like houses and cars. While the Federal Reserve and other central banks can prop up equity markets, creating the illusion of financial health through QE as well as manipulate currencies markets to its liking, you can’t build a house or a car without copper; and if demand rises that will be seen in the price. 


Platinum (NYMEX:PLN14)

Like gold and silver, platinum is traded around the clock on global commodities markets. It tends to fetch a higher price than gold during routine periods of market and political stability, simply because it’s much rarer—far less of the metal is actually pulled from the ground annually. 

Like silver, platinum is considered an industrial metal. The greatest demand for platinum comes from automotive catalytic converters, which are used to reduce the harmfulness of emissions. Jewelry also accounts for a great deal of demand. 

Petroleum and chemical refining catalysts and the computer industry also factor into demand.

Because of the auto industry’s heavy reliance on the metal, platinum prices are determined in large part by auto sales and production numbers. “Clean air” legislation could require automakers to install more catalytic converters, increasing demand, but in 2009, American and Japanese car makers were turning to recycling, or using more of platinum’s reliable (and usually less expensive) sister metal, palladium.

With aluminum, prices have been exceptionally weak for some years, but it’s not due to lower demand—there is demand from many countries. Aluminum is used in automobile production and in electronic transmission systems, boosting the demand from the automobile manufacturing side. 

But decreasing demand stems from China building its own aluminum smelting industry. China, a big importer of copper, has become self-sufficient and doesn’t need to import large quantities anymore. This has caused aluminum to be in over-supply for a number of years.

The metals markets are interesting and can offer a lot of trading opportunities if you can keep an eye on the fundamental drivers and related news.

About the Author

Yesenia Duran is Managing Editor at Futures magazine. She has covered the financial industry for more than 5 years. She originally joined Futures in 2002 after graduating from Northwestern University where she majored in journalism. In her free time Yesenia trains and prepares for the eventual zombie apocalypse. E-mail her at yduran@futuresmag.com, and follow her on Twitter at @yesifutures.