In this regular note, we provide a discussion on fundamental dynamics across the industrial metals, with a special focus on copper, zinc, and aluminium, in order to formulate a clear view on the Invesco DB Base Metals Fund (DBB).

By tracking many real-time micro indicators across the base metals space, we help readers to better assess the real-time changes in refined market balances.

DBB has edged higher since it plunged to its lowest since February 2016 at $11.91 per share on March 23.

The price recovery has been driven by tactical short-covering in base metals on oversold conditions, a tentative recovery in China’s economic recovery, and fresh supply disruptions caused by lockdowns, especially in Latin America.

While the rebound could continue in the near term (~3-month window), the weaker fundamentals of the industrial metals should result in a weak price environment in 2020.

For Q2, we expect DBB to reach a high of $14 per share.

Source: TradingView, Orchid Research

About Invesco DB Base Metals Fund (DBB)

Invesco DB Base Metals Fund allows investors to assert exposure to some of the LME base metals.

The composition of the Fund is as follows:

Source: DBB, Orchid Research

DBB’s assets under management total $115 million, with an average daily volume of $1.77 million and average spread (over the past 60 days) of 0.18%.

Its expense ratio is 0.80%, which makes it a relatively cheap ETF to get an exposure to the industrial metals complex.

Price trends

Source: Bloomberg, Orchid Research

While copper and zinc have rebounded notably from their March lows, aluminium has made fresh lows since the start of April.

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Contrary to copper and zinc, supply disruptions in the aluminium have proven minimal, which have not elicited some short-covering.

Nevertheless, we would argue that aluminium prices are oversold, so some technical short-covering is likely in the weeks ahead, especially if macro sentiment – boosted by massive Fed’s stimulus – remains positive.

Open interest trends

Source: Bloomberg, Orchid Research

Given the fluctuations in open interest since the start of March, the rebound in prices in copper and zinc has been driven by short-covering (open interest is down). This suggests a reduced bearish sentiment.

Worryingly, the decline in aluminium prices since the start of April has been accompanied by an increase in open interest, meaning the sell-off is driven by fresh shorting. This suggests an increased bearish sentiment.

Whether short-covering in copper/zinc leads to fresh buying and whether fresh shorting in aluminium leads to short-covering remains to be seen.

Exchange inventory trends

Source: Bloomberg, Orchid Research

Global exchange inventories have increased noticeably since late 2019, a clear sign of weaker demand conditions. Usually, downstream producers tend to restock in Q1, which results in exchange inventory outflows. The significant wave of inflows in Q1 signals a contraction in base metals demand, both in China and the rest of the world.

Unless 1) the recovery in Chinese economic activity is powerful enough (unlikely since the West remains shut down) or 2) supply disruptions are substantial (uncertain at this stage), global exchange inventories are likely to continue to trend higher, producing a depressing price environment.

Physical premiums

Source: Bloomberg, Orchid Research

Physical premiums are muted because there is no physical buying interest in the current macro environment. Physical premiums are not plunging, however, due to some supply disruption fears.

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Positioning among the speculative community

Source: Bloomberg, Orchid Research

The normalization in spec positioning across the LME base metals space since March suggests that investors anticipate a recovery in fundamental dynamics and therefore, are not excessively pessimistic.

From a contrarian viewpoint, this is not a good sign. We would prefer the speculative community to be excessively bearish in this current climate (like it was in 2016 or 2009) to have more conviction that we are near the bottom.

Closing thoughts

The rebound in DBB could continue in the near term, due to tactical short-covering, expectations for a recovery in Chinese economic activity, and fresh supply disruptions.

However, we think that this rebound will prove transient considering that the fundamentals of the base metals are likely to be markedly weaker than last year. The current normalization of spec positioning should push base metals prices higher in the course of Q2. Once specs are done with normalizing their positioning, downward pressure could resume as prices align with weaker fundamental dynamics.

In this context, we project a target price of $14 per share for DBB in Q2.

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Our research has not been prepared in accordance with the legal requirements designed to promote the independence of investment research. Therefore, this material cannot be considered as investment research, a research recommendation, nor a personal recommendation or advice, for regulatory purposes.

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