Base Metals: Dollar or Copper pulling the strings?

The strength of the dollar undoubtedly has an impact on dollar denominated base metals prices, particularly the current and very real concerns over its future performance given the low interest rate environment and quantitative easing measures.

On closer inspection however, the impact of the dollar varies markedly within the base metals complex. Of particular interest is that copper, and to a lesser extent aluminium, actually emerge as having a greater influence on the other metals than the dollar itself. For example, since the beginning of January, the correlation between zinc and the dollar/euro rate is 0.93. The correlation between zinc and copper however has been a near perfect 0.97. Similar jumps in correlation are seen in all of the metals except Tin.

The reason why the base metals complex is following copper appears to be a function of metal’s greater relative liquidity, the lack of fundamental impact in determining prices generally, but also due to the investment community viewing the industrial metals as one entity. Tin’s lack of liquidity and small overall market size (~400 kt compared to ~18-19 Mt for copper) has shielded it from the investment community.

With the base metals essentially moving as a unit, following copper wherever it goes, the result has been to render intracomplex relative value trades as irrelevant for the time being. Instead its been a case of picking a time horizon and being either long or short.

Correlations invariably break down. The break-down for the base metals will emerge when the fundamentals start
to re-assert themselves, most likely when supply becomes the constraining factor again. At that point, for example
being long-copper / short-aluminium would start to make sense. However, with a correlation between aluminium
and copper prices currently running at 0.94 we need to wait a little longer yet.

Courtesy: Commodities Research, Standard Bank