Base Metals Winners In 2013 Editor: China seems to have pulled off a so-called “soft landing”, deliberately slowing its economic growth rate from above 10% to around 7.5%. The Communist Party of China (CPC) took steps to throttle back growth in order to let the air out of asset bubbles (such as the one in residential property in cities like Beijing, Shanghai and Guangzhou), and rebalance the country’s economic model from export-led growth toward greater reliance on domestic demand, in particular household consumption.

With the Chinese economy now beginning a cyclical upturn, base metals should benefit. However investors should steer clear of commodity ETFs and ETNs that are based on futures contracts that must be rolled over. That’s because the returns delivered by these funds depend not only on the change in the spot price of the underlying commodity, but also on the slope of the futures curve. And when the futures curve slopes up, i.e. when it’s in contango, the value of the ETF slowly erodes.

Our Commodity & Energy Strategy service is looking to upgrade base metals from neutral to overweight soon, as evidence accumulates that Chinese growth is in a sustainable upswing. But which base metals should fare the best?

China bears dominated in 2012. But a glance at the performance of base metals, an asset class closely tied to the health of the Chinese economy, tells a different story.

Tin, a metal widely used as solder in the electronics industry rose 21%. This makes sense given the 12% growth in cell phone usage over the past year, and similar strength in the adoption of PCs, TVs and other electronics. Closely following tin are lead and zinc, two metals that are tied to the booming automotive and infrastructure industries, respectively.

According to our commodities team, 2013 could be the year for copper and nickel.
First, many Chinese indicators have bottomed and/or are now inflecting higher and nickel has one of the highest sensitivities to a rising Chinese PMI.
Second, the supply stories for both metals are much less bearish than their performance rankings in 2012 would imply, suggesting some mean reversion.

The bottom line

Nickel should shift from laggard in 2012 to leader in 2013H1, while copper should also outperform over a one-year horizon.

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