Using Base Metals As An Economic Indicator

Gold has been the stock market's darling for quite sometime now.
Investors watch gold's movement with bated breath to assess the
possibility of future inflation and weakness in global economies.
While investors can learn a lot by watching the performance of
precious metals, they should not overlook what can be learned by
watching the price movements in base metals.

The performance of base metals is an excellent way to gauge economic
activity around the world. While precious metals are stored up and
held for investment, base metals bear watching because these are the
actual inputs used in manufacturing, construction and production.
Companies cannot build their products or expand their facilities
without relying on these natural resources.

*Tutorial: Commodities*
*Types of Base Metals*So, what is a base metal anyway? Base metals are
common metals that can typically be found in plentiful supply. Copper,
zinc, aluminum, steel, tin and lead are examples of some of the more
popular types of base metals. Since base metals are more readily
available, they often do not have the hefty prices of precious metals.
For example, while gold traded at a whopping $1,400 an ounce in 2010,
copper traded for just $4 a pound. That's a pretty drastic difference!

The base metals have a variety of applications in almost every
industry. Steel is used for building houses, automobiles, plants,
factories and equipment. Copper is used for just about anything
including wires, pipes, construction projects, heating and cooling
systems. Zinc is used to produce batteries, fuel cells, die castings
and making brass. Aluminum is useful in creating planes, cans,
utensils, brakes and transmission lines. Tin is used to coat a number
of products, including cans, containers and packages. Lead is used in
construction projects and batteries. These are just a few of the uses
for these well-known base metals - there are thousands more.

*Base Metals and Price Movement*Metal prices are largely controlled by
consumer demand for the products that they are inputs for. Take the
price of steel as an example. Hot-rolled coiled steel peaked before
the financial crisis of 2008, reaching its apex in 2004 when global
economies were booming. New buildings, cars and many other products
were driving up the price up until 2004, and then demand leveled off
or began to decline slowly. Steel fell off of a cliff in early 2009,
as demand for the products and the metal itself waned. Iron ore,
copper and aluminum took similar plunges in the face of dropping
production and, therefore, dropping demand. The flat-lined or
declining steel prices from 2004 to 2009, when prices plummeted, can
now be interpreted as an early sign of economic problems to come.

Not everyone was selling out at the low, however. China went on a
metals buying spree in 2009 and 2010, and the metals market surged
once again. China stockpiled steel, iron ore and copper while prices
were low because they knew that a base-metals rebound was coming. The
country's government predicted the trend correctly and base metals
recovered nicely. The steel industry saw hot-rolled coil prices surge
to $700 during the global recovery of early 2010. Prices pulled back
somewhat during the summer of 2010 as stimulus packages stopped –
slowing government funded construction projects - and global economies
also slowed down. The lead time on base metal prices as an indicator
can be short, but there is a pattern that has held up in modern times.

*Base Metals and Global Economies*Investors who want to know where
global economies are headed should keep an eye on base metals. Base
metals are a great precursor for signaling economic growth. They are
used by many professional traders as a leading economic indicator.
Famed trader Dennis Gartman has been known to watch copper, steel and
aluminum indexes to judge the appetite of consumers around the world.
Gartman stated that many base metals "moved downwards long before the
data signaled weakness in the global economy."

*Base Metals and Demand*The demand for base metals during times of
economic uncertainty can tell you a lot about the economy as a whole.
High demand during tough economic times shows that both business and
consumer confidence remains high. Low demand leads to falling prices
and is a sign of fear in the marketplace. Investor appetite for these
hard metals decreases during economic slowdowns, just as it does for
producers. However, this decline has a limit, as dwindling supplies
and/or shortage fears, however temporary, help to buoy the prices of
base metals as stockpiling drives up demand.

Base metal production and demand nearly have a perfectly symmetrical
relationship. As demand for base metals increases, metal producers
ratchet up production. Consequently, the flood of supply on the open
market eventually leads to a decline in metals prices as supply
outpaces demand. Metals prices reach their highest point when three
factors align to distort the balance between supply and demand. This
is when the supplies of metals are tight, demand is strong and
production is already at or near full capacity.

*Other Factors*As with any other asset, base metal prices can also
rise and fall on speculation by investors and traders. For example,
the mere hint that a major investor like Jim Rogers is buying metals
can move the whole market on a given day. Moreover, reports about the
Federal Reserve easing monetary policy often drives up metal prices,
as the issuance of more governmental debt strengthens the demand for
precious and base metals because of their perceived hedge against
inflation. Currency moves also affect the metals market. A weak dollar
or Japanese yen can send investors running for the safety of hard
assets just like inflation fears do. As a result, using base metal
prices as an economic indicator requires that an investor look at
who is driving the demand. Is it the producers using the metals to
make more products or is it investors looking to escape inflation or
weak currencies?

*Bottom Line*As you can clearly see, base metals are a major factor in
driving economic growth, but their message to investors can be hard to
read. These metals are used for building homes, automobiles, plants,
equipment, pipes, wires and just about any other product that you can
find. If you want to know which way the economy is moving, looking at
the trend in base metal prices is a good place to start.

*by Mark Riddix*
Mark Riddix is the founder and president of New Horizons Financial
Management. New Horizons is an independent investment advisory firm
that provides personalized consulting services in investment and asset
management. Riddix has a degree in finance and has worked in
investment management for the past five years. He has also written a
personal finance column for Baltimore and Washington metropolitan
newspapers and writes a financial blog at
Source: Investopedia.Com