Though it's the energetic oil and the lustrous gold that hog media headlines as indicators of an upwardly or a downwardly mobile economy, economists affirm that the real indicator is consumption of base metals – particularly steel.

That consumption, commodities analysts and economists now say, is beginning to rise especially in the GCC where the governments are trying to use the still low prices to build up new oil and gas and infrastructure projects.

Prices have climbed three-fold in certain cases since they reached the ebb of their trajectory in early 2009. Though there is no direct correlation between crude and base metals, the two have risen together in the recent past contributing to an upturn in the mining sector, which had for almost six months been used to positive news only from gold.

"We are seeing impressive bounces in metals. An increase in energy prices on account of bullish US inventory data and some steadiness shown in Asian equity markets are leading to buying in metals. Also helping is a report from China showing that manufacturing there expanded for the fourth month. It happened after the official purchasing manager index rose to a seasonally adjusted 53.1 in May to 53.2 in June. A reading above 50 indicates expansion," said Edward Meir, a metals analyst at MF Global.

Steel industry insiders recently told Emirates Business that they expect both demand and prices of long and flat steel products to rise in the UAE. Prices had already improved from their depressive lows, they added.

What's perhaps the most interesting thing is the time that metal prices have historically taken to emulate the post-recession green shoots.

Michael Widmer, the metal strategist with Bank of America Merrill Lynch (BoAML), said it typically takes six months for the first signals of an upturn post a recession to seep into metal prices.

"Predicting an exact timing for the end of the recession phase is difficult. Yet, there are indicators such as a rising ratio of new orders to inventories in many countries – metal consumption follows this ratio with a lag of about six months, which suggests that the demand backdrop for metals may normalise. By the fourth quarter of 2009, a reduction in inventories through the supply chain may be facilitated by improved shipments, with the stocking cycle likely entering recovery phase. In 2010, we expect global metal demand to start expanding again," he wrote in his recent report.

However, in the immediate future, that is, in July, August and September metal prices could see further correction.

"Inventory adjustments continue to unfold and metal demand remains weak overall. This could be exacerbated through the summer months by the typical seasonal slowdown in industrial activity," said Widmer.

"In China, we are concerned about the way the stocking cycle has played out year-to-date: on the copper market, for instance, there are indications that the booking of shipments was partially driven by an anticipation of a strong demand recovery, but imports seem to have exceeded actual offtake. This suggests that shipments especially of copper (but also those of other base metals) to China, which have supported LME prices so far in 2009, could soften over the summer months. Hence, we believe that a correction in base metal prices is possible in Q309," he said.

There are signs that the fundamental backdrop may start to normalise, said the BofAML report.

"As to the nickel market, for instance, stainless steel inventories have been declining in many regions since the second half of 2007 to extremely low levels. This suggests limited scope for further large de-stocking, removing one bearish nickel demand driver. By 2010, we expect stainless steel orders to pick up, partially because of higher end-user demand, but also to replenish some of the depleted stocks. The global economy will likely to continue grow below potential, suggesting that metals consumption may not reach the levels seen earlier this decade but nickel prices are nevertheless set to recover," said the report.
Meir said Nickel, which has already performed considerably well so far, will continue to fare well. "Nickel is at $1,569 (per metric tonne), up $255; a possible bearish double top formation is showing up on the charts," he said, adding that in the short term, Nickel will face a support of $13,750 (per MT) and a resistance of $15,900.

As the economy starts to recover, shipments are rising, but firms are still cautious to boost output, which means that inventories and the inventory-to-shipment ratio continue to decline, said the BofML report. "In any case, cuts in industrial production subside, which tends to remove one bearish factor for base metal demand," it noted.

Finally, as shipments would recover strongly, corporations will boost output, which may be accompanied by a pro-cyclical increase in inventories. "Along with an increase in industrial activity, metals' demand is expanding at a rapid pace," said the report. BofAML divided the entire decline and upturn in demand for metals into four cycles and emphasised that production would improve in the fourth cycle.

The metal industry is witnessing a reduction in inventory levels, said the report, citing two examples. "Stainless steel service centres have continued to reduce inventories. This trend started in 2007 when record nickel quotations pushed stainless steel prices up. Because the de-stocking in the stainless steel supply chain has started well before the current economic slowdown and as stocks are significantly lower than the levels seen only a few years ago, we believe that stainless steel and nickel demand may be among the biggest benefactors of an economic stabilisation," said the report.

In the aluminium market, Alcoa President and CEO Klaus Kleinfeld said: "During the company's first-quarter earnings conference call on April 7, 2009, the inventories that our supply chain is holding have been driven down to a level, which we believe is absolutely not sustainable. We've seen, for instance, US Metal Service Center year on year inventories decline by 24 per cent. We believe that that's way beyond normal levels."

Widmer expects the metal markets to ameliorate in the US. "We expect this to happen as we move into 2010 and metal demand is set to benefit. Metal consumption could be further boosted by a gradual improvement in the performance of the US economy through the next year, which should induce market participants and stainless steel distributors, to increase some of their metals-related inventories," he said.

Japan's export-oriented economy has been hit hard by the global economic slowdown, as demand for the country's often base metal-intensive products, such as cars or electronics, evaporated almost overnight.

"Those production curtailments have been implemented was staggering, reflected in a 30.3 per cent yoy decline of industrial production in April, the largest drop among any of the developed countries in that month, helping to reduce stocks in many sectors. These measures had, not surprisingly, a substantial impact on Japan's metal offtake with aluminium and copper demand dropping by 38.2 per cent yoy ytd and 48.9 per cent yoy ytd respectively," said the report.

"We believe that Japan's economic backdrop remains, overall, mixed. Yet, we note signs of normalisation in economic conditions. For instance, shipments in some metal-intensive sectors such as manufacturing have started to stabilise at low levels, suggesting that production cuts may have to do less work in the adjustment of inventories going forward," it said.

While GDP in many of the traditional metal-consuming countries has fallen sharply, economic growth in China has remained remarkably steady. This was heavily influenced by an early implementation of the government's fiscal stimulus package. Yet, the country was not able to completely immune itself from the global eonomic crisis.

"Not being insulated from the rest of the world, Chinese corporations have been reducing inventories through the economically turbulent months in the second half of 2008, reflected in a decline of the finished product stocks sub-index. While this sub- index continues to post relatively low values, we note that the headline PMI hit 53.1 in May. The combination of lower inventories and higher output suggests that sales must have been stronger, placing the Chinese economy in recovery phase," said the report.

Since the country has single-handedly driven the metals markets, it's important to discuss the demand for each metal in China.

Influenced by expectations over an economic upturn, there is a possibility that market participants may have imported copper in excess of what is required at this stage of the economic cycle.

The Chinese stockpiling had been cited as the prime reason behind the rally in copper prices. "Given the lack of domestic market tightness, imports may start to tail off, thereby removing the factor that has given substantial support to LME prices during the past few months. This is worrisome as metals' demand in many countries is still weak," said the report.

Analysts at MF Global said they expect the gold prices that currently stand at $5,069 a tonne will find a resistance at $5,388.
The picture is similar in the domestic aluminium market where re-stocking by the government provided significant support to domestic aluminium quotations, prompting a surge in imports that gave some support to the London Metal Exchange prices of late, BofAML's commodities, said analysts.

"Influenced by the increase in aluminium quotations, there is strong evidence that domestic smelters have re-started production capacities, suggesting that the growth in shipments to China should start to subside," it said.

After China's stainless steel mills had shown production restraint, they have recently re-started capacities, incentivised in part by the effectiveness of the government's stimulus package. This explains partially why nickel imports have risen.

However, China's recent track record as an accumulator does dampen spirits.

"There are indications that domestic steel production is running ahead of demand, with anecdotal evidence suggesting that stainless stocks have been building. We also believe that some of the nickel shipped to China was in excess of actual usage. These considerations and evidence that domestic nickel production has restarted may dampen China's purchasing activity and remove the immediate upward pressure from nickel prices in the coming weeks," said BofAML analysts.

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