A crystal ball may be a bit much, but an interesting note to investors from Standard Bank recently may be almost as good.
The report suggests metal prices may have further to fall in coming months. (MetalMiner’s December MMI® readings are already showing dropoffs for several sectors; check out our reports starting today.) The gist of the bank’s argument is that leading indicators give a good correlation to future price direction and specifically current conditions of oversupply in many metals makes them correlate even more closely now than at anytime since the early 2000s.
China’s leading economic indicator, as published by the National Bureau of Statistics of China, has been in a slow but steady decline since early 2010. This leading indicator typically leads real economic activity by between 6 and 12 months. At the same time, the US leading indicator, as published by the Conference Board, has been on a steady increase since it bottomed in early 2009. Both countries are due to publish the numbers for October shortly.
What Exactly Is a Leading Economic Indicator?
As Standard Bank explains, leading indicators are a composite of individual data points, each tracking specific economic activities; such composite indexes typically lead the real economy by anywhere between 6 and 18 months.
Economic indicators provide an indication of a potential acceleration or slowdown in the real economy, and, by implication, potential changes in commodity demand. In the bank’s estimate, the relationship between China’s cyclical growth and commodity prices has increased in recent months.
More specifically, the relationship between industrial metal prices and the Chinese leading indicator has become much more correlated since the beginning of 2011, when arguably many industrial metals started entering surplus supply or were in surplus already. Standard Bank looked at the correlation between the LMEX index of metal prices and the China leading indicator and found it had increased to 0.91.
The last time there was such a close correlation was 2000 to 2004, when the US was the world’s largest metals consumer and the Conference Board’s leading indicator showed a correlation with LMEX of 0.97 – by contrast, at that time, China’s was 0.2!
The US indicator now has a negative correlation, partly as a result of the United States’ lower share of world metals consumption and possibly also due to the distorting effects of quantitative easing influencing metals prices.
To paraphrase the bank’s closing comments, China has become much more important to metal prices now than at anytime since 2000.
The print for September was marginally lower (declining from 99.89 bps to 99.64 bps). Therefore, another decline in October could spell further downward pressure on metal prices.