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In order to forecast the trend in the price of base metals, there are a lot of indicators to look at. Two of the most important indicators are capacity utilization and the China manufacturing PMI.

Previously, I noticed that capacity utilization for mining in the U.S. was improving in November 2012, with the rate growing to 91.1%. However, the problem is that the U.S. isn't that important anymore when talking about commodities. For example, in 2012 the emerging markets account for 75% of global iron ore consumption (Chart 1), while Asia, South America and Oceania account for more than 70% of global iron ore production (Chart 2). The same trend can be found in gold and silver production / consumption.

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Chart 1: Iron Ore Consumption by Continent
Chart 2: Iron Ore Production by Continent


It would be wrong to draw any conclusions on the prospects in the commodity market by only looking at the capacity utilization of the U.S. It's essential to include China, South America and Australia/Canada into the equation. Charts 3 and 4 give the latest status on the capacity utilization of Canada and Australia, two of the world's most important base metal producers besides China. The trend is not bullish, which means base metal prices will be sluggish going forward.

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Chart 3: Mining Capacity Utilization Canada
Chart 4: Australia Capacity Utilization

The trend in base metal prices is basically dominated by iron ore and steel (Table 1), as China consumes the most of those base metals. So we need to look at the capacity utilization of steel and iron ore to get an indication on the trend in base metals.

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Table 1: China's Share of World Commodity Consumption

If we look at world steel capacity utilization, the downward trend returns to the picture. Capacity utilization continues to decrease mainly because China adds more and more capacity.

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Chart 5: World Steel Capacity Utilization

As a side note, capacity utilization is not only an indicator for the trend in base metal prices, but can also be used to forecast the unemployment rate. A strong correlation exists between the unemployment rate and capacity utilization (Chart 6). Lately, capacity utilization can even be used as a leading indicator for the unemployment rate (with a lag of half a year).

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Chart 6: Correlation Unemployment Rate Vs. Capacity Utilization

The second indicator I want to look at to predict base metal prices is the China manufacturing PMI. Societe Generale has pointed out that there is a very high correlation between the China manufacturing PMI and base metal prices. If we know how the China manufacturing PMI evolves, we can predict the trend in base metal prices (Chart 7).

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Chart 7: Correlation Base Metals Vs. China Manufacturing PMI

The latest number on the Chinese manufacturing PMI is positive, posting a rise to 50.9 in December from 50.5 in November. This rise in PMI is consistent with the rise in iron ore imports to China, which I talked about here. In that article, I saw that China increased iron ore imports to the highest level since 2011: 65 million tonnes. China is importing 65.78 million tonnes in November 2012, so the rising trend in iron ore imports to China is continuing, which is bullish for the iron ore price.

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Chart 8: China Manufacturing PMI (Source: HSBC)

In fact, we already see a rebound in the iron ore price since September 2012 (Chart 9).

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Chart 9: Iron Ore Price


Conclusion:

To predict the trend in base metals we can look at countless indicators, of which capacity utilization and China manufacturing PMI are most important to me. When analyzing both indicators we see conflicting trends. While the capacity utilization in the steel industry is still declining (bearish for base metal prices), we still see improvement in the Chinese manufacturing PMI (bullish for base metal prices). So it is unclear how the base metals market will evolve going forward. Nevertheless, investors have an extra tool to monitor these two indicators to make their bet on base metals. A possible way to invest in base metals is to buy the Powershares DB Base Metals Fund ETF (NYSEARCA:DBB).

Source: How To Predict The Trend In Base Metal Prices