Marc Courtenay's  Instablog

"Stay with precious metals, urges RBS, but ensure also that you have industrial metal exposure. April heading to be the best month for prices in 40 years. Zinc is expected to slip into deficit next year and copper in 2011, but aluminium is carrying heavy inventories that may yet increase further."

That's how Rhona O'Connell from Mineweb.com summed up the latest report from RBS and gave some details that bodes well for precious metals.

After taking quite a hit on Tuesday we are seeing a pleasing rally in gold and silver on Wednesday. To me it will be significant if gold can break above $900 and head towards $920 with silver breaking through the $13 an ounce level.

The latest quarterly Commodity Companion from Royal Bank of Scotland records that the RBS Base Metal Price Index has since the end of 2008 risen by 20% and is on course for further gains.  Despite the fact that there is as yet little sign of any real demand growth, a number of elements have allowed commodities to prosper, and base and precious metals have taken the limelight with oil, natural gas and steel having to take a back seat. 

The primary factors behind the increase in metals prices so far have been; a) monetary and fiscal stimulus, 2) hefty supply cutbacks) Chinese metals stockpiling and d) the "cash-for-clunkers' boost to auto sales. 

The publication is a comprehensive volume covering not just the precious and base metals, but also bulk commodities, energy and the steel sector, each of which have their own individual profiles.  For now, precious and base are where it's at, but there is light on the horizon elsewhere in the sector as we look further out. 

RBS takes a reflationary view on the economy and is looking for anaemic world GDP growth this year, but is expecting a rebound to 4.0% in 2010.  The analysts note that in a volatile world themes, not forecasts, are perhaps most important and that "if you are seeking indicators of the upturn in the world economy, then look no further than metals themselves!"  

While platinum and palladium are expected to continue to outperform gold and silver, the favoured base metals are copper, zinc and lead, followed by nickel while aluminium brings up the rear among the base metals.  Bulk commodities, however are expected to record hefty declines in annual benchmark settlements.

 Oil's resurgence is further down the road according to RBS but the outlook for natural gas remains forlorn, while steel is expected to stabilise in the second quarter of this year after a tough first quarter.

The oil theme has convinced me to hold on to two of the ETFs I prefer which are USO and DBO (DBO is a more actively managed ETF the way I understand it.

The heart of the RBS report is covered nicely in Rhona's Mineweb article so I'll defer to her at this point:

"The economic outlook remains fraught with periods, with commodity consumption collapsing, business segments suffering severe growth dislocations and capital expenditure badly mauled.  As a result the jury is still very much out as to whether the raft of simulative measures will be able to stop the rot and give the necessary boost to consumer confidence that is necessary to kick-start the world's recession-hit economies.  One swallow may not make a summer, but the April Conference Board consumer confidence figure for the US, released after RBS went to press with this publication, recorded its fourth-largest ever increase and the biggest since the fall of Baghdad in spring 2003, with an increase to 39.2 after 26.9 in March. 

"Copper remains the RBS analysts' preferred base metal, and although a large surplus is likely this year, Chinese strategic stockpiling may absorb much of it.  An underlying surplus is also expected for 2010, but the market is expected to movie not growing deficit for 2011.  The recession has hit copper's project pipeline particularly hard.  The study comments that market-driven production cutbacks remain modest, and ever more so compared with other metals.  Some 25 price-related cutbacks are however noted in the mining sector and 21 similar restrictions in the smelting and refining sector and copper mine capacity utilisation is still way below historical levels.  There have also been a substantial number of project deferrals however and RBS believes that this has contributed to copper's price rebound as far forward prices had been looking too low. 

"Zinc is also one the most favoured base metals, with much more price recovery forecast for later in 2009 and through 2010.  Chinese stockpiling also plays a part here, but there have already been deep producer cutbacks that are expected to limit this year's surplus and RBS expects "continued producer discipline" to tip zinc back into deficit as soon as next year, ahead of a more genuine tightening of market conditions by 2012. 

"The situation is slightly different with aluminium and nickel.  Hefty producer cutbacks do at least seem to have brought about some nickel price stabilisation in the first quarter of 2009, with some 21% of world production sliced away, but the metal still faces an onerous inventory mountain with a stock-to-inventory ratio of more than twelve weeks.  RBS is looking for a surplus to be sustained even through to 2011 despite producer cutbacks.  Aluminium is expected to continue to suffer by virtue of its heavy exposure to the transport and construction sectors and demand is expected to contract by 8% in 2009.  Announced smelter cutbacks have amounted to 18% of world supply, but RBS is expecting another market surplus in 2009. 

"All the base metals are expected to sustain price averages in 2009 substantially below those of 2008, with both refined production and consumption fall across the board (apart from lead with respect to consumption), but the recovery is expected to be strong across the sector. 

This prospect for recovery can be ascribed in part to the consolidation of the mining industry and the rapid enforcement of supply cuts through the exercise of producer discipline in a "fabulous example of shared-pain, shared-gain". 

Copper and zinc price averages in 2011 are expected by RBS to be more than 40% above the averages forecast for 2009 and even though aluminium and nickel are less favoured; their 2011 averages are expected to be more than 30% and 25% higher than their respective 2009 averages."

The report bodes well for producers like Freeport-McMoRan (NYSE:FCX) and if you like international metals companies take a look at Sterlite Industries India (NYSE:SLT) which just happens to be up over 10% today.

For those who favor silver investing, New York precious metals consulting firm CPM Group forecasts that the net surplus in silver is expected to rise to 182.1 million ounces this year, which will approach the record 222.2 million ounces of silver purchased in 1980.

CPM's analysis also found that the key driver for silver prices "is investor attitudes toward silver and how those attitudes are being reflected in investor buying and selling of this metal. Over the past couple of years investors have significantly increased their silver holdings and this has been reflected in relatively high silver prices. It is expected that investors will continue to be interested in buying silver through 2009."

In their annual yearbook report, CPM notes that "shifts in the nature of investment management, changes in the nature of investment management, changes in the methods for investing in precious metals, and other trends all suggest that investors may continue to buy large volumes of precious metals for several years to come, seeking to maintain their safe haven investments even when economic recovery emerges."

The markets are all getting a nice lift today from statements today from the US Federal Reserve. The prepared comments show that the Federal Open Market Committee remains willing to risk high inflation in the years ahead if that means avoiding deflation now. Given the prevailing conditions, this is the right move if they are consistent with their stated position.

That is why all of us should maintain some corel, long-term positions in my favorite closed-end and exchange traded funds, including SLV, GLD, CEF, ASA and GDX. Although I'm anticipating some seasonal selling and maybe even a surprise pullback between now and November, the scenario for the end of 2009 and the beginning of 2010 looks encouraging for precious metals, base metals and for energy.

The RBS report is just one more solid piece of evidence that if the Federal Reserve sticks to their guns that eventually the Stimulus money and the Bailout money will trickle through the system in the US and other industrialized nations and create a spurt of new growth "down the road" that should make commodity buyers smile.

By the way, another interesting ETF to consider for commodities in general is the PowerShares DB Commodity Index Tracking Fund (NYSE:DBC). It's a unique way to own a proxy for the "basket of commodities" that make up the Deutsche BAnk Commodity Index.

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Disclosure: I'm long SLV, GLD, CEF, ASA, USO, DBO and SLT