Goldman Sachs - Base metals caught between a strong China and a still-weak ROW

We maintain our near-term bearish bias expressed in our April 22, 2009 publication, as we believe that the impact of the China-led rally has largely played out. In the medium- to longer-term, however, we remain constructive on the base metal sector consistent with an expectation of a strong economic recovery in China from 2Q09, and the beginning of a global economic recovery in 2H09. Therefore, we view any near-term pullback as a medium-term buying opportunity. Furthermore, we consider copper and zinc as most leveraged to the demand recovery given current higher production capacity.

Between a China pull and still a drag from the rest of the world
The strong pull from China combined with better leading economic indicators in several large economies has led to a broad rally in base metals prices in recent months. However, coincidental indicators outside of China are still deteriorating - albeit at a slower rate - and metals fundamentals are still fragile. Realizing the tug-of-war between a strong China today and a still-weak rest of world, the market has been trading range bound this month.

Recent China imports have largely gone to restocking
The China-led rally was mostly driven by government buying for strategic and industry support purposes, industry re-stocking in anticipation of a stimulus-led recovery, and pre-stocking for a typical high demand season in 2Q, while the impact from real demand pickup has just begun to emerge in March.

China needs some help from the rest of the world
The direction of metals prices from here depends on three factors:
The magnitude of supply response as prices and demand recover;
Further evidence of global economic improvement; and
The persistence of the China pull that jump started the improvement in the commodities fundamentals.

In our view, China has and will continue to contribute to the fundamental turnaround in commodities, but that China can’t do this alone.