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Brexit just a bump in the bull run for base metals

The EU referendum vote and the shock decision by 52% of the UK’s population to leave caused immediate shock waves throughout global financial markets: European stocks, the British pound, euro and global share prices all plummeted in the immediate aftermath, whilst safe-haven assets such as gold and the dollar rocketed up. Yet the base metals complex seemed to register only a small bump from the event, recovered quickly and is now higher than it was before the vote. Why is this?

The base metals complex has climbed 10% on average since January 1 on the London Metal Exchange. Zinc has been the star performer, up 28.0% to date, with tin in second at 16.4%. Lead is the only metal to have lost since January 1, down 1.2%, while nickel is up 7.0%. Copper is up 2.8% to date and aluminum 8.9%.

Sentiment improving before the vote

With market expectations leaning towards a remain vote in the week before the result, metals were moving in an upward direction largely due to improved sentiment rather than any apparent shift in fundamentals. Possibly because of short-covering in anticipation of a remain vote, Commitment of Traders showed speculative net short positions of copper on COMEX at record highs in the weeks preceding the announcement.

In the week prior to the vote, copper was up 5.07%, aluminum 2.08%, nickel 3.88%, lead 1.59%, tin 1.35% and zinc 2.35%. The complex as a whole was up 2.70% on the week, basis LME data.

Barclays drove home the point about weak fundamentals saying, “We stand by our call for mediocre copper import results in the coming months, as demand within China slows over the summer. Moderating copper imports will reduce the upward pressure on global prices," on June 21, highlighting again that in their view this rally was not supported by demand-supply dynamics.

"Tin is too high, I can see it coming down," one tin trader told Platts on June 23. "There is too much material around right now, stocks are high, the market is pretty dead so I can't see where the demand is, so I can see the metal falling," expressing his belief that tin was now well above its fundamentals.

Smaller than expected loss on 'exit' vote

Then in the early hours of June 24, markets erupted worldwide as results started coming through.

“We were looking for a correction in the [metals] market, but it is not as large as expected,” one trader said in the aftermath. This sentiment was echoed by others.

“There’s not the downside I expected; people are unsure, and are punting around in the market,” a second trader said on the same morning.

"The metals were all pushed up on the remain sentiment this week," a third trader added, "and now they are falling, but not as much as I would have expected."

Nickel was the biggest loser on the day, falling 2.38% by the close on June 24, aluminium and copper fell 1.40% and 1.60% respectively. Lead dropped 1.12%, while zinc and tin lost 0.95 and 0.98% each. The complex slipped as a whole by 1.40%.

By comparison, the GBP-USD lost 8%, the EUR-USD lost 2.6% and the FTSE 100 lost 3% by the end of the day.

Morning madness, afternoon calm

Activity on the LME was focused in the morning trading session, with the market surprisingly quiet by the afternoon.

Copper price with traded volume over June 23-24

The majority of the trading activity on the day was focused in the morning session, copper trading more than 23,500 lots before 9 a.m. according to a second broker, while tin lost $750 before 6 a.m. and recouped over the later part of the day.

While the initial price loss was significant, around $150, by 17:00 the price had clawed back $50, and the close on June 26 was already trading above the peak on June 23.

Looking at volumes traded between June 13-30 there was a notable increase over June 23-24.

"I think people don't really know what to expect," said the earlier broker, "but we will have to wait and see."

"Everything was pushed up prior to the vote, so we will see what level it corrects to," said a broker the morning after the vote.

At the end of June 24, a fourth trader said, "The market has taken [Brexit] well, there were some dramatic moves in the premarket, but it's been fairly quiet since then; copper did well to recover."

Rapid recovery

“The base metal complex went down; it was always going to on the Brexit vote, but by less than was expected,”  a purchaser said on June 27.

"In the short term, prices have to come off, Bremain was priced into the base metals all week, and they haven't corrected, so I think we are going to see them all fall now," said a fifth trader, who looks over all the base metals, on June 24.

Daily metals prices (normalized)

By June 29, the base metals complex closed 1.44% on average higher than the high point before the referendum vote. Tin is the only metal that didn’t break through its pre-Brexit high, but the tin contract is notoriously illiquid, and this may have played a part in this.

Comparing this recovery to other economic indicators, as shown in the below graph, the base metals complex was very quick indeed to recover, reaching pre-Brexit levels two days before the FTSE 100 managed the same.

The performance of the complex was also better than that of the FTSE 100 and the British pound over the period.

Performance of base metals complex, FTSE 100, GBP and EUR

The reasons for the rapid recovery have been put down largely to the fact that the UK leaving the EU would not impact the demand side. Europe consumes around 25% of global commodities, and the UK is only a very small fraction of this. This logic seems slightly perverse, however, as it was market sentiment on the referendum that inflated the prices, but it seems not to have had the same impact to the downside.

“On the LME, nothing has changed on Brexit. Britain doesn’t produce or consume much and even Europe is small compared to China,” a market source said on the afternoon of June 24.

The second key driver was the dollar. The greenback strengthened considerably on the vote, and historically the greenback and commodities have a strong negative correlation.

Base metal complex price vs dollar index

The market also seems to be increasingly optimistic, given how well the complex shrugged off the Brexit event, and this could be helping drive the increase in long positions that is now helping to push the bull run along.

“The market is quite optimistic; the base metals didn’t do so badly, and I think people are getting overly confident. Long positions are increasing, and the price is back up. Who knows where it will go; certainly copper is meeting resistance at $4,870, and I don’t think it will break that, but who knows,” a broker said on June 30.