What are base metals and how do you trade them?

Demand for base metals, more than gold and other precious metals, is a strong indicator of economic health. However, global events can easily affect supply, leading to extreme price volatility. This can make trading in base metals appealing to traders looking for opportunities for speculative trading. But successful trading depends on developing sound strategies and conducting thorough market analysis to anticipate price fluctuations and maximise opportunities.

What are base metals?

Unlike precious metals, base metals are versatile, abundant, lower in value, and easier to mine. As a result, they are extensively used in commercial applications and industrial sectors such as construction, manufacturing, and technology. They are non-ferrous, so they are not commonly used in steelmaking, despite their extensive industrial applications. Base metals are not used as a store of value. However, their prices are heavily influenced by demand and often reflect global economic trends.

Key base metals: Copper, aluminium, zinc

There are eight commonly traded base metals; this includes two alloys. However, in terms of volume traded, the key base metals are copper, aluminium, and zinc.

Copper's conductivity makes it indispensable in power generation and transmission, renewable energy systems, telecommunications infrastructure, as well as in motors, electronic equipment, and other commercial applications. Demand and copper prices often correlate with a slowing or growing economy; high demand for copper and prices suggest an improving economy, and lower copper prices suggest activities in some areas in the economy are slowing.

Aluminium is lightweight, has a high strength-to-weight ratio, and is mostly resistant to corrosion, making it widely used in aerospace, automotive manufacturing, packaging, and construction. With regulations in many countries now pushing for lower vehicle emissions, aluminium is being used to reduce the weight of vehicle components, improving fuel efficiency.

Zinc improves durability, so it is frequently used in infrastructure and construction projects. It is used in die-casting for the automotive and hardware industries or combined with copper to create brass. Most zinc is used to galvanise metals such as iron and steel, preventing rust and extending the lifespan of components.

Supply and demand fundamentals

Base metal pricing is intrinsically linked to supply and demand, with small shifts in either leading to price movements.

Factors affecting supply include mining production levels, ore grades, and operational costs in extraction and processing. Technological advances can increase supply, while stricter environmental regulations and sustainability concerns can limit it. Geopolitical stability in mining regions can immediately impact supply, with factors such as elections, conflicts, social unrest, and labour strikes playing a role.

Demand for base metals is driven by industrial growth, urbanisation, and technological development. Changes in consumer behaviour, such as increased adoption of electric vehicles, can boost demand for copper and aluminium. Large infrastructure projects in both emerging and advanced economies also raise demand. Conversely, a slowdown in infrastructure, property developments, or lower demand for consumer products can reduce the demand for base metals.

Anticipating price movements requires a strong understanding of supply and demand dynamics. A surplus and stagnant demand may lead to price declines, while a deficit can drive prices upward.

Global events affecting base metal prices

Global events can have immediate effects on base metal markets.

Political instability from elections, coups, conflicts, and government policy changes can affect foreign investments and mining operations. Natural disasters, such as floods, earthquakes, and mining accidents, can disrupt mining, processing, and shipping. Price volatility can follow when demand is high, especially if the affected country is a major producer of base metals.

Trade tensions, tariffs, and quotas alter import and export dynamics, affecting global supply chains. The uncertainty following tariffs or quotas can also lead to price volatility.

Base metal traders benefit from understanding the role supply and demand play in market prices. However, staying informed about international developments and geopolitical influences is equally important.

Economic indicators to watch

Anticipating shifts in demand that affect metal prices is possible by watching key economic indicators. These include:

• Gross Domestic Product (GDP) Growth Rates:
• GDP growth has long been used as an indicator of economic health. High GDP growth usually means an increase in industrial activity and construction, leading to higher demand for base metals.
• Manufacturing Purchasing Managers' Index (PMI):
• Indicative of the health of manufacturing and services, A PMI above 50 indicates expansion, often correlating with increased metal consumption. PMI is updated monthly and is a critical decision-making tool in many industries.
• Housing Starts and Building Permits:
• Increases in residential construction activity can boost demand for copper and aluminium used in wiring, plumbing, and structural components. Monitoring these indicators can be complicated, as not all countries release this data regularly.
• Automotive Production Data:
• Trends in vehicle manufacturing affect the demand for metals used in car bodies, engines, and electrical systems.
• Industrial Production Figures:
• Another monthly economic indicator, IPI figures show the output in the manufacturing, mining, electric, and gas industries. Many of these industries use base metals, and IPI figures provide a broad view of industrial demand.

Analysing industry news and trends

Market movements are influenced by various industry developments. Key areas to monitor include:

• Mining Production Reports:
  Updates on output levels, new discoveries, and operational challenges that could affect supply expectations.
• Technological Innovations:
  Technological advancements can alter demand patterns. For example, artificial intelligence (AI) developments have increased demand for powerful graphics processing units (GPUs) in computers.
• Regulatory Changes:
  Government policies on environmental regulations, trade agreements, and tariffs can impact both supply and demand. Regulatory discussions often progress slowly, making it essential to track new developments.
• Economic Policies:
  Central bank decisions on interest rates and monetary policy can influence economic growth and industrial activity.

Since base metal prices respond quickly to news and events, monitoring and analysing industry trends is crucial for short-term trading. Mining production reports can alert traders to sudden supply disruptions, allowing them to adjust positions before prices react. For instance, an unexpected decline in mining output due to operational challenges might trigger price increases for that metal, presenting a short-term trading opportunity.

Several industries experiencing rapid technological innovations—such as solar energy, electric vehicle (EV) batteries, and the expansion of 5G networks—are particularly relevant to base metal trading. New developments or projects in these industries can cause a surge in demand for certain base metals, potentially leading to higher prices. Markets also react immediately to announcements of regulatory and economic policy changes, such as new tariffs or interest rate adjustments. By analysing these reactions, traders can better anticipate price movements and adjust short-term trades accordingly.

Major exchanges for base metals

Commodities exchanges trading base metals can be found on nearly every continent. Some, such as Australia's Allocated Bullion Exchange (ABX), trade only precious metals, while others trade both precious and common metals. Major base metal exchanges are:

• London Metal Exchange (LME)
• New York Mercantile Exchange (NYMEX)
• Commodity Exchange, Inc (COMEX)
• Shanghai Futures Exchange (SHFE).

Over-the-counter (OTC) CFD trading

Over-the-counter (OTC) trading in base metals involves direct transactions between two parties, without the supervision of an exchange. In the base metals market, OTC trading is often used for contracts for difference (CFDs). These are agreements between two parties to exchange the difference in the value of an asset—such as base metals—between the time the contract is opened and closed.

CFD trading offers flexibility, as trade volume, pricing terms, and delivery dates can all be customised to specific needs. This allows traders to speculate on the price movement of base metals without owning the physical asset.

However, since negotiations are direct between the parties, transactions are not guaranteed by an exchange's clearinghouse. As a result, due diligence is essential to ensure the reliability of trading partners, as the counterparty risk remains a key consideration in OTC CFD trading.

Technical Analysis for base metals

Technical analysis is a method used when trading base metals, where traders examine statistical trends, such as price movement and volume. This approach assumes that all known fundamentals are already factored into prices, and that patterns tend to repeat over time.

Traders use technical analysis to identify trading opportunities by analysing chart patterns and indicators. The goal is to predict future price movements based on historical data rather than intrinsic value.

Traders following this approach need to:

• Determine whether a market is in an uptrend, downtrend, or sideways movement.
• Identify historical price levels where the market struggled to advance, which can inform entry and exit points.
• Examine trading volume to confirm the strength of a price movement. High volume during price increases suggests strong buying interest.

While fundamental analysis focuses on economic indicators and market conditions, technical analysis emphasises chart patterns and statistical measures.

Key chart patterns and trends

Technical analysis relies on recognising chart patterns and trends. Common patterns include:

• Head and Shoulders:
  This pattern can indicate a potential reversal from an uptrend to a downtrend. It consists of three peaks, with the middle peak being the highest.
• Double Tops and Bottoms:
  Signal a possible trend reversal. A double top signals a bearish reversal, while a double bottom indicates a bullish reversal.
• Triangles (Symmetrical, Ascending, Descending):
  Triangles represent periods of consolidation before prices break out in a specific direction.
• Flags and Pennants:
  These are short-term continuation patterns that follow a sharp price movement, indicating the trend will likely continue.

Predictions about future price movements can be made by identifying patterns. However, these should always be confirmed with other indicators and analysis, as false signals are possible.

Indicators and Tools for Trading

Technical indicators are mathematical calculations based on price and volume, used to interpret market data. Common indicators include:

• Moving Averages (MA):
  These smooth out price data to identify trends. Simple Moving Averages (SMA) calculate the average price over a specific period, while Exponential Moving Averages (EMA) give more weight to recent prices.
• Relative Strength Index (RSI):
  This momentum oscillator measures the speed and magnitude of price movements.
• Moving Average Convergence Divergence (MACD):
  This indicator shows the relationship between two moving averages of a security's price. It helps identify potential buy and sell signals.
• Bollinger Bands:
  These consist of a moving average and two standard deviations above and below it. They help assess market volatility and potential overbought or oversold conditions.
• Fibonacci Retracement Levels:
  These horizontal lines indicate likely support and resistance levels based on the Fibonacci sequence.

These indicators can strengthen trading strategies by providing objective data to support decisions. However, using multiple indicators can help reduce risk by confirming signals from different sources.

Risk management techniques

All trading carries inherent risk, making effective risk management essential. Diversification helps limit exposure to price risk in a single metal or asset class. In commodities trading, stop-loss orders can be implemented to automatically close a position when the price reaches a specified level, limiting potential losses.

A clear understanding of risk tolerance is essential, as it informs the amount invested in each trade and the overall portfolio size. Regular reviews of market conditions, positions, and trading strategies are also necessary. This helps traders respond quickly to changing circumstances.

Frequently Asked Questions

What are base metals and why are they important?

Base metals are common metals like copper, aluminium, nickel, tin, and zinc that are widely used in industrial applications. Properties such as conductivity, strength, and resistance to corrosion, along with their abundance and lower costs compared to precious metals, make them widely used in infrastructure, manufacturing, and technology sectors.

How are base metals traded in the market?

Base metals are traded on major commodity exchanges, such as the London Metal Exchange and New York Mercantile Exchange, via different contract types. They can also be traded over-the-counter, which allow for customised agreements. Traders in these markets hedge against price fluctuations or speculate on future price movements.

Is base metals trading risky?

Yes, trading base metals involves risks due to price volatility influenced by various factors like economic changes, geopolitical events, and supply disruptions. Losses can occur if the market moves against positions, making risk management strategies essential.

Can ETFs be a safer way to trade in base metals?

Exchange-Traded Funds (ETFs) offer a way to invest in base metals without directly trading commodities. ETFs track the performance of a basket of metals or specific metal indices, offering investors exposure to the base metals market with potentially lower risk.

Why analyse economic indicators in base metals trading?

Economic indicators offer insights into the health of economies and industries that use base metals. Indicators such as manufacturing output, construction activity, and GDP growth influence the demand for metals. Analysing these indicators helps traders anticipate changes in demand and make better trading decisions.