Why the Base Metal Rally Is Not Sustainable

By Chuck LeBeau Jul 16, 2009 12:50 pm

And five stocks that could fall when it ends.

The second quarter of the year has turned out to be astonishing for base metals. But can they sustain their gains, or will they slowly melt away?

Stockpiling by the Chinese, stimulus plans that were heavily concentrated on infrastructure, and a drop in production helped base metals utilize basic macro and microeconomic principles to enable a rally.

This recent rally is hardly sustainable and is most likely short-lived. The gains that have been seen in aluminum, copper, and other industrial metals have been caused by the phenomenon of reverting back to the mean; after all, the industry was badly battered due to the global economic meltdown.

Both producing and consuming companies around the globe continue to suffer from the economic woes brought on by the global financial crisis. As stated in an earlier article, corporate America is beating Wall Street’s expectations primarily due to cost-cutting factors -- not revenue growth and expansion.

So until the economy rebounds, corporations start outperforming due to growth (not due to cutbacks), and jobs are created, the industrial sector will continue to suffer.

Some equities that have benefited from the most recent mean reversion are the following:

1. The PowerShares DB Metals Fund (DBB), up from its March low of $10.95 to close at $15.42 on July 15, an increase of 41%.

2. Freeport-McMoRan Copper & Gold (FCX), closing at $50.91 on July 15, up 92% from a $26.49 March low.

3. Southern Copper (PCU), rebounding nicely from a March low of $12.74 to close at $21.83 on July 15, a jump of 71%.

4. Rio Tinto (RTP) up 52% after witnessing a March low of $91.91 to close at $138.96 on July 15

5. Alcoa (AA), almost doubling and closing at $10.15 on July 15 after hitting a March low of $5.22.

When investing in the aforementioned equities, one must keep in mind the risks involved. To help moderate these risks, implementing an exit strategy and identifying when the upward trend is coming to an end is vital.

According to the latest data from www.SmartStops.net, an upward trend in these stocks and ETFs would be over at the following price levels: DBB at $14.77; FCX at $47.05; PCU at $20.05; RTP at $128.01; AA at $8.97. Be aware that these levels change daily.

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