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Base metals
Preference: neutral

Current (24 Oct) (last month): Copper USD 7,815/mt (8,271); Nickel USD 16,336/mt (18,351);
Aluminum USD 1,912/mt (2,079)

UBS View
6-month target: Copper: USD 8,800/mt; Nickel: USD 19,000/mt; Aluminum: USD 2,100/mt

• After the swift uptick in prices, base metals have been under renewed pressure. The initial price strength – a simple catch up with Chinese prices triggered by a shift in demand expectations – is losing strength.
• In order to continue the price rally, a firm increase in final metal demand is needed. Since global economic growth is far from seeing such a demand uptick in industrial activity during 4Q12, we think that prices are likely to trade only sideways in the coming months before trending higher in 1Q13.
• Loose monetary policy is a good precondition for activity to pick up, but not a guarantee after so many rounds of monetary stimulus. We therefore look east to China. Although industrial activity growth in China is likely to bottom out, the upcoming leadership change in the country (November 2012 to March 2013), will likely delay a bigger investment program into 1Q13. The latest stimulus program will probably prevent Chinese IP from decelerating even further, but will not lift it meaningfully higher.
• On a single commodity level, we favor copper and nickel. For nickel, short-term supply issues due to a slower ramp up of new and existing projects have temporarily brought the market closer to balance than initially expected. Furthermore, we should see higher Chinese stainless steel demand with stabilizing housing activity and a demand pick up in stainless steel related products.
• With regards to copper, we expect import activity to remain strong, as seen in the import figures for September. Overall, the copper market should remain undersupplied, which could widen if financial demand is finding some store of value in the metal. We think this puts structurally low LME inventories at risk and should push the metal price towards USD 8,800/mt or higher over six months.

Recommendations
Tactical (6 months)
• We reiterate that the strong uptick in base metal prices is skating on thin ice, in our view. Real activity has yet to follow and support prices over a longer time period. 50% of the upside potential on a 6-month horizon is likely to be behind us, making only copper and nickel attractive, with +10% expected return.

Strategic (2 years)
• Although the strongest performance should be visible in zinc and lead, with existing mine capacity expected to peak in 2014/15, the recent price strength makes such an investment unattractive now, based on timing. Given a structurally solid supply side, investors should avoid aluminum and nickel. A firmer supply side should also limit the upside in copper.

Positive scenario
• China eases monetary policy aggressively, pushing credit growth to 20% y/y. In the US the Fed is able to lift GDP growth via QE3 and the ECB puts an effective backstop to declining industrial activity.

Negative scenario
• To passive Chinese authorities keep GDP growth on a constant deceleration path. A severe escalation of the Eurozone crisis (room for a break-up) triggers a setback in investment activity – including in Germany.

What we're watching
Why it matters

Demand
China's growth deceleration should come to an end. But hard economic activity indicators, especially for China, have yet to catch up with the increase in prices. Hence, the current base metal market is already reflecting considerable growth goodwill that is in need of a demand confirmation by China, the US or Europe.

Supply
Copper output continues to undershoot market expectations and should be watched closely, as investment activity in mines increased sharply. For zinc, prospects for mine closures have been delayed and should keep the market oversupplied.

Economic data/forward curve
Chinese economic data – trade data, CPI, IP and loan growth by financial institutions. Key date: 10-15 Oct

Net speculative copper position at Comex are far from being overstretched
[Chart showing bar graph of Long positions, Short positions, and Net long position from Jan-93 to Jan-11]
80
60 In thousand contracts
40
20
0
(20)
(40)
(60)
(80)
Source: Bloomberg, UBS, as of Oct. 2012
Note: Past performance is not an indication of future returns.

UBS
For further information please contact CIO's asset class specialists Dominic Schnider, dominic.schnider@ubs.com or Giovanni Staunovo, giovanni.staunovo@ubs.com
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Please see important disclaimer and disclosures at the end of the document.
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