DBB: Recession, Inflation Keep Industrial Metals In Balance

If this is your first time reading a Hunting Alpha article using Technical Analysis, you may want to read this post, which explains how and why I read the charts the way I do, utilizing principles of Flow, Location and Trap.

Introduction

Industrial base metals are used in the economy. Copper is used in electrical wiring, pipes and machinery. Aluminum is used in automotive, cans, and aerospace. Zinc is used to galvanize other metals and protect it from corrosion.

Naturally, as the economy slows down, the demand for these metals also slow down. Thus, recessionary fears are a headwind to these metal prices. On the other hand, inflation in many parts of the world is still at decadal highs. And that leads to upward pressures on these metals in a world where key input costs such as energy and transportation cost is higher.

According to my analysis, these dual forces currently are in balance. But I am on the lookout for incremental changes that may give me a tradeable direction.

My Instrument for Playing Industrial Metals

The Invesco DB Base Metals ETF (NYSEARCA:DBB) tracks an index of three base metal futures contracts: copper, zinc, and aluminum. Here is what this exchange-traded fund (“ETF”) is made of.

DBB ETF Composition

The DBB ETF holds three end-use industry metals at almost equal levels, including LME Copper Futures (HG1:COM) (33.6%), LME Zinc Futures (LMZSDS03:COM) (33.3%), and LME Primary Aluminum Futures (LMAHDS03:COM) (32.8%). Thus, the DBB ETF, whilst concentrated to only three industrial metals, has a balanced exposure.

Here are the key fundamental drivers I am watching to form a view on DBB:

Keep an Eye on Producer Price Inflation

The Producer Price Inflation Index for Industrial Commodities (PPIIDC) is a key metric to watch in order to gauge inflationary impacts on base metals.

After peaking in June 2022, the PPIIDC has been on a temporary decline, indicating easing of cost of operations for metal producers. The number one cost driver in focus in the current environment is energy costs. Thus, our outlook on the energy markets, which in turn is driven by how the European winter will pan out, and the status of the Russia-Ukraine war are key monitorables to get leading signs on base metal prices.

Wall Street Paints Bullish Outlook for Copper

Wall Street believes that a combination of a short-term supply pinch and long-term energy transition-related demand will send copper flying in 2023. Goldman analysts explain that the downward pressure expected in 2022 from excess surplus supply in the metal market did not occur. Instead, the copper cathode market (which is a raw material input for making end-use copper metal) has maintained a “clear deficit, with global visible stocks falling to their lowest level in 14 years.”

That said, let’s look at what the technicals are saying before committing to a particular direction:

Read of Relative Money Flow

An upward movement on the relative chart of DBB/S&P500 means DBB is making alpha against the S&P500 Index (SP500). Conversely, a downward movement means the DBB is underperforming the S&P500.

I anticipate a bullish pullback toward the monthly support. I recognize that we may see confirmation of a false breakout trap followed by a blast to previous monthly resistance levels. As such, I would be ready to place a buy position on this instrument, but I need to see that sharp spike down and a rebound before I make any moves.

Thus, my outlook on the DBB/S&P500 pair is a hold with a slight tilt towards a bullish uprising to the highlighted monthly resistance levels.

Read of Absolute Money Flow

On the standalone DBB monthly chart, the price is in a much wider range and is currently retesting a critical monthly resistance at $19.99. As the visible reaction to this level suggests, it is unlikely to break above this mark as a rejection is already in play. On the DBB chart, I see a fall in price over the coming months to the $17.25 monthly support, followed by a retest of the $19.99 resistance.

Thus, I foresee a range-bound movement, and so I am adopting a hold position on the standalone DBB. However, I believe that would be some short-term buy and sell opportunities along the way for shorter term traders.

Summary

Overall, I maintain a bullishly inclined “hold” outlook on the DBB vs. S&P500 pair and expect to see a sideways pattern on the standalone Invesco DB Base Metals ETF. I expect a retest of the critical monthly support on the DBB/S&P500, where sellers will likely get trapped, followed by a bullish rush.