DBB: Bullish Target Nearly Hit (NYSEARCA:DBB)

Thesis

In this regular note, we provide a discussion on fundamental dynamics across the industrial metals, with a special focus on copper, zinc, and aluminium, in order to formulate a clear view on the Invesco DB Base Metals ETF (DBB). By tracking many real-time micro indicators across the base metals space, we help readers to better assess the real-time changes in refined market balances.

DBB reached a high of $14.72 per share on July 13, which was extremely close to our Q3 target of $15 per share.

Sentiment has clearly shifted positively in favor of base metals since April, driven by positive macro conditions, including a faster-than-expected recovery in the Chinese economy. However, although some fundamental indicators have turned positive, physical demand conditions are still poor and are expected to soften even more in the summer months.

Nevertheless, we think that the macro is still conducive to firmer prices. The positive momentum could prompt the speculative community to exert further upside exposure to the base metals despite some fundamental weakness.

Our Q3-20 target for DBB is at $15/share.

Source: Trading View, Orchid Research

About Invesco DB Base Metals ETF

The Invesco DB Base Metals ETF allows investors to assert exposure to some of the LME base metals.

The composition of the fund is as follows:

Source: DBB, Orchid Research

DBB’s assets under management total $115 million, with an average daily volume of $1.77 million and average spread (over the past 60 days) of 0.18%.

Its expense ratio is 0.80%, which makes it a relatively cheap ETF to get an exposure to the industrial metals complex.

Price trends

Source: Bloomberg, Orchid Research

Copper, aluminium, and zinc have already made strong gains since the start of July:

  • Copper is up around 6% MTD, after a significant gain of 12% in June.
  • Aluminium is up around 4% MTD, after a gain of 5% in June.
  • Zinc is up 8% MTD, after a modest gain of 2.5% in June.

In addition to a risk-on mood and a weaker dollar, base metals have appreciated on expectations for additional supply disruptions due to rising COVID-19 cases in major mine-producing countries, especially like Chile.

Although output has not been lost yet, fears of supply disruptions have been enough to shore up investor sentiment and exert upward pressure on prices.

Open interest trends

Source: Bloomberg, Orchid Research

Open interest in LME copper and LME zinc have increased strongly since the start of July, suggesting that the price strength is primarily driven by new longs in the market. This is a bullish signal.

In contrast, open interest in aluminium has declined, meaning that the driver of firmer prices is principally short-covering. Investors are reluctant to turn more aggressively bullish on aluminium due to the mega surplus expected this year. In contrast to most other base metals, aluminium supply has been “sticky”, exacerbating the fundamental imbalance in the physical market.

Exchange inventory trends

Source: Bloomberg, Orchid Research

While global exchange inventories in aluminium and zinc continue to edge higher, they have continued to tumble in copper.

On this basis, copper’s fundamentals look the strongest across the board. The fact that copper inventories fall whereas aluminium/zinc do not is due to the significant tightness in copper scrap supply. As scrap supply conditions are tight, consumers need to switch to refined copper to satisfy their copper usage, exerting a pull on exchange inventories. In addition, there has been a significant increase in demand for copper in China to take advantage of the SHFE-LME arbitrage opportunities, and as such, copper inventories have become “invisible”.

Positioning among the speculative community

Source: Bloomberg, Orchid Research

The positive shift in speculative sentiment in favor is evident, with speculators having increased their net long exposure to copper. The increase in net long speculative positions in aluminium and zinc has been more modest, but it is worth noting that the speculative community is now net long across all the LME base metals.

Although physical demand is soft, we think that there is more room for further speculative buying in the near term, which should ultimately push DBB to our target.

Closing thoughts

DBB has already made strong gains since the start of the month, corroborating our bullish thesis.

Although we contend that demand conditions are soft, there are offsetting positive forces in the market, such as easy financial conditions, a weaker dollar, risk of supply disruptions, and falling inventories (copper), pushing the complex higher.

We expect the uptrend to continue further as long as these positive conditions prevail. Although the risks to our forecasts are skewed to the upside, we prefer to adopt a conservative stance for now.

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Our research has not been prepared in accordance with the legal requirements designed to promote the independence of investment research. Therefore, this material cannot be considered as investment research, a research recommendation, nor a personal recommendation or advice, for regulatory purposes.

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