by Raul de Frutos on MAY 23, 2016

All industrial metals have rallied this year after they hit new lows in January.

Some metals — such as steel, zinc and tin — have gained significantly while others such as aluminum, copper, nickel and lead haven’t made much progress yet. The price rally is not really being driven by supply cuts but by a combination of a weak dollar and the sugar rush of China’s stimulus, initiated late last year. We could be witnessing the end of this five-year-long commodity bear market, however, there is something rotten about this rally.

Chinese Stock Market Has Yet to Find Traction

China stock market ETF weakening since April. Source: @StockCharts.com.

China’s stock market is possibly the best benchmark for China’s economy or at least investors’ sentiment on China. The slowdown in the Chinese economy (weak demand while too much capacity) explains why industrial metals peaked in 2011.

Ever since, China’s stock market has fallen with commodity prices. Earlier this year we witnessed a rally in the Chinese stock market but the rally has been shy so far and it has, indeed, weakened since mid-April amid worries that Beijing might pull back on monetary stimulus while it steps up structural and financial reforms even as the economic recovery struggles to gain traction. The stock market weakness also comes after worse-than-expected economic data for April, suggesting that the financial stimulus package unleashed in China earlier this year could be losing its impact.

Base metals ETF (in brown) rising with China stock market ETF (in blue). Source: @StockCharts.com.

In the chart above we see how China’s stock market rose as China unleashed its stimulus program back in 2009 and how metal prices surged with it.

While overcapacity is still a problem, we’ll likely need to see China’s stimulus measures make a significant impact and that should be reflected in its stock market. A good start would be China’s stock market rising above April’s levels. Otherwise, metal bulls can only hope for a choppy market.