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Why are base metals doing so well?

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(Kitco News) Industrial metals are rallying while precious metals are taking a step back from aggressive price gains amid all the positive COVID-19 vaccine news, according to analysts.

Despite rising coronavirus cases in the U.S. and Europe, base metals are performing very well, driven by the risk-on sentiment and expectations that the global economy will begin to return to normal as the COVID-19 vaccine is released next year.

"Industrial metals continue to rally, despite a Covid-19 wave sweeping across the globe," TD Securities strategists said on Wednesday. "The change in demand expectations embedded in market pricing is significant and is being additionally supported by a growing global metals supply premium which is providing LME metals with another positive dimension to their returns."

Another major factor supporting base metals is robust Chinese demand, TD Securities added. "Chinese demand … [is] enough to keep commodity demand growth from waning despite lockdowns in Europe and lower mobility levels across many regions in the globe — a vaccine could catalyze another reflationary wave in rest-of-world economies," TD's strategists noted.

Copper is continuing to holding above the $7,100 a tonne mark on Wednesday. Meanwhile, zinc hit an 18-month high amid mine shutdowns in South Africa and tightening short-term supply. On the London Metal Exchange, benchmark zinc touched $2,770 a tonne on Wednesday, the highest since May 2019. Also, LME aluminum reached $1,998 a tonne – the highest level since November 2018.

Demand out of China is expected to continue to boost base metals prices in the near-term, said Capital Economics assistant commodities economist Samuel Burman.

"Collectively, the sharp rebound in China's economy has underpinned much of the recent rally in the prices of industrial metals," Burman said. "We expect supportive fiscal policy to keep industrial and construction activity strong until at least the start of next year, which could give a further lift to metals prices.

However, longer-term, the move might not be sustained as China's economic activity is projected to gradually slow by the end of 2021, Burman added. "We anticipate that fiscal support will be gradually withdrawn, which will weigh on infrastructure investment … This, in turn, will act as a drag on metals demand and prices, particularly for those metals used intensively in infrastructure, such as copper," he said.

Challenges surrounding the distribution of the COVID-19 vaccine could also put a pause in base metals' price action, said Rhona O'Connell, head of market analysis for EMEA and Asia regions at StoneX.

"Yesterday's strength in the industrial sector and equities in general, is, in a similar vein to the start of last week, now taking a step back as the prospects for a rapid and effective distribution of either or both vaccines (regulatory approval still needed) have given pause for thought. The base metals are thus narrowly mixed this morning," O'Connell said.

On the other hand, Precious metals, in particular, gold and silver, are taking a step back as the metals remain below $1,900 and $25, respectively.

"The strong performance in industrial metals isn't being mirrored by precious metals. A slump in investment flows to the yellow metal, catalyzed by the election uncertainty which cascaded to deflationary forces from potential Covid-19 lockdowns and a reversal in safe-haven flows from the vaccine announcement," TD Securities said.

The risk-on sentiment is taking attention away from the safe-haven assets and bringing more money into equities, according to analysts.

Gold has been struggling with significant ETF outflows, which could lead to November being the first month this year that sees net outflows from gold ETFs, said Commerzbank analyst Carsten Fritsch.

"[Gold] is still facing headwind from ETF outflows, which once again totaled nearly 10 tons Yesterday. 35 tons of gold have already been withdrawn from ETFs since the beginning of the month," Fritsch said.

Commerzbank remains neutral on gold as long as it holds the $1,850 level. However, if the precious metal loses that support level, then the market could see a move lower below $1,800 an ounce.

"Gold has recently failed just ahead of the $1,973.80 mid-September high, but continues to hold over the $1,850 low; for now, we are neutral. Should a breach of the $1,850 support be seen, we would allow for further losses to the 200-day ma at $1,792.24 and possibly the May high at $1,765.61," said Karen Jones, team head FICC technical analysis research at Commerzbank.

To re-start the price rally, gold will need to regain the mid-September high of $1,973.8, Jones added.

Longer-term, TD Securities sees the positive COVID-19 vaccine news as great for gold due to rising inflation expectations.

"We reiterate that the vaccine will ultimately be a boon for gold bugs, helping strengthen inflation expectations without immediate implications for central bank policy. Fedspeak and central bank speeches have recently implied as much, but the resulting implications for gold prices have yet to be priced," the strategists said. "The Fed's Flexible Average Inflation Targeting framework is a game-changer — with rates still bounded, the Fed's continued attempt to spark higher inflation expectations should suppress real rates deeper into negative territory. This will continue to drive investment appetite for precious metals, as capital seeks to shelter itself from increasingly negative real rates."

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