We believe the outlook for the industrial metals complex has certainly improved over the course of Q3, but nevertheless, significant headwinds remain. As a house we retain our bullish view on the USD, with tapering debate moving from” if” to “how quickly”. This is likely to keep emerging market currencies under pressure, but the producer currencies should fair relatively better as the Chinese recovery continues. Although we see marginal costs still falling, the rate is likely to be more modest in the second half of 2013 and into 2014.

Although most of the mining companies have cut their capex budgets for 2013 onwards, a response to waning cashflows, projects which are fairly advanced or under construction have still continued. A number of projects have also been completed in 2013 and are in ramp-up mode, with additional metal coming to market over the next two years. Even in a weaker demand / metal price environment, it is unlikely that mining companies will cut projects under construction. We estimate an average of 5% supply growth for the base metals in 2013E, rising to 7% in 2014E.

There is a marked difference between aluminium and nickel on the one hand versus copper and zinc on the other. Visible inventories for aluminium and nickel have been rising, whilst they have been falling for copper and zinc. On the face of it, the fundamentals are far more robust for copper and zinc, but aluminium and nickel prices have fallen to such extent, that 30 – 40% of the respective industry is loss-making. This suggests that aluminium and nickel supply discipline is more likely, and when this reaches a critical mass, it should be supportive for prices.

Given the weight of new supply, we remain cautious on the base metal complex. However, zinc is our relative preference, with flat Chinese smelting output keeping the market in a small deficit in the near term and a challenge to replace ageing mines over the medium term. Furthermore, we believe that China's structural shift could lead to changing dynamics in demand over the medium term. Although construction industry accounts for 55% of end demand for zinc, at least 40 % of demand is related to consumer products and transport. Zinc is likely to suffer less than other industrial metals such as copper as China shifts from an asset heavy led to a consumer led economy.

Eoin Treacy's view David dubbed the environment in the industrial metal complex “Supply Inelasticity Meets Rising Demand” from at least 2003 to reflect the difficulty and reluctance among miners to commit to increasingly supply. This persisted for a number of years even as prices rose and eventually encouraged new investment. The result has been an increase in supply albeit at the expense of a rise in the marginal cost of production. This suggests that while prices have fallen over the last few years, the prospect of a return to pre-2003 levels is unlikely.

Aluminium has held a progression of lower major rally highs since 2011 and while prices have at least paused in the region of $1750, a sustained move above $2000 will be required to suggest a return to demand dominance beyond the short term.

Nickel has been trending lower since early 2011 and a break in the progression of lower rally highs, currently near $15,400 would be the minimum required to question the medium-term downward bias.

Copper has held more of its earlier advance but an almost two-year downward bias is also evident here. Prices have been ranging in the region of $7000 for much of the year, but a sustained move above $8000 will be required to suggest a return to medium-term demand dominance.

Lead has been ranging mostly between $1750 and $2500 since September 2011. It has found support in the region of $2000 since June and a sustained move below that level would be required to question potential for higher to lateral ranging.

Zinc's range has become less volatile over the last 18 months and it is currently testing the lower boundary. Monday's upward dynamic suggests demand is beginning to return in the region of $1850.

Interestingly, this report does not cover tin which has some of the sector's more compelling fundamentals. Indonesia continues to restrict supply and as the dominant globally supplier has the capacity to affect pricing. Tin has been rangebound for two years and is currently rallying towards the psychological $25000 area.