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There are times when market action isn't tough to figure out and the recent rally in base metals is one of those times. For all the talk of the lithium, nickel and magnesium that would be needed during a surge in electric vehicles, broader metals prices continue to be driven primarily by Chinese imports and also by rising global manufacturing activity.The catch is that forecasts for the Chinese economy imply the rally could be short-lived.

China's dominance in global commodity markets is highlighted by the fact the country consumes half of the global supply of copper and coal produced each year. The top chart below, comparing year-over-year growth in total Chinese imports with the year-over-year change in the S&P/GSCI Industrial Metals Index, shows the dramatic effect Chinese demand has on metals prices.

The two lines on the chart have tracked closely since early 2009, when a gargantuan surge in China's money supply and credit growth (not shown on chart) led to a surge in infrastructure development and imports. With a short delay, metals prices followed closely behind.

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More recently, a continuing recovery in China's import growth that began in January, 2016, has been accompanied by an improvement in year-over-year metals prices from a 20-per-cent decline to a 31-per-cent appreciation.

The rally in metals prices has also been supported by rising global manufacturing activity, as the second chart underscores. The JPMorgan Global PMI Manufacturing Index – an index derived from surveys of manufacturing companies where a reading of 50 indicates no change in activity – has climbed from 50 to 53.5. Manufacturers purchase more resources the busier they get, supporting metals demand and prices.

In the short term, everything looks rosy for investors in the mining sectors but there are darker clouds building on the horizon where China is concerned.

The consensus economist forecasts point to solid import growth of 14 per cent for 2017 but a much slower pace for 2018 and 2019. Chinese leadership is attempting to reorient the economy's growth drivers away from its credit-related excesses and toward consumer spending, and slower gross domestic product and import growth is expected as a result. China's imports growth is expected to fall to 4.5 per cent next year and 3.0 per cent in 2019, according to Bloomberg data. Our first chart suggests that this slowdown will be accompanied with a much slower rise in metals prices.

Here at the Report on Business, we know through website traffic statistics that Canadian investors are increasingly uninterested in the Chinese economy. It remains the case, however, that energy and materials stocks account for more than 30 per cent of the S&P/TSX composite index, and the commodity prices that determine their profitability are, to a significant extent, dependent on Chinese demand.

Domestic investors, particularly those focused on resource, should frequently check in on China's growth prospects to limit risk in their portfolios.

Scott Barlow, Globe Investor's in-house market strategist, writes exclusively for our subscribers at Inside the Market online.

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