Skip to main content

The U.S. industrial sector continues to shrink, leaving investors looking for reasons to justify the strong rally in copper and other commodities at a time when signs of an economic recovery appear tepid at best.

The industrial production data scheduled for release today are forecast to have declined 0.9 per cent during March, compared with a 1.4-per-cent plunge in February, according to a survey of economists by Bloomberg. This would be its fifth consecutive monthly decline.

The capacity utilization rate is expected to drop to 69.6 per cent in March - its lowest rate in 42 years - from 70.9 per cent in February.

This is the fastest rate of decline in industrial production since 1980 and it probably picked up pace in the first quarter with auto makers closing plants to clear out bloated inventories, said Sal Guatieri, a senior economist with BMO Nesbitt Burns Inc.

"Both manufacturing and retail inventories, while finally starting to burn off, are still close to record highs back to 1947, reducing the necessity for production at this point," said Derek Holt, vice-president of economics at Scotia Capital. "Thus inventories need to burn off at an accelerated pace before any recovery in industrial production takes place."

With no signs of a pickup in U.S. industrial production, that leaves question marks over the recent commodity price rally.

"I feel some measures of risk aversion have prematurely factored in a recovery," Mr. Holt said. "It also appears to be counting on a strong recovery, which I don't believe will happen." He is looking for a slow recovery in fits and starts. "There won't be a straight-line trajectory."

As for counting on sustained demand from China, the spring recovery is marked by forced growth such as stimulus spending on infrastructure, but the question is whether it will be sustainable, Mr. Holt said. "I'm not sure what the next wave [of growth]for them will be," he said. Infrastructure spending will only insulate China from some of the downturn marked by the speed at which plants are being shuttered, he said.

Scotia Capital's China analyst, Na Liu, describes the strength in commodities as stemming from "China's buying spree." China is importing copper, crude oil, aluminum and zinc to add to its stockpiles, take advantage of low-cost imports, and in anticipation of the impact of its fiscal stimulus package.

China is also sparking short-term growth by injecting massive loans into its banking system, which is generating higher household spending and real estate deals, but that might only have short-lived effects, Mr. Holt said.

In the short term, the metal markets are being fuelled by Chinese restocking of copper reserves, which has led to an "early anticipatory uplift" by investors, said Michael Smedley, chief portfolio manager of Canadian General Investments Ltd., a closed-end fund.

Other metals were severely depressed and that resulted in mine production curtailments, which also set the stage for a rebound in prices, Mr. Smedley said. "The improvement in mining stocks is consistent across the board."

While cautious about the short-term prospects for the metals sector, Mr. Smedley remains optimistic about the long term. After years of neglect in the mining sector, there's few new projects under development and few new mines have been built. "Inevitably, there will be gains in metals and mining stocks in light of future production demand and because of the supply imbalances," he said. "The world keeps growing."