If China's old economy doesn't find its footing, metals demand could take another hit, Goldman Sachs said.
"Only a major pick-up in Chinese demand is likely to be sufficient to balance metals markets such as copper and aluminum," Goldman said in a Thursday note. "This is because metals supply generally continues to grow, while Chinese demand is not, so demand has to work hard to catch up."
Data from China on Wednesday showed factory output growth slowed to a seven-month low of 5.6 percent in October, while investment expansion slipped to the weakest pace since 2000.
Analysts have raised a slew of concerns about the Chinese economy as it transitions from a manufacturing base to services; The country is hooked on debt, the shadow banking sector has imploded, so-called "zombie" companies are yet to be weeded out, the property market sometimes shows signs of a bubble and major industries are slowing.
"The lack of a significant pick-up in sequential activity in China's 'old economy' since the collapse during the first quarter of 2015 is of increasing concern," Goldman said. That's despite China cutting interest rates six times in less than a year and taking other aggressive monetary easing measures.
Goldman is especially concerned because the drawdown of inventories in the consumer-appliance and auto sectors has slowed; it had expected the de-stocking to flow into a pick-up in metals consumption growth, starting in the fourth quarter and flowing into 2016.
The bank noted that its GS China Metals Consumption Index, which is based on physical output data for commodity-consuming components of China's industrial production sector, remained in sharply negative territory year-on-year, similar to the index's performance during the 2008-09 Global Financial Crisis.
Goldman doesn't believe recent supply cuts to copper and aluminum will be sufficient to offset declining demand.
With copper, for example, despite an earlier slowdown in supply growth, output from previous investment will come on-stream just as cuts in consumption bite. Goldman forecasts copper prices will fall to $4,800 a ton by the end of this year and $4,500 a ton by end-2016 on headwinds from China, which accounts for nearly half of global copper demand. On the London Metal Exchange, copper futures were trading around $4,836 a ton on Friday.
"While recent supply cuts in copper and aluminum may appear to bring the markets closer to balance, the cuts in our view are not sufficient to do so, given they were driven by demand weakness in the first place," it said. "Indeed, it is our view that the supply cuts confirm the bear case for these metals."
The bank also expects the declines in commodity demand may become self-reinforcing.
"China is likely to continue to slow credit growth over the medium to long term, given credit growth is still running at roughly double the rate of gross domestic product growth," it said. "This, together with a dollar bull environment, is set to disproportionately impact commodity-intensive fixed asset investment in manufacturing and property, with self-reinforcing negative feedback on producer currencies and commodity cost support."
-- Huileng Tan and Matt Clinch contributed to this report.