Weak China, robust dollar a 'toxic mix' for commodities

Copper production
Munshi Ahmed | Bloomberg | Getty Images
Copper production

Market perceptions of weaker Chinese growth and a resurgent U.S. dollar are a "toxic mix" for already battered commodity prices, and these headwinds will continue to impact prices in the second half of the year, says HSBC.

The bank this week cut its price forecasts for base metals in 2013 by up to 12 percent and also revised down next year's price targets by up to 13 percent.

Andrew Keen, global head of metals & mining at HSBC, said the adjustment to near term forecasts for base metals is a reflection of poor market sentiment for the sector going into the second half of the year.

"We are shaving some demand growth in the near term," Keen said in a report. "We lower our 2013-14 demand growth forecasts to reflect slower GDP (gross domestic product) growth in China."

Slowing growth in China, the world's biggest consumer of base metals, has triggered a broad selloff in commodities. The price of three-month copper on the London Metal Exchange, for example, slumped to its lowest level in almost three years at the end of June to hit $6,602 per metric ton - levels unseen since July 2010.

(Read More: China's economy slows for second straight quarter)

Andrew Su, CEO at brokerage Compass Global Markets, said he expects copper prices to fall another 10 percent this year as China's economy slows.

"We've had some investment banks calling for a figure below 7.5 percent for the last quarter, I think it can potentially go down to 7.1 percent for Chinese growth in the third quarter - we're quite bearish on base metal prices," Su said.

(Read More: Weak China data flags more bad news for copper)

Data this week showed that China's economy slowed for a second straight quarter this year, down to 7.5 percent in April to June from a year ago, compared to 7.7 percent in the first three months.

Meanwhile, a surging U.S. dollar, which is up almost 4 percent against a basket of major currencies this year, has also been a big damper for commodities, as a stronger greenback makes dollar-priced metals more expensive for non-U.S. investors.

The case for dollar strength remains intact on back of the likelihood of the U.S. Federal Reserve scaling back its stimulus program later this year, analysts say.

(Read More: Record number of asset managers bank on strong dollar)

According to HSBC, an oversupply in metals like aluminum, nickel and zinc continues to be persistent, and will depress prices.

"Although we have seen some output cuts in China and the West, we believe this is still not sufficient to address aluminum's structural surplus," Keen said. "We lower our 2013 forecast to $1,934 a metric ton from $2,100 a metric ton and our 2014 estimate to $2,100 a metric ton from $2,200 a metric ton."

Victor Thianpiriya, commodity analyst at ANZ, however, said base metals led by copper could see relief rallies in the near term even though these will be short-lived.

"Speculative positioning is still very short in copper, meaning any better-than-expected Chinese economic data will have an outsized effect on pricing. But demand is seasonally weak in the third quarter, which should mean that short-covering rallies are faded," Thianpiriya said.

(Read More: As China tightens credit, copper snapped up to raise cash)

Copper did climb as high as $7,046 a metric ton on Wednesday on short-covering, within reach of a near one-month high hit on July 11, Reuters reported.

—By CNBC.com's Rajeshni Naidu-Ghelani; Follow her on Twitter @RajeshniNaidu