China’s Covid-19 Outbreak Cools Metals Rally

Analysts say Covid-19 lockdowns and travel restrictions in major Chinese cities could weaken demand for metals, helping offset the supply-chain snarls and dwindling inventories resulting from the Russian invasion. While prices for many metals remain above prepandemic levels, their retreat from records eases some immediate concerns about supply shocks adding to an inflationary spiral.

This year’s extended surge in prices for raw materials has helped push inflation to a four-decade high, spurring the Federal Reserve to signal a rapid course of interest-rate increases in response and sparking declines in stocks and bonds.

China is key to global commodities markets, with its large manufacturing sector accounting for about half the world’s copper consumption, while leading the globe in aluminum production and use. Many economists have already warned that the Chinese government will miss its growth target of around 5.5% this year, and investors fear its zero-Covid policy will result in more lockdowns to come.

The iShares MSCI Global Metals and Mining Producers exchange-traded fund fell 11% in April, the largest monthly percentage decrease in over two years. Companies in the ETF get 27% of their revenue from China, according to FactSet.

“With their [Chinese] economy being sidelined, this run-up in prices has run into a bit of a wall,” said Ed Meir, a consultant focused on metals at brokerage ED&F Man Capital Markets. Mr. Meir believes metals prices have peaked in the near term but prices will remain higher than they have in the past.

Earlier in the year, some investors piled into commodities to hedge portfolios against persistent inflation and geopolitical turmoil. Russia is also a large metals producer, exporting more than 15% of the world’s aluminum and about 10% of nickel during 2020-2021, according to a note by Citi Research.

The flow of investor dollars into general commodities mutual and exchange-traded funds, however, has slowed recently, according to data from Refinitiv Lipper.

“This is the first real test for a lot of investors that might not have a long track record of allocating to commodities. What’s your pain threshold?” said Luke Kawa, asset allocation strategist at UBS Asset Management. “A lot of what you’re seeing is that in some cases, the pain threshold is not too high at all.”

Mr. Kawa said his firm isn’t looking to add any more commodities exposure in the near term.

Despite the recent declines, prices remain elevated for a broad swath of metals. Crude-oil prices have backed off their post-invasion highs but are still up 40% so far this year, while European natural gas is four times the price it was a year ago, raising the cost of metals production.

Other factors look poised to weigh on prices, however. A stronger U.S. dollar has weighed on metals, which are priced in the U.S. currency, increasing their cost for overseas buyers. The WSJ Dollar Index in April logged its largest one-month percent climb in about a decade, lifted by expectations that the Fed will raise rates rapidly, including a potential half percentage point move this week.

“The commodities backdrop right now is very complicated because you say, ‘Hey, global growth is slowing down,’ and by itself that should be somewhat of a negative,” said Keith Lerner, co-chief investment officer and chief market strategist at Truist Advisory Services Inc. “On the other side, you have the invasion.”

Write to Hardika Singh at hardika.singh@wsj.com