Stocks and bonds were under pressure Monday, a day ahead of the Federal Reserve's verdict on interest rates. But metals and related stocks were higher amid evidence of shrinking supply and a bullish call from a Wall Street powerhouse.

The Dow Jones Industrial Average dropped 29 points, or 0.26%, to 11250. The S&P 500 index dropped 0.1% to 1301 while the Nasdaq Composite rose 0.1% to 2315.

The benchmark 10-year Treasury bond fell 9/32 in price while its yield, which moves inversely, rose to 4.70%.

The stock and bond markets fear the Fed may signal more rate hikes after delivering an expected quarter-point rate hike on Tuesday.

Metals and mining stocks, however, were shining anew. Alcoa ( AA) was the biggest percentage gainer on the Dow after Citigroup raised its price target.

Citigroup metals analyst John Hill also took the opportunity to upgrade Inco ( N) and Alcan ( AL) to buy from hold, and Phelps Dodge ( PD) to hold from sell.

Among metals, copper rose 1.5% to $2.43 a pound, just short of an all-time high of $2.438 reached in European trading. Gold gained 1.2% to $567.40 an ounce, a three-week high, while silver jumped 1.5%, to $10.895 an ounce, a 22-year high.

Among metals mining stock indices, the CBOE Gold Index and the Amex Gold Bugs Index both advanced 3.4% while the Philadelphia Gold and Silver Exchange rose 2.9%. Big gainers included Freeport McMoran ( FCX), up 5%, and Meridian Gold ( MDG), up 8%.

Supply/Demand Trumps Central Banks

Commodity prices -- including precious and nonferrous metals -- have soared in recent years, coinciding with a period of historically low interest rates globally, as discussed here .

But given that the world's leading central banks have mostly turned to tightening mode, it might be logical to expect a pullback in commodity prices. In fact, the Reuters Jefferies CRB Index has dropped 7% since hitting a high in January.

Beyond rising rates, some commodities players are looking at another key driver, at least for some metals: dropping supply and higher demand, an equation that always leads to higher prices.

On Monday, the action began in European trading hours as weekly data compiled by global commodities exchanges revealed that copper stockpiles had slumped 7.7% while zinc inventories had dropped to their lowest point in nearly five years last week, according to Bloomberg.

Coincidentally (or not), Citigroup turned bullish on copper and nickel and -- to a lesser extent -- on aluminum and gold.

Much like Goldman Sachs's now-famous "super spike" call last March (predicting crude oil might reach $100 per barrel), Citigroup says metals are now in the "sweet spot" of a commodity "super cycle."

A combination of 15 years of underinvestment, industry consolidation, mounting regulatory pressure and high input costs are preventing the big mining groups from "meaningfully" boosting supply, Hill writes.

At the same time, demand is not waning, thanks to strong global growth. Hill predicts these conditions could push copper prices above $2.50 a pound, nickel above $7.00 a pound, and aluminum above $1.25 a pound.

"As a consequence, we expect a wave of upward earnings estimates revisions, both short- and long-term, and a very favorable environment for the equities," Hill writes.

Still, coming after the pullback in most commodity prices since January, the strategist's call is mostly based on the upside seen in the metals themselves. Supply and operational problems aren't good news for miners' production volumes, their costs or their margins.

Hill, therefore, narrowed his field of mining stocks to what he calls the "leading laggards."

He raised his price target on Inco to $60 from $44, citing the miner's potential to rise in "stature and relevance" as a North American diversified miner. The stock gained 0.8% to $49.46 on Monday.

Alcan's price target was raised to $55 from $48, as Hill believes it should start benefiting from a strategic transformation, including the sale of non-core businesses and new management. Alcan finished up 1% at $45.76.

Phelps Dodge's price target went to $83 from $57, reversing Citigroup's previously bearish call on copper prices and on the stock. The stock rose 2% to $76.61.

Alcoa's price target was lifted to $37 from $36, on the basis of expectations of a strong year for aluminum and Wall Street's "overly conservative" earnings estimates on the stock. The stock rose 1.7% to $30.33.

"Metals have shrugged off interest rate jitters, intermittent oil/gas sell-offs, multiple bouts of profit-taking, seasonal demand slowdown," he writes.

But much like Goldman's "super spike" call on crude, Citigroup's metals call may prove wrong or premature. Tuesday's FOMC announcement will be the first test of the theory.
In keeping with TSC's editorial policy, Godt doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. He appreciates your feedback; click here to send him an email.