Material Matters: China And Chile Visits, Copper, Iron Ore, And Gold

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 By Chris Shaw

Following a recent visit to China, Citi remains of the view materials intensive growth in that economy of better than 20% per year will continue, driven by the combination of urbanisation and fixed asset investment.

In terms of the various sectors of the economy, Citi's view remains housing is not in a bubble as while the government is attempting to slow speculative investment there remains significant strength in the social housing end of the market.

In the power sector, Citi notes official forecasts are for electricity generation to grow at the same rate as GDP, with half the increase in capacity to be green energy. The latter is viewed as an ambitious target by Citi. While high coal prices and capped tariffs may squeeze utilities shorter-term and so slow the pace of generating capacity growth, Citi expects a continued rapid expansion in transmission capacity.

The outlook for rail remains robust, Citi noting an additional 30,000km of track will be added over the next five years. This will add to an existing network of around 90,000km.

In terms of how this could impact on commodities, Citi suggests copper demand may be affected by slower generating capacity growth, though transmission growth will be an offset. While inventories held by speculators may not be falling, consumer inventories remain very low in the broker's view.

Coal imports are expected to increase and domestic costs will rise. Citi suggests Chinese authorities are aware of the potential impact on international markets stemming from China becoming increasingly dependent on imports in various commodity markets.

Deutsche Bank has also been on tour but this time in Chile, visiting a number of copper operations in that nation. The tour highlighted known problems of declining grades and water shortages, though the broker notes the former is being offset to some extent by brownfield expansions and the latter by the use of sea water or desalinated water.

Deutsche estimates Chilean copper production could increase by more than three million tonnes annually by 2018-2020, but long lead times of 5-8 years for new projects is likely to see the global copper market remain tighter for longer.

The other point made by Deutsche is even while Chilean copper production is expected to grow solidly long-term, so too will operating costs. On the broker's numbers industry cash costs could increase by 10-15% over the next decade given the higher cost of pumping sea or desalinated water to high elevations.

A meeting with Codelco's head of global copper sales offered some additional market insights, Deutsche noting the company remains bullish on copper demand in 2011 even allowing for the expectation China remains out of the refined market until next March.

Codelco expects China to purchase another 400-500,000 tonnes of copper in 2011 on top of the around six million tonnes purchased in 2010, which equates to an increase of around 8%. European demand is also strengthening as confidence is returning to the global market.

Codelco's forecast is for a 300,000 tonne deficit in the copper market in 2011, which Deutsche notes supports the company's view of a tight market in the year ahead given LME inventories are currently estimated at only 350,000 tonnes.

Given a positive outlook for copper, Deutsche continues to rate major Australian players BHP Billiton ((BHP)) and Rio Tinto ((RIO)) as Buys. PanAust ((PNA)) is rated as a Hold, while Equinox Minerals ((EQN)) and Oz Minerals ((OZL)) are both rated as Sells by the broker.

China continues to be a major influence on the global copper market, RBS noting Chinese imports of copper rose by 29% in month-on-month terms and by 21% in year-on-year terms in November. While in many cases Chinese demand growth has been met by increases to domestic supplies, RBS notes this is not the case in copper.

While there are some concerns stockpiled material could be released into the Chinese market, inflation concerns and underlying bullish tones for the copper market in general should limit any such releases in RBS's view.

This means no change to the broker's base view of ongoing elevated prices in the base metals sector through 2011, before further gains in 2012-2014. Strong uptake of physically backed ETFs (Exchange Traded Funds) offers some upside risk to prices in RBS's view.

The outlook is similarly positive for iron ore, as RBS notes in this market as well China is not able to source enough domestic supply to avoid importing material to meet its needs. Iron ore imports also rose in November after a weak October, increasing by 26% in month-on-month and 12% in year-on-year terms for the month.

The uptick in imports in the month leads RBS to suggest steel producers may have started bringing production back on line following recent energy saving and electricity cuts. Any further reactivation of steel capacity in December should support Chinese spot iron ore prices around current levels of US$165 per tonne into the first quarter of 2011 in RBS's view.

Standard Bank has again looked at speculative interest levels in commodity markets, suggesting the latest data confirms gold remains best placed to withstand any substantial long liquidation in positions. COMEX gold spec positions as a percentage of open interest are largely flat on last week at around 30.32%, a level Standard Bank notes is below average levels of the past year. Similarly, silver spec open interest positions remain below levels that would suggest a crowded market.

In contrast the net spec length for both palladium and platinum are high at 57% and 64% respectively, while NYMEX crude net specs have risen in the past week and now stand at 8.95%. For copper, Standard Bank notes spec length of 16.75% is on a par with the levels seen before the price correction in the metal in late October, so outside of gold and silver the bank is growing increasingly cautious with regards the potential for a short-term price correction in commodities.

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