The Copper Enigma: Surplus Or Deficit For 2012?

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– Supply side poses issues for copper
– Opinions divided as to surplus or deficit in 2012
– Copper prices expected to remain supported given solid demand
– Goldman Sachs rates the Australian copper plays

By Chris Shaw

A slowing in Chinese economic growth and the ongoing eurozone debt crisis have financial markets focussed on the potential for copper demand to decline, but Macquarie has cautioned investors should not forget about ongoing supply issues for the metal.

As Macquarie points out, the latest copper production data from Chile show output this year is well down from the levels of the previous two years. This issue is not new, as Chilean copper supply has not shown sustained growth for several years.

This reflects slower than planned ram-up at new mines, technical problems at existing operations, declining ore grades, strike action and adverse weather. Such issues are not confined to Chile and Macquarie suggests this sets the stage for global copper mine output to deliver its lowest year-on-year rise since the early 2000s.

Previously, the market had been expecting copper mine output growth of more than 300,000 tonnes this year but the latest data suggest the increase for the year is now unlikely to be more than 100,000 tonnes. Risk remains to the downside in Macquarie's view, to the extent mine output may not increase at all.

Given most of the expected demand growth for copper this year was to come from emerging markets, and the likes of China will still post increased demand for 2011 albeit at a lower rate of growth than previous years, Macquarie is left with the view the global copper market will remain in deficit for 2011/12.

Goldman Sachs doesn't agree, with downgrades to global GDP growth forecasts suggestive of lower copper consumption through 2012. These downgrades coincide with an expectation of accelerating supply growth, something expected to be enough to push the copper market into a modest surplus in 2012 and a larger surplus in 2013. 

Such an outcome would change the psychology of the copper market in the view of Goldman Sachs, as it suggests Chinese importers would be less likely to chase copper prices higher as aggressively as was the case in both of the last two years.

As well, assuming investment flows again turn positive for copper, Goldman Sachs doubts investors will chase copper all the way back to recent highs. This reflects the lack of a strong consensus view the market will be in deficit in the year ahead.

Even allowing for a surplus in copper in 2012, Goldman Sachs is forecasting an average price next year of US360c per pound or US$7,937 per tonne. This would be the second highest annual average price on record but is down from a previous forecast of US485c per pound. 

Such a price would imply a median cash margin for copper miners of more than US250c per pound, so there is no change to Goldman Sachs rating copper as its preferred base metal from an equity investment standpoint.

With respect to China and copper, Macquarie cautions against believing recent Chinese copper stock numbers that indicated total copper stocks at end-2010 were around 1.8 million tonnes. This was up from 1.2 million tonnes at the end of 2009.

As the data imply a stock build of 600,000 tonnes in 2010 and one million tonnes in 2009, it suggests Chinese stocks at the end of 2008 were just 300,000 tonnes. As this equates to only three week's consumption across the entire stock chain, Macquarie argues this number is simply too low a starting point.

In contrast, Macquarie estimates total Chinese finished copper stocks at the end of September 2011 are less than one million tonnes, which implies a 400,000 tonne stock decline to date across this year. This equates to year-end stock last year of 1.4 million tonnes, which compares to the official estimate of 1.9 million tonnes.

The difference in Macquarie's estimate relative to China's CNI-A estimate can be explained by an under-estimate of real consumption growth in the broker's view. With stocks likely lower than official data supplied by the Chinese, Macquarie remains of the view China is poised for another re-stocking cycle when credit conditions improve.

Goldman Sachs agrees re-stocking in China will occur, though likely on a more price sensitive basis than was previously the case. A more measured approach, combined with the potential for the global copper market to be in surplus next year, leads to the expectation Chinese buyers will be less likely to chase the metal and so push prices up sharply.

National Australia Bank notes speculative demand for copper has declined further through September, with net long positions having recently moved into negative territory. Softer investment demand suggests further price declines, but in the bank's view supportive fundamentals should sustain prices around current levels.

Short-term though NAB expects global market volatility will continue to drive commodity prices, as the demand outlook remains uncertain at present as the European sovereign debt crisis is offsetting stronger economic data out of the US.

While there have been some signs of a slowing in activity among a number of emerging economies, NAB suggests this in part is related to flow-on effects from Japanese disruptions earlier in the year. 

For copper specifically, NAB notes Chinese consumption has remained solid, thanks in part to support stemming from the government's large affordable housing program. Lower prices should also support demand for copper, as Chinese consumers look to replenish stockpiles. 

As with Macquarie, NAB notes strike action has had an impact on copper supply globally, while state intervention is also playing a role as higher taxes on production are lifting costs for miners. Looking ahead, the bank suggests investments in primary capacity in China and Latin America in particular should see output increase, which would reduce upward pressure on the copper price.

Copper remains the exception to NAB's view supply will outstrip demand for base metals over the next two years. NAB's Base Metals Price Index is expected to fall by around 13.5% over the final quarter of 2011 before rising by around 6% in 2012.

For copper the bank is forecasting quarterly average prices of US$7,370 per tonne for the December quarter this year, US$7,660 per tonne in the March quarter of next year, US$7,740 per tonne in the June quarter of 2012 and US$7,800 per tonne for the final two quarters of next year.

In terms of gaining copper exposure via listed Australian equities, Goldman Sachs has an order of preference of PanAust ((PNA)), Sandfire Resources ((SFR)), Aditya Birla Minerals ((ABY)), Oz Minerals ((OZL)) and Discovery Metals ((DML)). Of these, PanAust and Sandfire score Buy ratings, Aditya Birla is rated as Hold and Oz Minerals and Discovery Metals score Sell ratings.

By way of comparison, the FNArena database shows Sentiment Indicator readings for the five companies of 0.9 for PanAust, 0.6 for Oz Minerals, 0.5 for Sandfire and 0.3 for Sandfire. Aditya Birla is not covered by brokers in the FNArena database.

 

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