Commodities | Sep 09 2010
By Greg Peel
Since the advent of exchange-traded commodity funds, the speculators have moved into the physical copper market like never before. Previously, the LME was reserved for industry buyers and sellers with the futures market available for cowboys, but that is no longer the case. Base metal prices are now far more volatile intra-day than they used to be, often leaving the industry players on the sidelines scratching their heads. And such volatility has also drawn the technical traders.
This is one reason why, as Barclays Capital notes, price action in copper in 2010 has been dominated by shifts in macroeconomic sentiment rather than direct demand/supply. Note the following three-year graph:
Having followed the global economy down in 2008 and back up to the beginning of 2010, copper then fell with stock markets on the Greek crisis, recovered, and fell again in the wider European crisis. But even now as fears of slowing in both China in the US have given way to some more positive data, copper is back up at its 2010 highs, while stock markets are still well short.
The move is even more surprising given August is typically a month of seasonal weakness. And indeed, China has been recently de-stocking as it usually does at this time. Yet we've seen little but strength.
Morgan Stanley notes the “real” copper market has recently been feeling the effects of a temporary short squeeze as exchange inventories have fallen. Usually once a short squeeze plays out the copper price very quickly falls back to a pre-squeeze level. But underlying this near-term factor is a wider factor of scarcity of supply. As Macquarie notes, copper mine supply growth for the twelve months to May was a paltry 0.5%.
Morgan Stanley thus suggests this time copper will remain well supported even as the short squeeze ends, and the metal may trade up to US$4.00/lb (from around US$3.50 currently).
Despite its de-stocking phase, China remains the significant swing consumer of copper, with Macquarie noting Chinese semi-fabricated copper output rose more than 20% over the year to July. The fact “apparent” copper demand rose only 4% is a clear indicator of Chinese de-stocking. But global demand for copper ex-China rose a surprising 11% in the year to May, so the copper price is not simply beholden to the whims of Beijing monetary policy.
The result of all of the above is a dramatic swing in global inventories from a 1.2mt surplus in 2009 to around a 300kt deficit in 2010 to date. Macquarie sees a deficit of 425kt in 2011, with Barclays' forecast not dissimilar.
Barclays notes Chinese de-stocking has led to a fall in Shanghai warehouse stocks of 40% since the beginning of May. With global consumption rising, Macquarie notes the London Metals Exchange has also seen inventory withdrawals over the past month despite this being typically a seasonally weak period.
So what happens when the season swings back to typical strength?
And therein lies the tale of copper's potential upside. With Chinese copper stocks low and consumption strong, China is going to have to step up imports. Construction across the developed world is adding to demand, yet fresh copper production growth is minimal. Even if Beijing were to slow the Chinese economy more aggressively, analysts do not believe a fall in demand would be enough to put global supply back into surplus.
If the US economy does not double dip as feared, copper speculators will drive higher prices. If it does double dip, Fed quantitative easing will weaken the US dollar anyway, pushing up the copper price. It's a bit of a win-win, other than the fact copper has already outperformed the US economy, as noted by the above graph (and using the stock market as the leading economic indicator).
So is there upside left? Macquarie suggests “it's not to late”. Barclays is looking for a move to US$8000/t (currently around US$7675/t) faster than it had previously forecast. Morgan Stanley sees support up to US$4.00/lb, and is expecting a round of price forecast upgrades when commodities analysts provide their new price forecasts at the end of the September quarter, which will require marking the copper price to market in their forecast models.
