Copper, Which Way Next?

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The copper market has had an astounding run this year but the rise on the LME above $7,000 per metric ton while simultaneously seeing rising stocks is making some question if we aren’t into an irrational exuberance phase. Physical buying has undoubtedly decreased; Chinese imports (the main engine of demand this year) have dropped in recent months, down 40% in October as the SHFE price has dropped below the LME price closing the arbitrage window. Stocks on the SHFE have risen to a four year high and because the level of stocks held by traders and consumers is almost impossible to estimate with any accuracy, opposing sides of the bull/bear argument are putting their own slant on what is happening. Certainly stocks are rising in South Korea’s LME warehouse, often seen as a divert destination for unwanted Chinese material.

The bulls would point to rising GDP in China, 8%+ in the third quarter, predicted to be 9%+ in the fourth quarter as highly supportive for ongoing demand. The government’s infrastructure stimulus package still has a long way to run. Some 200 bn RMB has been spent this year but a further 300 bn is planned for 2010, much of it on national grid upgrades which will consume large quantities of copper. Household appliance manufacturers are also running at capacity boosted by government subsidies for consumers to upgrade and the forthcoming traditionally strong first half air conditioning manufacturing market, all big copper consumers. Those that are looking at this demand picture are suggesting that the drop in imports is really just a sign that consumers are drawing down the invisible stocks held by traders and in their own inventory, creating a pent up demand to be released in the New Year.

The bears tend to focus more on the current supply demand picture, the rising level of stocks, falling Chinese imports of both cathode and scrap, lower treatment charges being charged by Chinese smelters, as signs that demand is slackening fast. Their fear is that the continuing strength in the copper price is a function of financial investors piling into the copper markets, partly in anticipation of continuing rising prices and partly as a hedge against a dollar that is expected to continue to slide. Chilean Mining Minister Santiago Gonzalez is quoted in a Reuters article as saying last week, “We think that the financial sector is starting to exert influence over copper prices like it did in 2007 and 2008, and I don’t mean speculation… but people investing heavily in metals and commodities.” Gonzalez said he expects copper prices to average $2.70 a lb (US$ 5,950 per metric ton) next year.

Commerzbank recently updated their forecast for copper in 2010 to $6,450 per metric ton ($ 2.93/lb) observing at the moment the absence of physical demand is being made up by investors and saying “Euphoria is dominating commodity markets … this creates the risk of a significant price correction.”

Meanwhile Xstrata is taking a long term bet on copper, announcing they will increase capital spending to US$6.8 bn next year, an increase of 89%. Of this, $4.9 bn is to go toward expanding existing projects primarily copper. The company plans to double copper output to 2 million tons per annum by 2013.

Long term, Xstrata is probably onto a sound bet, short term though we are with the bears. Demand appears robust in China and stimulus spending will continue to support the price but stocks are rising as fast as the price. Sooner or later fundamentals will reassert themselves and their will be a correction. It will take western world demand to pick up before global stocks begin to come down significantly and there is little sign of that happening in a meaningful way before the middle of next year at the earliest.

–Stuart Burns

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