Dr. Copper’s Prognosis? China Inventory Threat Drives Price Volatility

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The investment market loves this fictitious character named “Dr. Copper” and often refers to his ability to predict the direction of the market, but for much of 2013 – and so far this year – the Dow Jones and the copper price have been going in opposite directions.

Is this telling us the disputed linkage is broken or, as some suggest, could the falling copper price actually be a harbinger of a stock market retrenchment this year?

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There is no question that commodities in general have been impacted by a number of significant developments in recent months. Investec’s Quarterly Overview makes reference to curbs on Chinese credit, weakening Chinese economic data, the Ukraine situation, Indonesian export restrictions, hawkish Fed statements and labor unrest in South Africa as all having an impact on commodity prices, in some cases supportive and in others negative.

But there is little in there to support the prospect of a pick-up in global growth this year beyond the gradual recovery in the West and the gradual slowing in the East.

The firm has downgraded its price predictions on the basis of their most recent view of the market and put copper price volatility down to concerns over the threat of inventory liquidation in China where a total of some 750,000 tons is estimated to be held in bonded warehouses, mostly held as collateral via letters of credit. This could be liquidated if solvency issues increase in China; Beijing is restricting speculative credit and trying to clamp down on the shadow banking community.

The degree to which they pursue this policy in the months ahead could dictate the fate of a fair portion of this metal, or so the market fears.

In theory, though, while a rising availability overwhelms a slowing rise in demand, the market should correct itself as lower prices close capacity and restrict supply. Timing, of course, is everything, as we have seen with the aluminum market where oversupply has persisted for years and is only now being restricted to the point where prices may be encouraged to rise slightly.

Copper prices, though, are at the stage were the pain is being felt, at least at the periphery.

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Copper prices fell to a three-year low in March and although they have recovered a little since then, an FT article reports that miners responsible for 10 percent of global production are losing money.

To be continued in Part Two, along with a copper price forecast.

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