Copper: Further to Fall or Overblown Market Slide?

Is copper in a death spiral of falling prices or has the fall been overblown? It’s a question that is taxing both consumers and producers after the London Metal Exchange copper price plunged $500 a ton last week to a low point of $5,353.

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As Reuters points out, that is a level not seen since 2009, the year of the global financial crisis. Pessimism regarding copper’s price is not hard to find, a long standing chart support level at $6,000 per metric ton dating from 2010 was breached early in the week and not just chartists but technical players of all sorts followed the price down.

Option traders covering positions, black box funds responding to algorithms, all piled in to sell the market. Not that last week’s fall was a one-off, the price has been grinding lower since the summer of last year as a narrative of oversupply and falling demand sapped any belief that prices could rise. Slowing growth in China as Beijing seeks to rebalance the economy away from construction and export-dependent manufacturing towards domestic consumption has cooled physical demand for copper in the world’s largest metals market at the same time that a clamp down on the shadow banking sector in China has depressed demand for speculative or financially driven demand for the metal.

Just a couple of months ago in October, the highly respected International Copper Study Group forecast that after 5 consecutive years of supply deficit, the global refined copper market would record a 390,000 metric ton surplus this year as a wave of mine investment translated into increased supply. As the price has fallen, money managers have viewed copper as firmly in bear territory and reduced copper holdings as a result.

This view of rising supply has been prevalent for months and proceeded the downward trend since last summer. The collapse of last week, though, had more to do with a collective wave of depression that the rout of the oil price has more to do with falling global growth than with overproduction. Quoting Jeffrey Gundlach, co-founder of DoubleLine Capital, Reuters illustrated this thinking – “The drop in copper, simultaneous with the collapse in crude oil, can only be interpreted as an indication of slowing global growth.”

Adding fuel to the fire, the World Bank released a report predicting global growth of “only” 3% this year, up from 2.6% last year. Not bad, you might say, but it’s their second downward revision. In October, the Bank predicted 3.2% global growth this year, in turn a cut from its 3.4% forecast made in June 2014. Bears would argue LME inventory has been edging up by 25 kilotons since the start of December and the SHFE is standing at 550-600 kt. Yet, every coin has two sides and the flip side here is the available tonnage on the LME – available meaning excluding that already marked for drawdown – is only 171 kt, extremely low by historical standards according to Reuters. In addition just two market players have a squeeze on the market, allowing them to push cash to 3-month premiums over $70 per metric ton.

So are we seeing a collapse in physical demand, or a flight of investor demand, or simply an overreaction?

We would argue that while some part of all 3 is going on, we are now in overreaction territory. Physical demand has not collapsed. Indeed, while growth is slowing, global growth is still forecast at 3% this year. The collapse in oil prices is due to deliberate overproduction on the part of OPEC, slowing demand growth in Asia and a fall from price levels that had factored in restricted supply due to geopolitical pressures in 2013/14.

Yes there is more oil around than the markets need, but that is not due to a collapse in demand rather like the super tankers that move it, it’s due to a medium-term deliberate policy of overproduction at the same time as record US tight oil production. Demand was slowing and production (particularly shale oil production) has been rising for several years, with OPEC refusing to adjust production to match demand an oil price fall was inevitable.

Meanwhile, the fall in copper prices, like the fall in oil prices, has the seeds of self correction. Substantially lower copper prices will slow scrap risings as dealers hold on to high-priced inventory in hope of an upturn, Reuters says. Likewise, lower prices will spur demand, particularly strategic buying from players such as China’s State Reserves Bureau.

Demand, at the moment, is seasonally low, particularly ahead of the Chinese Lunar New Year, but is expected to pick up in February. Lower copper prices will deter more mine production and limit investment. Those new mines are slow to come online and have varied and various technical issues limiting ramp up. The growth of supply is lagging earlier expectations to the point that some analysts are revising 2015 predictions to a market not far from balance. So far, the bears have pretty much had it all their way, but a copper bounce cannot be ruled out by Q2 rather than even lower prices. Still, we would be contrarian in saying we could see prices higher than they are now. Not by much, sure, but the one-way downward bet is not as strong as some would have us believe.

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