It’s déjà vu for the copper market.
Almost exactly a year ago, the London Metal Exchange copper contract was the battlefield for a fierce war of wills between bullish hedge funds and investment banks betting on higher prices, and Chinese consumers who ran down inventories as they waited for a better opportunity to buy.
That battle was won by the Chinese – although they had a good deal of help from dithering politicians in the eurozone and the US – as prices eventually tumbled. Fortunes were made for prescient bears such as Michael Farmer and David Lilley of Red Kite, one of the best known metals hedge funds, while Barclays Capital, taking the opposite view, ended the year with a loss in metals and the departure of the head of its LME team.
A similar tussle is once again playing out between Chinese consumers and bullish funds. With copper prices jumping 15 per cent since the start of the year, Chinese buyers have largely avoided the spot market.
The result is that not all of December’s record copper imports are being consumed, leading to a sharp increase in copper inventories at Chinese warehouses. Stocks at Shanghai Futures Exchange warehouses last week rose to the highest in a decade, up 160,000 tonnes since early December. Inventories in so-called “bonded warehouses”, where metal can sit before import duties have been paid, have risen from 200,000 tonnes to about 400,000 tonnes over the same period, traders estimate.
Other indicators of the Chinese copper market also suggest weakness.
Premiums for metal in bonded warehouses above LME prices have fallen to as little as $60 a tonne, down from more than $120 at the start of the year. The Shanghai copper futures curve has been in a wide contango, with the copper for delivery in three months trading above spot metal, since the beginning of the year, indicating a well-supplied market. And the difference between Shanghai and LME copper prices has not been sufficient to incentivise imports into China since the start of the year.
Will this year’s “China vs the bulls” show be a rerun of last year’s bloodbath? One important question is how long Chinese consumers and traders can wait before they need to return to the international market. Last year, bonded inventories were thought to be as high as 650,000 tonnes, and stocks at the level of individual manufacturers were significantly higher than they are today, most industry observers believe.
But there are two more fundamental differences between this year and last year for the copper market.
First, the bulls have become more humble. This year, few are willing to bid up the price in the face of slack Chinese demand. Moreover, even if they are sceptical of the ability of miners to boost production, most recognise that 2012 at least in theory marks the beginning of a significant increase in mine supply of copper. Analysts and funds who last year were talking of average prices in excess of $10,000 a tonne with spikes reaching as high as $13,000 have now toned down their expectations. Even the most bullish would be satisfied with a return to the $9,000-$10,000 range.
In a demonstration of the change in mood, the market has been much quicker to respond to the softer Chinese conditions this year. Copper prices on the LME have fallen 6.7 per cent from their early February peak, closing at $8,175 a tonne on Friday.
Second, China is at a different point in the economic cycle than it was a year ago. With hindsight, the softness in the Chinese copper market last year was an early warning of tighter monetary conditions that have helped to cause a broad-based slowdown in Chinese growth.
Now, the Chinese economy is in the middle of that slowdown. Growth in production of white goods has slowed significantly and the construction sector is looking shaky, with Goldman Sachs economists returning from a recent trip with predictions of a 20-30 per cent year-on-year drop in first quarter project starts.
But apart from the true China bears, most observers believe current conditions may be close to the nadir for the Chinese economy, with looser monetary policy – exemplified by a cut to banks’ reserve requirements over the weekend – reinvigorating the world’s top consumer. As Max Layton at Goldman Sachs puts it, metals markets are locked in a “battle between the current softness in Chinese end-use demand, and the likely future strengthening in demand”.
The sense of déjà vu may be overwhelming, but the outlook for copper is no foregone conclusion.
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