Where is Copper Headed?

GRONINGEN – Copper prices rose again on Friday both in New York and London on the back of the release of US economic data that showed the country’s GDP grew at a rate of 3.2% for the fourth quarter of the year.

The data, which showed that the US economy expanded by 2.9% for the whole of 2010, the most in five years, has lent credence to the view that the US recovery is now firmly underway. And, because it is the world’s second largest user of copper, this in turn has fed into copper prices.

On the flip side of the demand coin, this week has also given rise to continued concerns about the pace of growth in China, the world’s leading consumer of copper.

The Asian superpower announced earlier this week that its economy grew at 10.3% for the 2010, this led to worries that China will have to move swiftly to combat the threat of inflation and, thus, begin to cool its economy – which would ultimately be bad for copper prices.

As Bank Credit Analyst puts it: “The latest reserve requirement ratio (RRR) increase has triggered fears that the Chinese authorities are about to significantly accelerate policy tightening, which could lead to a sharp slowdown in domestic credit and consequently overall economic growth.

But, while, BCA believes that this should not be ruled out as a risk to the global economy, the odds of it coming to pass are low.

Rather, it believes that, “the Chinese authorities will maintain a tightening bias, and will guide credit growth closer to nominal GDP growth. This will be a multi-year process, and will be highly contingent on the global environment and the domestic economic situation.”

So, where does this leave copper prices?

According to the VM group, copper looks likely to be the star performer of the base metals in 2011.

Writing in the January edition of its ABN Amro Metals Monthly report, the consultancy says: “First, sentiment is firmly rooted to the premise that demand growth in China will be coupled with greater appetite in the US and elsewhere. The macro environment is also positive, with investors now tempted to favour high return, high-risk assets. Indeed, the appreciation of the copper price is regarded by some as a near certainty, thus it is currently perceived as being a part hedge against risk and fairly immune to the periodic reversals in macro sentiment, despite the occasional wobble.

French bank Natixis, however, is not as convinced, commenting in a note this week that “In sharp contrast to the recent peaks in base metal prices, the Baltic Dry indices have fallen to their lowest levels since the crisis in late-2008 / early-2009. While this fall can in part be explained by the rise in global dry bulk shipping tonnage, as well as the disruption to coal and iron ore deliveries caused by flooding in Australia, the extreme lows reached by these indices in recent weeks is most likely indicative of a more general slowdown in the growth of industrial activity in Asia.

It adds, “This can also be seen in Asian metal stockpiles. Asian LME and SHFE stocks of copper, zinc and lead have all risen in recent weeks, while the decline in aluminium stocks is easily explained by the recent cutbacks in Chinese output. We maintain our view that western economic recovery, although welcome, is unlikely to be able to compensate for a potential slowdown in growth among developing countries and hence the recent high correlation between G3 equities and base metal prices may not persist for much longer.”

Supply side squeeze

One of the major reasons behind the rise in copper prices has been the expectation of a supply squeeze in the medium term. As the VM Group writes: “Dominating copper’s allure are its supply-side shortfalls, which are now well established. Mine supply has not kept pace with demand for many years, nor has it responded with alacrity to the meteoric price rise, implying that structural difficulties exist.”

It does, however warn that there are caveats to this view, in particular the potential for substitution if prices remain high.

“Although much of the easily substitutable end uses for copper were already made in the last cyclical peak period between 2006-2008, high prices (and indeed the prospects for even higher prices) will ultimately lead to demand destruction wherever that is possible. Because of the inherent difficulties in measuring substitution, it may not be clear in the next year just what effect the high copper price will have on demand, but we expect it to be significant.

“Scrap copper volumes will also soar on the high price, but to what extent is also very hard to measure accurately. Even so, scrap will partly offset sluggish refined growth in 2011 and we expect the copper price to average ~$9,150/t in 2011.””

The extent of the coming supply squeeze has been questioned before. Speaking to Mineweb Earlier this year, Simon Hunt, of Simon Hunt Strategic services said, “The fundamental question that one has to ask is: ‘what is demand and what is real consumption?’  Since 2005, the financial sector has got highly involved in copper by often buying directly or indirectly, cathode copper from the producers and warehousing it outside the reporting system.  That is demand and demand has been strong but real consumption – that is material that goes into furnaces – has been a completely different dynamic since 2005.

“You have major cable makers saying to the industry that between 2006 and the end of 2010 one million tonnes of copper will be lost to aluminium and fibre optics… Also across many products, manufacturers through improved design and tighter specifications are allowing something like 20% to 40% to be used per product.  Air conditioning and refrigeration tubes are a fine example, but there are many across the board.”

The question then becomes, what happens to copper prices if demand from Asia isn’t sufficiently supported by demand from the West and the supply squeeze doesn’t materialize quite as expected?

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