The recent bull-run in copper prices is not something you would expect to find in the script, given the turmoil in the financial markets.
After skyrocketing to the $4.65-per-pound level in mid-February, copper prices had a sharp correction, falling by more than 15%, before finding support at $3.85 per pound. The stock market continued its ascent through the end of April. The stark divergence was a bit of an enigma because the two markets normally move in unison – give or take. Perhaps the copper market was more prescient than the stock market in foreseeing the potential harmful effects on the global economy that would result from the fallout from the European sovereign debt crisis and the inability of the US Congress to reach an agreement on raising the Federal Government’s debt ceiling. But then, copper prices rallied by 40¢ per pound even while the stock market was in the midst of a scary decline. The usefulness of copper prices as a harbinger for future economic conditions looked questionable.
The copper rally gathered steam when rare winter storms hit the copper belt in Chile in late June and early July, causing a complete shutdown for several days at huge mines, including Escondida, the world’s largest copper mine. Coupled with ongoing labor disruptions, the slowdown in Chilean output provided the foundation for the current leg of the rally that has brought prices all the way back to the $4.50 level. Is this strength sustainable?
During the recession in 2008, prices fell dramatically because demand was so weak. As soon as the global economy began to recover in 2009, however, the mining industry could not keep up. Current supply-side trends remain sluggish. Monthly Chilean output data have been directionless, alternating between strong and weak results. Overall, average monthly production since the beginning of 2011 is down 0.05%. Mine output in key producer Indonesia is seen falling by more than 25% this year because ore grade is declining.
While it’s quite true that the output problems in Chile – weather and labor – are of a temporary nature, it does highlight the vulnerability of a single region that provides 30% of world supply.
Chinese demand has carried this bull market, and its survival could hinge on what the future holds for the Chinese economy. Imports have been slumping. The most recent data, released on July 21, showed that month-over- month copper imports for June rose by 19.7%. However, when compared with June 2010 – a more vital barometer of the long-term trend – year-over-year imports fell by 15.9%. Chart 3 shows clearly that, despite the handsome uptick in June, imports have been trending downwards for over a year now.
Analysts use the term “implied demand” when referring to Chinese copper usage, but that is really just import data. As such, demand is falling.
We’ve drawn attention several times to the phantom stockpile of copper held in bonded warehouses. It is not included in exchange warehouse calculations and is rumored to have grown to as large as 700,000 tonnes.
However, the very same sources that have publicized the information about the off-exchange inventories are now saying that the stockpile has fallen by half. This could mean that the copper is actually being used by bona fide industrial copper consumers and possibly explains the weak imports that we’ve seen over the past few months.
The most recent report from the International Copper Study Group’s (ICSG), released on July 21, shows that the global copper balance sheet posted a supply/demand deficit of 69,000 tonnes for 2011 through April.
The contango narrowed during the worst of the weather-related supply disruptions, but has returned almost to its widest level, even while prices are making a run for the all-time highs. Although producers are struggling and the major consuming regions outside of China are compensating for softer Chinese imports, the market seems well supplied.
It’s been a powerful move, particularly considering the shaky economic environment we’re in. With each visit to the press conference podium on Capital Hill by Senators and Congressmen from either party to report on progress (or lack thereof) of the debt talks, the markets gyrate violently. It’s a dangerous trade at these levels. For the bold, sell September copper at the market, but don’t risk much beyond the contract highs.