Back in June, copper prices were poised to crack the $3-per-pound level. The market bounced sharply – by close to 15% – but has since retraced a sizable chunk of that rally (Chart 1). Was the rally warranted or just a due-course correction?
To be sure, there have been some bullish developments. On Aug. 21, in its most recent update of the global balance sheet, The International Copper Study Group (ICSG) reported that for May, refined copper slipped into a 17,000-tonne deficit, the first monthly shortfall in six months. While production growth remained robust, demand, primarily from China, grew at a faster clip. Year to date, the market remains in surplus, but if current trends continue, that could be gone in a hurry.
Global economic growth has been steady, but not earthshattering and it was reflected in consumption patterns. In the ICSG’s study period of January through May, U.S. demand was unchanged from the same period last year, but consumption in all other regions, including Europe, Africa, and Asia (excluding China) was negative. The Chinese compensation factor, however, overwhelms the sluggishness in the rest of the world.
It was widely expected that once the torrid pace of Chinese economic growth would slow, so would copper usage. And that was true up until several months ago. Economic data have surprised to the upside, however, and it has been reflected in apparent Chinese demand.
Chinese imports for July were 291,000 tonnes, up 14% year-over-year. That was the fourth consecutive monthly increase and the highest level since last September. Moreover, the storied inventories sitting in bonded warehouses – which according to some accounts reached close to 1 million tonnes early this year – has been whittled down. One analyst says that the stockpile has fallen to 300,000 tonnes. If this is accurate, it would mean that the imported copper is being used for industrial purposes, rather than just being locked up in financing deals.
Exchange warehouse data also indicate a tightening market. Chart 2 shows that combined inventories at LME, Shanghai, and COMEX warehouses have fallen substantially over the past two months.
Another bullish factor for copper – of a longer-term nature – is rising production costs. Costs vary from region to region, but declining ore grades in the major mining centers, in addition to rising labor costs and higher energy costs everywhere, mean more expensive extraction. A case in point is Chile. The country produces about one third of the world’s copper. The Chilean state-owned mining company Codelco, which alone accounts for about 11% of global output, reported on Aug. 30 that cash production costs for the first half of 2013 were $1.71 per pound. That’s up from $1.47 in the first half of 2012.
On the bearish side of the equation, production has been strong, and without the single bullish factor of Chinese demand – large as it may be – surpluses will continue to expand. Chilean output has been down year-over-year in only one month this year – in April, by a modest 1.2%. For July, the most recent month for which data are available, output was an up an extraordinary 16.3% year-over-year. That brought year-to-date output to a gain of about 6.5%. That’s in line with early expectations, but still a very robust number.
In conclusion, it is a single-issue bull market. If Chinese imports were to back off again, there would be precious little to keep prices from collapsing. Still, history has shown that the Chinese phenomenon, for this and many other commodities, can last for sustained periods of time.
We advise using the recent setback in prices to cover short positions. This would replace our current protective stop of $3.45 per pound, basis nearest contract.