Can Copper Recover?

March 16, 2011

Will tight supply and reconstruction efforts in Japan help buoy the red metal amid lackluster Chinese demand?


Analysts have been bullish on copper for a while now—who wouldn't be, after last year's price rise of 31.44 percent? But 2011 may prove to be a different story. Year-to-date, copper prices have dropped 4.95 percent, while inventories at both the London Metal Exchange and COMEX have risen. With Chinese inflation—not to mention Japan's recent earthquake—increasingly worrying investors, where will copper prices go next?


Contango, Prices And Inventories All Rising

As recently as mid-December, copper was in backwardation; spot prices traded at a premium implying high demand for spot copper. That has since changed, with copper now in contango and spot demand—and prices—dropping. (See last week's Contango Report for more details.) Traditionally, copper prices are always volatile and the past few weeks have been no exception. Just look at the chart below, which covers the past 15 months:


Copper (Jan 2010 - YTD)


For most of 2010, the typical inverse relationship between price and stockpiles held: Prices rose, especially for the last six months of the year, while at the same time, LME copper stockpiles plunged.

But as the chart shows, that relationship doesn't seem to be holding in 2011, where recent copper prices have vacillated between $9,500 and $10,000/tonne. Although copper prices have dropped nearly 5 percent since Jan. 1, stockpiles of the metal have increased sharply. Note that when inventories were last at these levels, the price of copper was $2,000 less per tonne.


Chinese Imports, Inflation Depressing Demand

But further price decreases may be on the way, depending on what the market makes of recent developments in China and Japan.

As the world's largest copper consumer, China and the health of its economy directly influences what goes on in the copper market. Right now, the focus remains on inflation: The Chinese government has stated its preference to cap 2011 inflation at an average of 4 percent. So far, that hasn't happened - February's inflation rate was 4.9 percent—and concerns remain that the government will clamp down further on monetary policy. Peter Buchanan, commodities analyst and senior economist at CIBC, told Reuters, "We do think they will have to tighten their policy further, so China is not going to be the strong performer this year, that it was last."

With tightened monetary policy, economic growth could be limited and demand for industrial metals—including copper—would drop.

Compounding inflation fears is news of lackluster Chinese imports. Year-over-year, Chinese imports increased 19.4 percent—which seems robust until you realize that imports were forecast to rise 32.3 percent. Copper imports showed even more dramatic declines, with copper imports dropping by 35 percent in February alone.

While the market reacted predictably to that news, it is important to remember that business closures for the Chinese New Year holiday most likely contributed to the large import drop. In fact, many analysts believe that it is more accurate to look at January and February data together. When that data is examined, the decline works out to be only 2.4 percent lower compared with the same time period last year.

Still, with China consuming about 40 percent of the world's copper, any drop in demand has serious repercussions on the market. What's more, fear remains that other external factors, such as rising oil prices, will have negative effects on China's economy, and by extension, copper.

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