WHAT TO DO NOW?
1) China and Copper - where to from here following the National Congress of the China Communist Party?
Copper spent most of 1H 2017 trading within a narrow sideward trading range as muted demand coupled with ample supply kept prices pinned closer to $6000/tonne. Supply side shocks that concerned the market at the start of the year abated as Q3 started. From July 2017 onwards, Copper was bought aggressively along with other metals to close the quarter +17.5% at a three year high of $6970/tonne. As the global growth picture started to improve across the board, money managers started adding to speculative positions from long 62,391 contracts at the start of July to a peak of 78,054 contracts towards the end of August. By the end of September, managers reduced their positions towards 60,021 contracts. Industry analysts estimated a small surplus in Q2 to now forecasting a deficit of 51,000 tonnes in Q3. The market expects mine supply to grow at just over 3% in 2018. The copper focused companies have seen their capex decline over the last few years on lower copper prices as they were not incentivised to produce or expand. Hence there has been a decline in investment since 2012. If there are unexpected disruptions of course this will push the copper price curve higher. Taking China’s growth projects and infrastructure intensive projects, demand is expected to be 3% y-o-y growth in 2017. There is no doubt that longer-term implication for grid investments and expansions, followed by the use of electric vehicles and batteries used to make those vehicles imply a surge in copper demand. However, these secular changes have medium term implications since it will not be a one-way grind higher in demand.
Another thing that has caused confusion on the health of the Copper market has been the yo-yoing of LME warehouse copper stocks appearing sporadically in Asian and European warehouses, which have seen stock levels increase 18% and 68% respectively, and then disappearing from time to time on exchange stocks.
This has caused some volatility in the Copper price as it reached $6900/t ($3.14/lb.) in September making new highs forcing in all the momentum players only to then fall back down to $6413/tonne (below the key psychological $3/lb. level). This reversal caused aggressive selling as traders thought the momentum had broken. This push and pull of physical Copper through the LME warehouse system has generated a series of contradictory signals as to the market’s underlying dynamics. The global exchange stocks picture, including inventory held in COMEX and Shanghai Futures Exchange (SHFE) warehouses, is less chaotic. Volatility in the LME component has been inversely mirrored in the Shanghai component, with the underlying up trend driven almost entirely by COMEX, where stocks have rebuilt to 13-year highs. LME spreads are a much better indication of what is happening in the physical market than looking at the outright price itself.
When the benchmark cash to three months was priced at $46/tonne contango, a level not seen since December 2009, the price followed lower arguably.
But what else is going on?
Let us not forget China and all its leveraged wealth management products and shadow banks that are linked to the Copper price and physical inventories. When the North Korea debacle started, there was probably a loss of appetite by banks to finance copper in South Korea due to the escalating tensions with its northern neighbour, which also saw some Copper inventories unload.
Any restriction in leverage in the system will impact the Copper price, as it is a direct beneficiary to global growth/expansion and the credit finance boom. It does certainly make it harder to trade it purely on fundamentals as one wonders what the true surplus or deficit is. The Copper market is a tight market ranging from surplus of 50k tonnes to probably a deficit of 100k tonnes. So we are in a relatively “tight” market and so the margin of error is small if there are big global events. This is in direct contrast to say the Oil market that has a lot more supply out there to work through, hence less receptive to geopolitical noise and global growth factors per se.
Yellen certainly hasn’t made matters any easier for Commodity market players. Her constant shift from hawkish to dovish bias changed the outlook for the USD and hence the underlying Commodities given their inverse correlation to the dollar supporting Emerging Market demand when dollar is lower and vice versa when dollar is higher.
Chart 2: LME Copper Stocks
33 | ADMISI - The Ghost In The Machine | November/December 2017
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