By Stuart Burns
The copper market is in a state of change -- maybe not a pivotal moment, but certainly nearly all analysts agree it is moving from a period of deficit to a period of surplus. That will have a number of different effects on the copper market and on prices, some of which we will look to consider here. As Andrew Keen, an analyst with HSBC, is quoted as saying in a Reuters article recently: "Copper, perennially described as fundamentally tight, actually finished 2012 posting a gain in inventories. This market remains balanced in our view, and this is enough to keep prices high when sentiment is good."
In the same note, HSBC raised its forecast for the average spot price in 2013 to U.S. $8,000 per metric ton from $7,500, but more in response to the current price levels than a change in the bank's view of the fundamentals. The World Bureau of Metal Statistics reported the copper market was in deficit during the January to November 2012 period by 250,000 tons, but that reported stocks rose by 23,400 tons during November, a trend that has continued in January, reversing outflows seen in 2012.
Indeed, Standard Bank even speculated in a recent note to clients whether copper could become a financing play like aluminum and zinc. Observing that in one day last week, 31,400 tons was delivered into an LME warehouse in Antwerp, largely locking that metal up from end-user consumption by long exit queues, the bank prompted the question: What would it take to make this a trend?
Let's Do the Copper Contango
For aluminum and zinc, a global surplus has resulted in a strong contango on the LME, enabling forward-price premiums to be sufficiently high to facilitate spot purchase and forward sale at a profit. For copper premiums, certainly shorter-dated spreads would not have to ease much to provide a similar window. What is required is a sufficient freely available metal surplus to allow forward premiums to rise.
For a market that has traditionally been constrained by poor supply, the aforementioned notion has been a bit far-fetched up to now, but HSBC in its quarterly review suggests the supply market is finally changing. Net growth in concentrate or mine supply has struggled to reach 2% for the past seven years despite strong copper prices, which one would expect would have driven substantial new mine and expansion investment. But the bank believes new mines such as Oyu Tolgoi (expected to add 75,000 tons) and Xstrata's Southern Peru operations (expected to add 90,000 tons) -- combined with growth at Chile's Escondida of 75,000 tons and Grasberg at 90,000 tons -- will change the supply landscape over the next two years. Even taking a pessimistic 7% disruption rate -- production not meeting projections -- the bank projects a period of strong production growth in 2014-15, as the graph below shows.
Copper demand in 2012 was poor. The downturn in Europe, which has led into a probable overall recession from the end of the year, combined with weak U.S. demand and a weak third quarter in China, saw global copper growth of about 2.2%, by the bank's estimates. Chinese real demand is not expected to take off in 2013. The Chinese market is well served with inventory, although as we have identified in previous articles, some of this may be locked up in financing plays of China's own design, facilitating grey market borrowing.
But even so, refined metal supply is strong on the basis of increased smelter refining, since better TCs have been available in recent months. We have seen in the past that speculative inventory build is likely to occur if copper prices drop to $7,000-7,500 per ton, but the greatest risk to demand HSBC sees as coming from North America and Europe, encouraging the bank to reduce its global demand growth forecast for 2013 from 5.5% to 4.3%. Even so, growth in excess of 5% would be required to dent the 200,000-ton surplus that HSBC sees for this year.
Although some others see a lower surplus -- closer to 100,000 tons -- most agree the market will be in surplus this year and is expected to grow further in 2014-15. HSBC sees 650,000 tons in 2014 and 1 million tons in 2015.
As a result, prices are expected to decline in 2014-15, although Chinese strategic buying should place a floor at about US$7,000 per ton. The final graph (below) shows global stocks as a ratio to consumption, and although we started off by exploring Standard Bank's speculation that copper may become another financial play like aluminum, the drop in global stocks, as illustrated by the graph, suggests that's unlikely. However, HSBC's graph runs only up to the end of 2012 and, as previous peaks and troughs show, the recent adherence to the average is as much an exception as it is the rule.
Much will depend on demand; supply is almost certain to rise strongly from this year onward, and Chinese demand looks like it will pick up. Although much of the infrastructure investment is going into sectors that are not heavily copper-demanding -- nearly 50% of copper consumption in China is in the power industry, while transport and construction make up less than 20% -- industrial and consumer activity is picking up and looks like it will be solid in 2013-14. The unknown is the U.S. and Europe. As the current copper price tells us, sentiment is certainly more positive in that area than it was six months ago, but by no means a dead certainty.