Base Metals and Global Changes

We shared our concerns about the pace of copper’s gains between sending the last Dispatch and Journal. Since the Journal went out copper moved to just shy of US $ 2.20 per pound ($4,850/t) before starting its current consolidation phase. This is the same price area at which it was seeing support attempts on the way down in mid-October. The LME’s forward price curve has flattened, but continued warehouse inventory reductions suggest further support at this level is possible.

China

Recognition that metal buying can be a longer term store of wealth, in China or elsewhere, is likely helping support the price. A strong arbitrage gain on bringing copper into China is drawing down LME stocks; scrap copper is still not showing up at the levels China had been used to sourcing. The LME zinc price has gained for similar reasons, and other major metals have tagged on as well. Is this getting to be too much of a good thing?

Overall copper production in China is reported to have been up in Q1 by 8.7% on a year/year basis. Also, analysts from Antaike, a state-sponsored metals market research group, indicates a three year plan by Beijing to stockpile 400 Kt of copper, a similar weight of lead and zinc, and 1000 Kt of aluminum. At the same time, Beijing will be phasing out old smelter capacity at similar levels. Working against that was a rumor that Beijing’s metal traders have started to put purchases made earlier this year back into the market.

This seems at odds with earlier reports that 300 Kt of copper are to be stockpiled by the government this year, and begs the question of whether some policy has been revised.

We think that Beijing wants an orderly market. Overly weak metal prices can mean supply constraints that would eventually push prices much higher and/or simply sideline growth. That doesn’t mean a quick price jump now makes sense either. If that seems at odds with phasing out older smelter capacity, keep in mind China is replete with small inefficient smelters using too much power and expelling too much pollutant. Much has been made about the need to maintain job growth in China to still unrest. In fact, new polluting industry laying waste to the farmland that is the real “safety net” for China’s peasant class is the most likely source of disquiet.

A side note to the push to consolidate the smelter sector in China comes from the steel makers. The major foundries are in a continued stand-off with the Big 3 iron ore exporting companies (RTZ, BHP Billiton (BHP) and Valle) about this year’s contract rate. To press their point, the exporters are offering product to China’s small steel makers using bulk discount rates usually reserved for large buyers. Not surprisingly, China wants its steel making firms to consolidate as well. One policy that may deal with both an oligopoly and the masses at the same time seems sensible enough to us.

“China” is sometimes used as though an all encompassing thread connecting its denizens' actions (including by us, we admit), but it is by no means a monolith. We think the general thread that China’s government wants to replenish its strategic stockpiles is true, and certainly there have been musings from its higher-ups about global currency backing using both baskets of national currencies and baskets of hard goods.

How to achieve this while attending to the wounded west still has large question marks attached to it. That rumors out of China are moving metal prices is the point of our seeking balance. This doesn’t mean China is uniquely capable of moving markets, or that it wants to be. It's also well worth noting that the state inventories being replenished were largely drawn down when metal was sold into the market in 2007. Not to put too fine a point on it; China is buying back copper for $1.50-2.00 a pound that it sold to hedge funds for $4.00. Don't be too quick to assume it's Beijing that is the foolish trader here.

Financials

Alas, in the West meanwhile some formerly big banks put out their Q1 results. These initially generated a bit of cheering at their seeming ability to meet low expectations. Now... with enough detail out, combined with a trial balloon today from Washington on converting its bail-out preferred shares into common stock, the rally in the US financials sector appears to be stalling. A willingness to accept the presumption of capital within assets for which there still is no real market pricing seems to have been short lived. The wagering has moved away from recovery pricing in this sector, to the prices at which its worst off might be wrapped up. The naked empire unwinds apace.

Canada

In Q1 the resource over-weighted Toronto Stock Exchange generated 33% more financings than it had a year earlier (C $11.9 billion in ‘09 vs. $8.9 billion in ‘08). The heavy weighting in gold financings through the TSX that dominated the first two months of the year is shifting towards copper, and a few other minerals. This by no means indicates the mining sector is ready for a straight line rebound, but it does speak to the relative comfort institutional players are finding in it. Gold sector spending indicates concerns about the US and its currency, but copper wagers are about the emerging East.

Conclusion

We continue to view a balanced approach to metals the as the best way to navigate the shifting winds of global commerce. Consolidation will be the market theme for the next while, and that means shaving positions and looking for the next opportunities does make sense. But we do think the next shift will be as swift as this one has been.

Disclosure: No positions in companies mentioned

(Reprinted from the April HRA Dispatch)