By Julian Murdoch
Analysts have been bullish on copper for a while now — and 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. 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:
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 influence 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.
Quake's Long-Term Impact On Japanese Demand
As cleanup and recovery crews continue to struggle amid aftershocks and nuclear emergencies to rescue survivors from the 9.0 magnitude Sendai earthquake, the quake's aftermath is also being felt elsewhere: In the markets. In the short term, domestic demand for copper — as well as for other base metals — will drop, as Japan's manufacturing plants remain closed due to quake damage as well as power supply disruptions.
Global copper product supply could also be affected. Japan is the No. 2 buyer of copper ore after China, and its smelters supply finished product to manufacturers around the world. The third-largest copper producer, Mitsubishi Materials Corp, (MIMTF.PK), has halted production in its Fukushima prefecture smelter.
Given the continuing state of emergency, saving lives takes precedence, and there's no way to tell when these operations will resume. But as the response switches from rescue to cleanup and then on to reconstruction, domestic demand for copper and other base metals should rebound as the smelters will come back online.
In the past, Japan has typically consumed around 5 percent of the world's copper — but that percentage will certainly increase over the next few years, as reconstruction begins and the country's infrastructure and housing are rebuilt.
Which brings us back to supply. Analysts already predicted 2011 would see tight copper supply. Adrian Day, president of Adrian Day Asset Management, told HAI, "There is no new supply this year, but [there is] potential for supply disruptions from aging mines."
Meanwhile, Chief Executive of Codelco Diego Hernandez said the supply-demand balance would likely continue into 2012 and that prices were already higher than expected.
Between tight supply and the possibility of increased demand from Japan stemming from recovery efforts, copper may be able to rebound from its current doldrums in the coming months.