Why Freeport-McMoRan's Rally Is A Bubble

| About: Freeport-McMoRan Inc. (FCX)

Summary

FCX shares have shot up remarkably of late due to a rise in copper prices and the company’s strong results, but its rally is not going to last long.

China, which consumes 40% of global copper, has been witnessing a continuous decline in copper imports as inventory is building up and demand is weak.

Moreover, the rally in copper prices has been driven by speculative imports of copper into China rather than real demand, which is another reason why prices could drop.

FCX might start facing a drop in copper prices since the construction industry in China is about to face weakness on account of unsold inventory and oversupply.

Freeport-McMoRan (NYSE:FCX) has been in fine form on the market in the past month, rising to the tune of almost 45% as the price of copper has risen remarkably. In fact, last week, copper achieved its largest rally in the past 35 years, rising along with an improvement in coal and steel pricing on the back of Chinese consumption. Moreover, the fact that Freeport posted a profit last quarter has also added to the stock's rally as it broke its trend of continuous losses of seven quarters.

But, in my opinion, the strength in copper prices will not last long as demand for the commodity in China is apparent and not real. Let's see why.

Copper oversupply will hurt Freeport

Though China has been importing copper in large amounts, there is not enough demand in the market to consume the imports. As a result, the country's copper imports have started losing momentum of late. For instance, in the month of October, China's copper imports were down almost 15% from September.

This decline in China's copper imports is not surprising as demand for the commodity in the country has not been strong. Rather, copper imports in China have been driven by speculation and not demand. For instance, at the end of March this year, China had more than $2 billion worth of copper, or 400,000 tons, sitting in its warehouses. This inventory build-up was a result of buying activity by smelters in China who try to take advantage of weak pricing through derivative contracts.

As such, China's copper demand is not driven by the actual need for the product, but by speculation. This is the reason why copper imports into China have declined for seven consecutive months on the trot. Since China consumes around 40% of global copper, a slowdown in imports by the country has weighed negatively on copper stocks.

For instance, from August to September, copper inventory at the London Metals Exchange shot up by 58% in just a month. Looking ahead, I won't be surprised if the oversupply trends continue since end-markets that consume copper in China will remain weak. As a result, the likes of Citi are of the opinion that the recent rally in copper prices is "premature" as the commodity has been overbought on euphoria. In fact, certain miners themselves have been forecasting weak copper prices. As reported by Mineweb:

"Despite the recent rally "fundamentals haven't changed, I don't think there's any change in supply and demand," Mikinobu Ogata, senior managing executive officer of Sumitomo Metal Mining Co, said in Tokyo on Friday. Current prices reflect speculative money flowing into the market, Ogata said. The producer cut its full-year forecast for copper to $4,726 a metric ton, from $5,000 in May."

Why the Chinese market will continue to be weak

Copper prices have rallied of late on the speculation that a boom in the U.S. construction market will lead to higher demand. However, investors should not ignore the fact that China is a bigger consumer of copper, and a slowdown in the country's real estate market will be a headwind for the commodity. This is because a fourth of the copper production goes into the construction industry, which is facing a slowdown in China, which accounts for 40% of global consumption.

In fact, due to the economic slowdown in China, the unsold inventory of real estate stood at 739 million square feet earlier this year, an increase of 16% from the year-ago period. What's more, it is being said that the real estate market in China is now in a bubble that could cause bad debts of $615 billion.

As a result, in order to control the bubble-like situation, the Chinese government has decided to increase down-payment requirements on homes so as to reduce the risk of default. For example, residents of Nanjing will need to make a down payment of 35%-50%, up from the prior requirement of 30%-40%. Additionally, certain states in China have also decided to put in place home purchase restriction plan so that a bubble due to price rise is restricted.

These measures will lead to a slowdown in the real estate market in China, which will hurt copper consumption. Since construction is one of the primary industries where copper is used, this is a headwind for Freeport-McMoRan.

Conclusion

The rally in copper prices is not sustainable. This is bad news for Freeport-McMoRan investors since the impressive rally that the stock has witnessed of late could come to an end once the fundamentals of the industry catch up with pricing. Hence, it will be a good idea for investors to book their profits in Freeport-McMoRan before the slide begins.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.