Copper's Rally Could Be Short-Lived

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Includes: CPER, CUPM, JJC
by: Alpha World

Summary

Despite recent gains, copper market faces headwinds.

After falling to a six-year low earlier this year, copper prices have rebounded.

This surge should be a short-lived though.

I remain bullish on copper in the mid- to long-term.

Copper prices crashed to a six-year low in mid-January. Tumult in the Chinese stock market and a rout in the broader commodity and oil markets weighed on the red metal, which was already struggling due to years of oversupplies. However, the copper market has been on recovery path since then.

Copper prices have rallied since mid-January. Although prices are still a way below the peak of about $4.50 per pound it reached in March 2011, the recent turnaround in the copper market has sparked some interest among investors. Indeed, some of the copper mining stocks have gained sharply in the recent past as the red metal rebounded.

Several factors have pushed up prices. Growing speculation that major oil producers would cut or limit production to balance the fundamental imbalance in the market has not only supported oil prices but also lifted the sentiment in the broader commodity market. This is because commodity-focused portfolios, which typically include a big chunk of investments in crude oil, also consist of copper.

A weaker dollar, thanks to a dovish monetary policy statement by the Federal Reserve, earlier this month, has also spurred prices of industrial and precious metals. As commodities are priced in U.S. dollars in international market, a weaker dollar, typically, tends to support the demand.

Also, several small and mid-scale copper miners, struggling due to a long-stretch of low price environment have stopped mining activities. These closures have helped cutting the excess glut in the market as global output dropped.

And last but not the least, China, the world's leading consumer of copper, has lifted the global sentiment after it showed its readiness to shore up its economy through fiscal stimulus measures.

Now, the question is whether copper prices continue to rise higher? In my opinion, this rally should be short-lived. The rally is driven more by sentiment and speculation. The fundamentals in the copper market are still very unbalanced.

Despite closures of several copper mines, the market is still under a supply glut. Even if demand from China picks-ups in the middle-term, excess supplies will continue to keep pressure on copper prices. Copper prices have been on downward trajectory since 2011 and yet, the market, witnessed a record copper surplus of 147,000 metric tons in 2015.

According to Freeport McMoRan (NYSE:FCX) estimates, copper supplies need to get trimmed by about 700,000 metric tons this year, if the market has to see any sort of equilibrium by 2017. And that looks unlikely given that leading miners in South America have ramped-up production this year. For instance, copper production in Peruvian mines were up about 41% in January, y-o-y. As a result, copper prices should see some correction, sooner rather than later.

Mid-to Long-term Outlook Solid

That said, we need to keep in mind that an extended period of low-price environment should result in more closures of miners in coming months. These expected closures and resultant fall in output should help copper market reach equilibrium, possibly by 2018-19. In my opinion, this will be the period, where copper prices will benefit from market fundamentals rather than mere speculation. It is also expected that the market will turn into a deficit by 2018 as there are not many new copper mines coming into play due to falling quality of copper assets. Indeed, as I have noted in several articles before, copper's fundamentals in the mid-term are better than most other base metals.

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.

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