Copper – supply tightness offsets demand weakness

Neil Buxton of GFMS Metals Consulting says the copper bull market has been written off prematurely a number of times. This has come about primarily due to myriad supply disruptions, which led to final output being well below initial expectations. The easiest way to quantify the impact is to look at the mine utilisation figure that declined from an average of 92% in 2004 to 87.5% in 2007. According to the International Copper Study Group (ICSG), the rate fell to around 82% in Q1 of this year. Supply disruptions have continued since then – usually a combination of labour disputes and power-related issues – implying little improvement in the rate in Q2. Global demand in the first quarter was essentially flat at 4.556 Mt. Somewhat surprisingly, the data on the US and Japan show gains of around 3% year-on-year in Q1. This is at odds with most indicators within the automotive and construction sectors (key consuming markets), as well as the anecdotal evidence on these countries, which suggests that offtake is weak.

Further supporting this view, Japanese copper wire and cable shipments fell 4.8% year-on-year in April to 70,500 t. The production of rolled products was unchanged in April at 86,300 t. Copper shipments by North American distributors fell by 10% year-on-year in May, due to the fall-off of demand for wire and pipe.

ICSG has reported European (EU-15) demand down 8% year-on-year, however some of this can be attributed to destocking. Prysmian – the Italian cable and wire manufacturer reported a 3.4% rise in sales over Q1, attributed to an 11.3% rise in sales from its energy cable division. However, rather than showing healthy demand in Europe, the company attributed the rise as due to strong offtake from China, the Middle East and Russia in the high voltage cable sector.

Activity in key copper consuming industries within China remains upbeat. Fixed asset investment continues to run around 25% ahead of last year. Automotive production up to May rose by 18.1% year-on-year. There were also double-digit gains in the output of electricity generation equipment (+12.7%), alternating current motors (+15.5%) and household goods output, such as washing machines (+18.5%) and refrigerators (+17.5%).

However, the demand for copper cathode is more subdued than suggested by figures above. This reflects a combination of destocking and substitution triggered by high prices and a greater use of scrap. China’s copper cathode imports in May fell by 26% month-on-month and 19% year-on-year to 94,196 t. Judging by the latest preliminary data, this trend has continued in to June, with imports of refined copper dropping 12.6% month-on-month.

Will sub-prime worries begin to overshadow production losses, he asks?

Most of the economic and financial data suggests that conditions in the construction sector – the single largest market for copper – will get worse before it gets better. The credit crisis took another downward spiral with the problems at the US mortgage groups, Fannie Mae and Freddie Mac. Even if the Fed, and US government provide support, it highlights that the credit crunch has still to fully unwind. Another factor that may curb copper demand growth is the potential for the weakness to spread to the non-residential sector, which has longer lead times and is less affected by hikes in short-term rates than the housing market.

The bottom line is that the copper market will be increasingly reliant on supply disruptions to continue to support prices at their elevated levels of close to $8,500/t in mid July 2008. If the flow of bullish supply-side news begins to dry-up, the performance of some of the other base metals suggest that there is significant downside potential.

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