China and the Uncertain Future for Copper

When it comes to copper, no country is as pivotal as China given it alone accounts for 45 percent of global demand.  The dramatic slump in copper prices to six-and-a-half-year lows can be laid squarely at the door of the world’s second-largest economy as its economic slowdown deepens. The recent surprise Renminbi (RMB) depreciation dealt another blow to the hard commodity sector, amid worries that China’s buying power will diminish and its economy is still to stabilize.

But for such a fundamentally driven, industrial metal it is necessary to look beyond the avalanche of pessimistic China sentiment to the underlying drivers of demand and growth. Evidence suggests the physical demand outlook for copper is still holding up and Beijing still has potential stimulus in reserve.

For example, reports that the giant State Grid is poised to quicken the rollout of advanced power distribution infrastructure – which alone makes up half of the country’s consumption of copper – has allayed some fears over the metal’s outlook. The National Energy Administration set a target for spending on power infrastructure at 300 billion RMB, almost double last year’s total, part of a planned 2 trillion RMB spend until 2020.

Nevertheless, there still remains considerable uncertainty over wider industrial and property-related demand for copper, as well as supply. To get a clearer picture on copper and current trading performance, we sat down with Youngjin Chang, Senior Director of Metals Products and Yvonne Zhang, Director of Metals Products for Asia, at CME Group to find out more.

 

The sheer size of China’s demand underscores its importance to copper and other industrial metals such as aluminum, nickel and zinc.  In your view, how have the decline in China’s fundamentals, industrial data, and currency intervention impacted the global futures markets?

YZ:  China’s continued economic slowdown is undoubtedly a major factor in copper prices as with other industrial metals where it has been the single largest consumer.  It is generally accepted that copper prices are a key indicator of economic activity, given its widespread use in industrial production and infrastructure, so this makes prices highly sensitive to the recent economic weakening.

Despite this, not all news from China is downbeat. In July imports rose 3 percent to 350,000 tonnes, the first year-on-year increase since May 2014.  Although lower prices have reduced the total value of imports, volume is proving more resilient. In fact, copper inventories at Shanghai bonded warehouses have picked-up in recent months. For copper, demand is quite elastic to price falls, leading to lower prices stimulating restocking.

With regards to the futures market, we saw record open interest on August 11 in CME Group copper futures, which coincided with the initial RMB depreciation. This is significant because it means participants are holding a position as opposed to short-term trading. I would also say it is consistent with the growth in the use of futures as a hedging tool in order to take the price uncertainty out of the market.  Average daily volumes on copper have been up 38 percent this year to date.

Beyond China is there anyone else who can take up the shortfall in demand for copper?

YC: As China has been the single largest consumer of all industrial metals it will take some time for the physical and derivative market to adjust to this “new normal” of slower growth.   At the moment there is no single new source of demand comparable to China but there are still a number of countries that are on the rise and could be sources of incremental growth – from India to Vietnam and Africa.  Another source of potential longer-term demand is China’s ambitious “One Belt One Road” infrastructure building initiative to connect its western provinces, the Middle East and Africa. This will ensure China’s continued presence in commodity markets as a major player, even though today the project is still at an early stage.

How does the supply side impact the outlook for copper?

YZ:  In recent weeks we have begun to see acceleration in copper supply being taken out, even if temporarily. For example, Glencore has said it would suspend operations at two mines in Zambia until 2017, while Anglo-American has also announced supply suspensions.

Due to the nature of copper mining, there is a certain dynamism when it comes to supply in balancing the market. Compared to the energy or steel industries, where there is a need to re-establish facilities when supply is removed, copper mining can be switched off much more easily and quickly when it becomes uneconomic.

I would also point out that copper is an efficient market at finding equilibrium, due to it being an international and tradable commodity. This is made possible due to its relatively high price in proportion to freight costs making it transportable, and the fact that just about every country has some interest in copper.   Unlike iron ore for instance, it is not dominated by a handful of oligopolistic producers, and regional differences or price premiums are relatively low.

What is the feeling in the market of where copper goes next in terms of the amount of directional trades?   With copper now halving from its 2011 peak, have you seen any indications of structural shifts in the market?

YC: There is some sense the market still remembers the correction in 2008, which appears to be giving way to bigger moves down to retest these levels. Although we have been on a downward trend, it has also been characterized by large price swings and substantial volatility.

There is still no consensus view on the direction of the market, due to the lack of clarity on future demand drivers with uncertainty remaining over China’s economy, as well as the supply situation.  For the futures market this is actually positive as it means conditions are attractive to trading futures, with ample liquidity in order to put on different positions, cost effectively.  The current market is attractive for both producers and consumers seeking to lock-in prices at current levels to protect against further falls, or future price increases.

Are there any important correlations across the hard commodity complex and currencies and have they changed?   For example, it is well known the Aussie dollar is traded as a proxy for iron ore and China.

YZ:  The Australian dollar’s correlation to China’s iron ore demand is perhaps a special case because it is the largest producer and China is its single largest customer. Australia accounted for 64% of Chinese iron ore imports in the first quarter of 2015, according to data provided by the Department of Industry of Science in its China Resources Quarterly report.  Copper does not have that concentration in production where two countries are so intertwined, although in Chile it is still the country’s largest export material.  Here we have been seeing correlation in prices with the Chilean peso, which has also fallen heavily this year.

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