Characterized as uncertain

Copper prices were quite volatile in 2014. The move toward a supply surplus raised expectations for lower prices; as a whole, the market has trended lower.

To Dec. 19, 2014, prices averaged $6,875 per metric ton, down from $7,330 for the same period in 2013. But this masks some sharp price moves in the first half of the year—first to the downside and then to the upside.
 

Supply surpluses

The first sell-off was triggered by a Chinese corporate bond default, which raised concerns that the shadow banking system in China might be in trouble. With copper having been widely used as collateral in the shadow banking system, there were fears that metal held as collateral could find its way back into the market if lenders decided to liquidate.

This led copper prices to fall to $6,321 per metric ton from roughly $7,400 at the start of the year, but prices were rallying again by late March—the earlier sell-off had been a knee-jerk reaction.

The rebound picked up pace when it became apparent that the projected supply surplus was not materializing in light of a number of supply disruptions, the most notable of which was the lack of concentrate exports from Indonesia after producers balked at paying the export taxes that the country’s government had imposed at the start of the year.

In addition, other ramp-up issues, including those at the 450,000-metric-ton-per-year Oyu Tolgoi mine in Mongolia, meant the supply surplus in 2014 was not as high as expected.

The copper market has a history of not meeting production targets, and 2014 was no exception. Surpluses are expected in 2015 and 2016; the degree to which these materialize remains to be determined.
 

Uncertain demand

While supply has not be as plentiful, actual demand also is likely to have grown at a slower rate than earlier forecasts predicted because China, Europe and many emerging countries have suffered from economic slowdowns.

However, considerable uncertainty exists as to the state of real demand for copper. Top-down observations (taking into account economic data) would suggest weakness, while official figures from the International Copper Study Group (ICSG), Lisbon, Portugal, indicate healthy growth in demand.

In the first eight months of 2014, global usage is forecast to have risen 12 percent compared with the same period in 2013. Demand for refined copper was boosted by an apparent shortage in high-grade copper scrap, which means more copper cathode was used by semifabricators.

Chinese demand rose a reported 21 percent in the first eight months of 2015 based on a 27 percent increase in net imports of refined copper. Given the economic slowdown in China and the earlier practice of importing copper as a means to get credit there, it seems highly unlikely that Chinese usage has been anywhere near as strong as the ICSG data show, with its figure swollen by a degree of stock-building.

The ICSG data put the market in a supply deficit of some 509,000 metric tons for January to August; had that been the case, copper prices would not be trading near four-year lows.
 

Bearish outlook

The outlook for copper remains slightly bearish because the supply surplus is expected to grow in 2015 and 2016. Even though supply disruptions are likely, we still expect oversupply of approximately 200,000 metric tons in 2015 and roughly 500,000 metric tons in 2016.

These forecasts are not without risk. While lower energy prices and weaker commodity currencies are likely to prompt producers to maximize their efforts to boost output and weaker economic growth could weaken demand further, weaker oil prices and the potential for stimulus in China and Europe could improve the prospects for demand.

On the basis of the big-picture outlook for copper, we would expect prices to remain under pressure. While they are still above the marginal cost of production, prices possibly could fall further. We would not, however, look for them to follow in the footsteps of oil or iron ore, which have suffered heavily from planned increases in supply as producers have attempted to increase market share.

Copper stocks do not seem too high—at least at the exchange level. LME (London Metal Exchange) stocks are low at 170,000 metric tons, down from a 2014 high of 359,075 metric tons and a peak of 678,225 metric tons in June 2013; Shanghai Futures Exchange stocks stand at 92,829 metric tons, down from 125,850 metric tons at the end of 2013; and COMEX stocks stand at 26,915 metric tons. Collectively, exchange stocks account for around 1.3 percent of annual consumption.

Since the nearby time spreads on the LME have been in a backwardation for most of the second half of 2014, there is probably not too much metal stored outside the LME system in the West. But the situation is different in China. In addition to exchange stocks, stocks in bonded warehouses in Shanghai are thought to number nearly 600,000 metric tons, which lifts the volume of above-ground metal, which in turn should provide something of a cushion against either a pickup in consumption or in supply disruptions.

In addition to these stocks, China’s State Reserve Bureau (SRB) has been building up its copper reserves—it is thought to have bought some 500,000 metric tons in 2014. This metal once again will enable the Chinese to feed metal out into the market should shortages threaten its industrial capability or if prices rise too far.

In short, there are considerable quantities of copper around to prevent any shortage and, with surpluses expected this year and in 2016, the risk to prices is mostly to the downside.

China is a net buyer of copper each year but, while it might be thought that weaker prices would be in its interest, the country is also a large producer of the metal. Beijing is keen that prices do not fall to levels that prompt production cuts, which would affect revenue and jobs.

In the past, China’s SRB has purchased metal to support the price of copper and its domestic copper industry. Because the SRB already was more active than usual in its purchasing in 2014, there is a risk that it may not have the capacity to provide extra support to the industry in 2015 should prices continue to fall.

Still, given the country’s foreign exchange reserves and its structural copper supply deficit, it may take the long-term view to accumulate even more copper should prices continue to weaken.
 

Oscillating prices

With marginal costs of production thought to lie around $5,500 to $5,800, there is at present little pressure on producers to cut output. In addition, lower oil prices will have reduced marginal production costs, so it is conceivable that the overall weak climate for copper could result in a further decline in prices.

The funds on COMEX are already net short 32,958 contracts of copper, with some 80,129 contracts of gross shorts, which is near the record level of 84,928 contracts. The previous peak was 78,588 contracts, suggesting that shorts are increasingly comfortable with holding a bigger short position.

While this could mean further downside pressure on copper prices as a result of fund shorting, the large short position also means, conversely, that the market is susceptible to short covering.

On balance, we feel the weaker economic climate will continue to weigh on copper prices in the first quarter of 2015, but the likelihood of further stimulus in Europe and China may well trigger short-covering rallies en route.

We, therefore, feel copper prices are likely to continue to oscillate sideways to lower, with dips prompting nearby pricing and short covering while rallies attract nearby hedge selling. With a supply surplus on the market for the next two years, a significant turnaround in the global economic outlook would be needed before the market gets outright bullish again for copper.

Such a scenario is most likely to play out in China, but stricter governance there and a commitment to rid the economy of overcapacity may well mean the global economy must acclimatize to slower growth in China and emerging markets for a while.

Still, China’s economy is massive, so even growth of 6.5 to 7 percent means a great deal more metal is consumed each year, so there is probably little room to get too bearish.

The author is head of research for U.K.-based FastMarkets, www.fastmarkets.com, a provider of delayed free and live subscription-based metal market news, data and research. He can be contacted at william.adams@fastmarkets.com.