Seeking clarity

The U.S. economy may finally be showing signs of improvement, but primary and scrap copper markets continue to languish.

The red metal has descended from the heights it reached several years ago, when China’s consumption of copper helped drive prices to record levels.

Those days are long gone, however. While China continues to buy copper scrap from the U.S., its overall consumption has declined. As well, the amount of available copper scrap in the United States is constrained by the lackluster economy. As a result, margins are extremely tight for copper scrap processors.

While China’s Operation Green Fence generated a lot of press over the last two years, it has had a middling impact on the copper market, sources say. One factor, however, that has created logistical problems is the scrutiny of inbound shipments, which has slowed the flow of copper scrap (as well as a many other commodities) through China’s ports.

Dealers say copper markets have been moving in fits and starts. In late spring and into the early summer, prices were heating up, fueled by renewed optimism and encouraging news. China, which continues to be the primary factor influencing the market as it consumes 40 percent of the world’s copper, appeared to be getting its proverbial house in order after an economic slowdown that hammered the metal. The country also was expected to benefit from an economic stimulus package introduced by the Chinese government.
 

Failed stimulus

While most metals analysts said they did not expect China’s economy to return to the double-digit growth seen through most of the first decade of the 21st century, there was a sense that the stimulus package could steady the economy, which had slowed quite sharply in a short time.

This infusion of spending was expected to act as some sort of adrenaline shot that would boost infrastructure spending in China, which would ultimately boost demand for copper and copper scrap.

However, several sources say the stimulus package was far less ambitious than originally expected. Copper markets, which saw a fairly pronounced run-up in prices in expectation of a sharp boost in demand, have declined in reaction to the actual stimulus package.

The stimulus package was expected to focus on infrastructure spending, including building construction, which consumes a significant volume of copper and thereby copper scrap. Analysts with Goldman Sachs estimate that roughly 61 percent of China’s copper consumption is related to housing and property activity. Of that amount, nearly half is related to telecommunications, lighting and local power infrastructure.

However, according to news reports, a number of new commercial and residential buildings throughout China remain empty. This news, plus the news of a Chinese builder that has warned of a possible bond default, has concerned companies that have pinned their hopes on the return of the Chinese housing sector.

The Chinese company Huatong Road & Bridge Group indicated in a mid-July statement to the Shanghai Clearing House that it might be unable to meet a $64 million bond payment that was due by the end of July. While the company was able to avoid the default, according to a report in The Wall Street Journal July 23, it was the first company to announce a possible default in China’s interbank market—its largest bond market. According to several published reports, as the Chinese economy continues to struggle, other firms could follow suit.

Additionally, if the widely held perception that China has a huge oversupply of housing results in other firms halting construction activity, demand for copper and copper scrap could slow further.

Goldman Sachs analysts believe this excess inventory will lead to falling copper prices over the next six to 12 months. The analysts write, “Importantly, we find strong empirical evidence for the relationship between completions strength and copper prices, with our China demand indicator based primarily on this, and our global demand indicator having a very strong relationship with copper prices.”

Supporting the lackluster outlook for copper consumption in China, a recent report from China’s General Administration of Customs reveals that China imported 350,000 metric tons of copper goods in June 2014, nearly 8 percent less than in the prior month.

The cancelling or postponing of many previously announced building projects has led China’s Ministry of Industry and Information Technology to call for the closure of more than three dozen copper smelters, many that consume copper scrap, by the end of 2014.

One U.S.-based scrap exporter says that even after these announced closures, “there is still an overcapacity in China.”
 

Collateral damage

Another issue contributing to the uncertainty surrounding China is the reported practice by some traders of using the same stockpile of copper as collateral on loans with multiple lenders.

According to The Wall Street Journal, “Western banks are looking into allegations that a Chinese trading company illegally pledged metals as collateral to more than one lender. The operator of Qingdao Port, the eastern Chinese port where the metals are stored, has confirmed that Chinese authorities are investigating allegations of fraud relating to stockpiles of metals.”

The June 19 article continues, “An estimated one-third or more of Chinese metal imports are believed to be used as collateral for loans from China’s ‘shadow banks,’ a vast network of loosely regulated lenders. Rather than being used to meet actual demand, these stocks are imported into so-called bonded zones, areas where import taxes don’t apply, and re-exported when they are no longer needed as collateral.”

After learning about this practice, many banks have begun to withhold letters of credit that are used in commodities financing, The Wall Street Journal reports, which has slowed the overall movement of copper and other metals into China.

According to multiple reports, Chinese government officials have begun an official investigation into the matter. Perhaps 3,000 metric tons of copper (as well as roughly 10,000 metric tons of aluminum) may have been pledged several times, these reports note.

In related news, the Industrial & Commercial Bank of China has applied for the right to not settle a letter of credit (LoC) it had issued that was tied to copper shipments into Qingdao Port.
 

Investment activity

Another challenging factor affecting scrap and prime copper markets has been investment community activity.

Several years ago when copper prices were soaring to record highs, many physical handlers of the metal blamed the activity of trading houses for much of the volatility. However, following the economic downturn, many of these same investment tools related to copper and other metals dissipated. More recently, several scrap metal dealers say investment operations are returning to the market, contributing to the current uncertainty.

According to some observers, investment groups may re-enter the base metals markets to take advantage of the expected rebound in China’s economy. This could help to firm up pricing for the metal by 2015, which analysts say they expect to see.
 

No longer super

One class of pessimists sees the downward trend in copper arising from the perceived end of the commodity “super-cycle,” which has buoyed pricing for many commodities.

Many metals, including copper, more than doubled in price throughout the 12 years through 2010 as China’s growing demand met with supply constraints, according to a Bloomberg article dated July 16. However, many of these same metals have declined in price since then.

The Bloomberg article says banks such as Citigroup Inc. and Deutsche Bank AG have called an end to the so-called commodities super-cycle.

The article cites a recent Goldman Sachs report, “Emerging Market Forex and the End of the Commodity Market Super-Cycle,” which states, “A prolonged period of elevated commodity prices has catalyzed a supply response. We do not expect a collapse in global commodity prices. But we do anticipate substantial declines.”
 

Closer to home

All the machinations on the global stage have left many domestic scrap dealers with whiplash. China slowing its purchases of copper scrap has changed the landscape in the United States, with a number of domestic scrap dealers saying they are having an easier time finding copper scrap, especially insulated wire, which is typically a material Chinese consumers seek.

One scrap dealer selling into domestic, high-end applications says the market in the Northeast U.S. is in decent shape. “Our customers are doing well.”

Another source says domestic conditions have improved, though margins continue to be the biggest challenge. With fewer offshore end markets for copper, domestic consumers can squeeze prices, shrinking margins even more, he says.

“We can get it, but we can’t sell it,” a scrap dealer in the Northeast says.

A scrap dealer in the eastern U.S. agrees. “It is easier to find copper, but it is much harder to find the buyer for it.”

He continues, “Copper consumers can be far more selective with what they will buy. They may go to their preferred suppliers and have better control over prices they are willing to pay.”
 

Better luck next year

Copper scrap likely will be locked in a tight trading range throughout the rest of 2014. But analysts say they expect 2015 to be a much better year for the metal. The global economy likely will strengthen by next year, and new mining capacity, which added significantly more copper to the global market, will have been absorbed, they say.

Additionally, many of the uncertainties concerning the Chinese economy should be resolved, which should provide more clarity to the market.

Despite the outlook, one scrap dealer says copper scrap will remain in demand over the long term given its varied uses.

“The reality is that copper has a role to play,” another scrap metal dealer says.

The author is senior editor of Recycling Today and can be contacted via email at dsandoval@gie.net.