By Kunal Shah
Copper prices have recovery well since the start of 2012. The prices of the red metal soared to as high as $8,600/tonnes on the LME as against the low of $6,600/tonnes in the last quarter of 2011 despite robust imports of refined copper from China.
One of the major reasons for this correction in the last quarter of 2011 was credit crunch, especially in the Euro zone. Due to the ongoing debt crisis, the premium that the European banks had to pay to borrow the green back had surged dramatically, causing a massive downside in commodities and an unprecedented rally in the US dollar.
Moreover, positive bond auctions of the troubled economies in the Euro zone and the European Central Bank’s pledge to pump liquidity into the markets indicate that the debt crisis could abate in the coming quarter. The Euro/USD pair rallied to 1.32 in January 2011 from 1.265.
A massive drawdown of copper stocks from the LME warehouse, strong imports by China, supply concerns, weakness in the dollar and improvement in risk appetite of the markets are the key reasons for the sharp upside in copper prices.
Road Ahead
We will not witness a substantial recovery in the Euro zone due to slower growth and the adoption of austerity measures, despite ECB infusing liquidity into the markets. This will subsequently hurt copper, which is often considered as a good economic indicator.
China has been a major consumer of copper and since 2009, we have seen an exponential rise in copper imports by China on a year-on-year basis. The annual growth of copper imports in China stood at 19.12% from the year 2004-11, a massive rise of 50% in copper imports. Further, a decent GDP number of over 9% recorded last year supported copper imports by China.
However, contraction in the GDP in FY12 caused by global slowdown is quite likely to result in the lower demand for copper. According to our estimates for FY12, copper imports are likely to grow by a mere 4-5% as compared to the incremental growth of 50%, last year. Therefore, we believe China may not buy copper as aggressively as it did in 2010-11.
The global manufacturing activity, also considered as a good indicator of the demand for copper, fell to 7-8% as against the first half of 2011. From a double digit GDP, it has contracted to 8-8.5%, clearly indicating that the demand outlook for the red metal is not as attractive as it seems.
In 2011, copper prices moved above $9,200/tonnes, resulting in a cool off in imports of refined copper. Also, due to the ongoing problems in the housing market in China, it would be difficult for copper to sustain above $9,000/tonnes.
Looking at the inventories, which is continuously declining, we do not foresee a robust demand. There have been instances in the past where prices have corrected sharply on the LME despite low inventories. Hence, taking a call only on the basis of a declining LME inventory could be risky as prices had corrected sharply even in 2008, despite inventories being at their lowest levels.
The actual demand for copper in the coming quarters may remain weak and the rally in copper futures should be used as a good opportunity to go short. For the current as well as the next quarter, I do not see copper breaching $8,700/tones. Instead, on the downside, I see it testing $7,800/tonnes. Therefore, I am not very bullish on copper in the near future.
(Kunal Shah is Head Commodities Research at Nirmal Bang Commodities Ltd)
