Copper's world is coming apart. Its price has fallen 16 per cent so far this year and is 34 per cent below February 2011's all-time closing high. This isn't just a case of slowing economic growth. The forces that influenced its stunning rise over the past decade are shifting. The metal's cycle is entering its downhill run.
Copper's surge reflected flat supply running into surging demand, mainly from China. It was in a persistent supply deficit between 2005 and 2012. The number of days of consumption covered by copper stocks fell from more than 60 in 2003 to less than 20 by 2008. The market has now loosened. Already, the stock-to-consumption ratio is back up to 50-55 days. Market fundamentals are also on shaky ground, with giant consumer China showing signs of economic cooling and the US and European recovery still fragile.
The US economic recovery and a revival in the housing sector specifically could compensate demand worries to some extent but not enough to shake off the negative sentiment and trend.
In the past, on the demand side, China's growth shot up on rising construction activity. But off-late, as the country's recent credit crunch demonstrates, copper consumption growth is likely to level off. Between 2005 and 2012, disruptions such as strikes took approximately between seven and nine per cent of global mine supply off the market. So far this year, though, disruptions have done less damage to supplies. Moreover, an earlier surge in investment in additional capacity brought on by higher copper prices is starting to bear fruit.
Copper's premium to the marginal cost of supply has fallen to 34 per cent, meaning, marginal cost at each level of production, includes any additional costs required to produce the next unit. Even so, that is still much higher than zinc's premium of four per cent. Nickel and aluminium, meanwhile, trade at discounts, reflecting excess supply.
One of the major reasons to this was the decline of the dollar in which copper is quoted against the currencies of major producing countries such as Chile and Australia, where costs are priced in local terms. Copper price moves have shown a greater correlation with the dollar than other industrial metals, even higher than gold. Going ahead and over the medium term, better economic prospects in the US and signs that the country's extraordinarily loose monetary policy is ending should support a stronger dollar. That will tend to cap copper's upside, and especially as weaker commodity prices will tend to weaken producing countries' currencies anyway. Further, copper producers could start hedging more aggressively by selling future output, as economic challenges and demand destruction looks inevitable.
The technical picture perfectly confirms to the underlying trend which is weak and the prevailing bias which is also bearish. The benchmark LME 3 month forward is seen making a head and shoulder pattern which is bearish in nature indicating a sharp decline in the coming months. Any near-term rise should get capped in the $7,200-300 range going forward. In MCX, the chart picture does not look that weak as LME, because of the possible depreciating bias of the local currency (rupee).
The author is director - Commtrendz Research
