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Bulging Chinese Inventories Undermine Copper

There is more copper in China than at any other time in history — and economic growth in the world’s largest consumer of the metal is slowing. The combination of those two facts has cast a pall over the usually bullish mood at Cesco week in Santiago, the largest annual gathering of the world’s copper miners, traders, consumers and investors.

Reel of uninsulated copper wire
Charles D Winters | Photo Researchers | Getty Images
Reel of uninsulated copper wire

“The general mood is not good,” says Gonzalo Sánchez, vice president for sales and marketing at Antofagasta, the Chilean copper miner. Or, as Michael Widmer, head of metals research at Bank of America Merrill Lynch, puts it, “one of the most depressing Cesco weeks ever”.

The price of copper is seen as a bellwether for the global economy thanks to its widespread use by the manufacturing industry. Copper is also important for the profitability of blue-chip miners such as BHP Billiton , Freeport-McMoRan , Rio Tinto , Anglo American and Xstrata , and traders including Glencore and Trafigura.

Already, benchmark copper prices on the London Metal Exchange have dropped 7 percent since the start of the month, dipping below $8,000 a metric ton for the first time since January. Many are expecting the metal to test $7,500 or even $7,000 in the next few months.

The reason is straightforward: after a dramatic buying spree at the end of last year, China is groaning with copper inventories.

“We are definitely at the highest level of stocks in China ever,” says Paul Settles, principal copper consultant at CRU, a consultancy. He reckons there is just over 3 million metric tons of copper in China, including the government’s strategic stocks, an increase of 918,000 metric tons in the past six months.

That means Chinese imports of refined copper, or cathode, one of the most closely watched datapoints in the copper market, are likely to slow from the record 1 million metric tons in the first quarter of the year as the country, which accounts for 40 percent of global copper demand, works off inventories.

“Rightly or wrongly, cathode imports into China are seen as a bellwether,” says Richard Wilson, chairman of metals at Wood Mackenzie.

Estimating that China needs to import only another 1.7 million tonnes in the rest of the year, he sees a “substantial” drop in imports in the coming months. “The market being the market, that will be viewed very negatively.”

The large increase in Chinese inventories has coincided with a wave of broader macroeconomic concerns and a fresh bout of fears over Europe to unnerve investors.

“The thing that has rattled people is not just that we’ve had a slowdown in China, but that it has come at a time when there is some political uncertainty as well,” says Robert Lind, chief economist at Anglo American. “In the short term, this could lead to continuing volatility.”

But, echoing a widely held view among miners and traders, he says that investors have become too pessimistic. “China’s demand for commodities should remain very strong, underpinning higher real prices in the medium term than we’ve seen historically.”

Indeed, few miners in Santiago this week were concerned by the prospect of a “hard landing” for the Chinese economy. Diego Hernández, chief executive of the largest copper miner Codelco, conceded that the market could see some “volatility” in the next 2-3 months but predicted that after that the tight supply-demand balance would prevail.

Moreover, not everyone views the rise in Chinese stocks as a reason to be bearish. The rise in Chinese stocks has come at the expense of the rest of the world. Since September, inventories at London Metal Exchange warehouses have almost halved, falling to the lowest level since the financial crisis.

Outside the exchange, executives say companies are holding very low levels of inventory due to the challenge of financing it.

Indeed, Mr Settles of CRU estimates that 58 percent of the world’s refined copper is now being held in China — the largest proportion on record. Traders say that China may hold as much as three quarters of the “spare” stock that is actually available to the market.

“On its own the high stocks in China is bearish. But it has only made things tighter in the rest of the world,” he says.

Indeed, the LME market has witnessed a scramble for metal in the past few days as traders seek to acquire physical metal from the exchange.

The rush for delivery on Tuesday pushed the price of copper for immediate delivery to $114 a metric ton above copper for delivery in three months — the highest such “backwardation” since September 2008, and a traditional sign of a tight market.

“If there’s a strong second half in China and they eat up all those stocks, and the rest of the world doesn’t go to hell in a handbasket, we’re heading to a very tight market some time in the second half of this year and the first half of next year,” says Mr Settles.

Or as one senior industry executive puts it: “You could say the Chinese have just cornered the copper market.”

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