Goldman Sachs is pretty bullish about copper prices. Here's why

Futures Now: Buy the copper rally?
Futures Now: Buy the copper rally?

A rally in copper prices is expected to pick up pace as higher demand from China exacerbates supply shortages sparked by outages at large mines, Goldman Sachs said.

Copper, which is used as a proxy to gauge China's economic health, has had a torrid time in the past few years. China's economic wobbles led to a reassessment of demand and fueled a broad-based slump in commodities, prompting companies to slash investments.

Many investors unable to sell Chinese assets due to the country's capital controls instead dumped copper to express their unease.

But there have been signs of recovery recently.

The copper market is gripped by fears of a supply squeeze as potential outages threatens a market which has slashed capital expenditure in the last few years since a sustained broad-based commodities slump since the summer of 2014.

Benchmark three-month copper on the London Metal Exchange was trading about 0.4 percent higher at $5,888 a metric ton on Wednesday morning at 12.25pm HK/SIN time, after gaining 1.7 percent in the previous session to $5,925, near a two-month peak of $6,007.

This comes as protests over public work projects in a far-flung highland region of Peru have blocked roads used by MMG Ltd., a Hong Kong-listed company, to transport copper concentrates from its mine Las Bambas, Reuters reported citing a representative of the ombudsman's office .

MMG produced just 300,000 tons of copper in the first 11 months of 2016–just a small fraction of the 20 million tons globally–but the news of copper supply disruption is the third this week to spook the market after similar news from the world's top two largest mines.

On Wednesday, BHP Billiton said it has begun halting operations at its Escondida copper mine in northern Chile, the world's largest, ahead of a planned strike on Thursday, a union leader told Reuters. Chile and Peru are top copper producers by volume.

Over in Indonesia, Freeport-McMoRan Inc warned on Wednesday it will reduce output at the Grasberg mine, the second largest in the world, as the company deals with a smelter strike and struggles to renew its mining permit.

The supply disruptions come just as China's economy appears to be on the mend.

Two workers inspect copper plates that are to be transported in Antofagasta, Chile. The country is the world top producer of the red metal.
Matias Recart | Bloomberg | Getty Images

"The timing of these disruptions (at the Escondida and Grasberg mines) is important since, should they materialize over the next three months, they would be occurring over the same period as we expect to see a strong seasonal and cyclical uptick in Chinese demand post Chinese New Year and into the second quarter of 2017. This could contribute to a tighter second quarter, which is normally a period of seasonal deficit (in a balanced market)," wrote Goldman Sachs analysts in the report.

"With exchange copper stocks already very low, these strikes could add to anticipated physical (and spread) tightness during the second quarter," they added. The two mines is expected to produce about 9 percent of world mine supply this year, Goldman estimates.

If workers are Escondida go on strike for 20 days (the midpoint of the lengths of the prior two industrial disputes related to contract negotiations at Escondida during 2006 and 2011) alongside a one-month shipping delay from Grasberg, there will be a combined production loss of almost 100,000 tons, or 1.8 percent of quarterly world mine supply, they said.

Another place where there may be labour-related issues is Rio Tinto's Bingham Canyon copper mine in Utah where contracts are due to expire in March, Goldman said.

Risks from labor contract renegotiation may also resurface in the fourth quarter of the year, they added.

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