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Monday, 8 August 2016

Rising Smelting Capacity Provides Glimmer of Hope to Investors

Copper continues in the grip of abundance supplies, low demand and weakening global economies. The slow growth of the global economy is also not helping the copper prices either. Since the demand of copper is not showing any significant improvement, global economic development is currently guiding the short term volatility in the prices, but in a tight range.
The supply of copper have turned on the deficit side in the month on month analysis as major mining companies have resorted to significant capacity reduction amidst declining demand though the overall supply scenario continues to be robust. ICSG data, the refined copper market for April 2016 (excluding the adjustment for changes in China’s bonded stocks) showed an apparent production deficit of around 110,000 MT mainly due to strong Chinese apparent refined copper demand. When making seasonal adjustments for world refined production and usage, April showed a production deficit of about 32,000 MT. The refined copper balance for the first four months of 2016, including revisions to data previously presented, indicates a production deficit of around 119,000 MT. This surplus is shown merely on the demand and usage pattern of copper in global market. On the mining side the production is estimated to have increased by around 4 per cent (260,000 MT) in the first four months of 2016 compared with production in the same period of 2015. Concentrate production increased by 5 per cent while solvent extraction-electro-winning remained essentially unchanged. The increase in world mine production was mainly due to a 51 per cent rise in Peruvian output that is benefitting from new and expanded capacity brought on stream in the last two years. A recovery in production levels in Canada and the United States, expanded capacity in Mexico and a ramp-up in production in Mongolia also contributed to world growth. However overall growth was partially offset by a 4 per cent decline in production in Chile, the world’s biggest copper mine producer and a 13 per cent decline in DRC where output is constrained by temporary production cuts. Production of refined copper also showed a positive growth of over 4.5 per cent (330,000 MT) in the first four months of 2016 compared with refined production in the same period of 2015, primary production was up by 4 per cent and secondary production (from scrap) was up by 5.5 per cent. The main contributor to growth was China (+8 per cent), followed by the United States where production increased by 18 per cent. Output in Chile and Japan the second and third leading refined copper producers increased by 5 per cent respectively. Refined production in the DRC and Zambia declined due to the impact of temporary production cuts.  
During the same reference period world apparent refined usage is estimated to have increased by around 6 per cent (460,000 MT) compared with that in the same period of 2015 mainly due to strong Chinese apparent demand. Chinese apparent demand increased by around 14 per cent based on a 30% increase in net imports of refined copper from the lower net import level in early 2015 and consequently lower apparent demand. Excluding China, world usage declined by around 1 per cent. On a regional basis, usage is estimated to have increased by 6 per cent in Europe and 9 per cent in Asia (when excluding China, Asia usage declined by 3 per cent), while declining by 20 per cent and 4.5 per cent in Africa and in the Americas respectively and remaining essentially unchanged in Oceania.    
The global economic scenario is uncertain with declining housing demand in US, continuing slowdown in China and strengthening of dollar. Indication of slowdown in US demand have started coming with the cooling of Housing Data as the MBA mortgage applications index fell 3.5 percent last week, a third straight decline, while purchases also dropped as per data from the Mortgage Bankers Association. U.S. construction spending in June unexpectedly fell 0.6 per cent. Recently, the Chinese manufacturing PMI (purchasing managers’ index) data were released. The divergence between the official PMI data and Caixin manufacturing PMI data was observed. According to the data, the official Chinese manufacturing PMI for July was 49.9—below the market’s expectation of 50. It indicates a contraction in the manufacturing activity. On the other hand, the Caixin manufacturing PMI released by Market for July was 50.6—the first expansion since February 2016. Amid weak signals of demand from China, the Market is looking forward to the monetary stimulus from the country’s central bank. The Market participants are expecting a monetary stimulus from the Central Bank of China in the near term.
Apart from the dynamics of supply and demand and global economic scenario, the copper is finding small support from the rising smelting industry which is ever expanding. Although copper prices have fallen by over 50 per cent since they reached a peak in 2011, Chinese copper smelters have not reduced the pace of capacity expansion, thanks to historically high treatment and refining charges (TC/RCs) over the same period. Despite excess smelting capacity and progressively tighter concentrate markets, we can expect the Chinese smelting industry to continue growing during the next four years.  In fact, there is potential for even higher growth rates than we currently expect in our base case scenario, due to the short lead times associated with the development of new smelter projects and changes in project status.
There are several reasons for this situation. First, there is room for China's cathode self-sufficiency rate to increase further.  Even though China has been the biggest producer of copper cathodes in the world for several years, it still needs to import between 30-40 per cent of its total cathode consumption every year, which means that government support, in the form of low-cost loans, environmental approval and access to land, among other, is readily available for smelters. Second, in spite of the economic slowdown, Chinese copper producers have remained profitable due to the high TC/RCs. According to the latest data from China Nonferrous Metals Industry Association (CNIA), profits obtained by Chinese copper smelters hit RMB 2.0B in Q1 2016, up 41.35 per cent y-on-y. Third, rising copper prices provide additional incentives to Chinese copper smelters.  It is expected that refined copper prices would reach the bottom of the cycle in 2017 and to start rebounding from 2018 onwards. In those cases, being exposed to an increasing copper price trend might be an opportunity for significant profits. Fourth, the lead-time of Chinese copper smelting projects is very short. Over the past six months, massive expansion plan in the smelting plants have been laid. A few to be mentioned are Chifeng Jinjian's 400,000 MT/year expansion, Zhongqi Copper's 100,000 MT/year expansion, the 100,00 MT/year Lingbao smelting project, Shenghai Chemical's 50,000 MT/year expansion and Yantai Guorun's 50,000 MT/year expansion. It is expected that over 70 per cent of the increase in global smelter capacity during the next four years will take place in China. Thus the above reasons certainly provide increased positive support to the copper market and to the long term investments.

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