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Thursday, 9 February 2017

Copper Likely to Consolidate Further after Steep Rally

The financial health of the global economies is being reflected in the copper prices. It made a sharp rally in the last two to three months and at present is searching for support as the bullish sentiments are losing steam and are paving way for consolidation. The rating of the copper industry by various rating agencies also played a crucial role in deciding the direction of the market. Last year, Moody's embarked on a sector-wide review of the 87 global mining majors that it covers, eventually downgrading 36 companies, including marquee names like Rio Tinto, BHP Billiton, Freeport-McMoRan and Chile's state-owned Codelco. The likes of Anglo American and Vale also lost their investment grade rating for the first time leading to large scale production cuts, adding partial support to the copper market. At the same time simultaneously, the global economy was facing the major economic slowdown the entire industry contracted and it led to crash in demand for copper which eventually led in the state of surplus adding increased bearishness in the copper prices. But, towards the end of 2016, from the month of 0ctober the scenario began to change with added stimulus being provided by the projection of high industrial demand from China and positive economic data flowing in from major global economies. At present, the copper market is on lookout for sustained support from the end using industry to sustain the prices. 

The supply of copper in the world market continues to be on the surplus side putting pressure on the prices. World mine production is estimated to have increased by around 5 per cent (815,000 t) in the first ten months of 2016 with concentrate production increasing by 7 per cent and solvent extraction-electro-winning (SX-EW) declining by 1.5 per cent. The increase in world mine production was mainly due to a 43 per cent (590,000 t) 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, Indonesia and the United States, and expanded capacity in Mexico, also contributed to world mine production growth. However overall growth was partially offset by a 4.5 per cent decline in production in Chile, the world’s biggest copper mine producer, and a 6 per cent decline in DRC where output is being constrained by temporary production cuts. On a regional basis, production rose by 6 per cent in the Americas and 10 per cent in Asia but declined by 4 per cent in Africa while remaining essentially unchanged in Europe and Oceania World refined production is estimated to have increased by about 3 per cent (540,000 t) in the first ten months of 2016 with primary production (including Electro-winning increasing by 2.5 per cent and secondary production (from scrap) by 6 per cent. The main contributor to growth was China (increase of 7 per cent), followed by the United States where production increased by 12 per cent and Mexico (18 per cent) where expanded SX-EW capacity is contributing to refined production growth. Output in Chile and Japan, the second and third leading refined copper producers, declined by around 1 per cent and increased by about 4 per cent respectively. Production in the DRC and Zambia declined by an aggregated 13 per cent mainly due to the impact of temporary production cuts.

On the demand side there has been increase in few countries. World apparent refined usage is estimated to have increased by around 3 per cent (515,000 t) in the first ten months of 2016. Growth mainly due to increase in Chinese apparent demand as world usage excluding China remained essentially unchanged. Chinese apparent demand (excluding changes in unreported stocks) increased by around 5 per cent based mainly on 7 per cent growth in refined production as in fact net imports of refined copper declined by 4 per cent. Net refined copper imports have been on a declining trend in 2016 with the monthly average in the third quarter 40 per cent below that of the 1st half. Monthly average Chinese apparent demand in the 3rd quarter 2016 is 5 per cent below that in the first half. Usage in the United States and Japan, the second and third leading refined copper using countries, is down by 4 per cent and 3 per cent respectively.

As per the latest Moody’s report on the global base metal sector, the industry has witnessed a starkly different picture, with higher metal prices and, for the most part, stronger company balance sheets, better liquidity, and better debt-maturity profiles, which is expected to provide more support to the industry. After the US prudential election results, the things have changed on the positive side with US going for more infrastructural expansion. The other major driver of the rally in base metals and positive investor sentiment towards mining came on the back of improving data from China that largely reflects stimulus spending by the Beijing government last year. Moody’s upward revision of Chinese GDP expansion to 6.6% and 6.3% in 2016 and 2017 respectively from 6.3% and 6.1% before is also likely to provide support to the copper prices. 

The recent Development in the market suggests that the market is likely to consolidate for a longer period than expected and then make a slight downside movement. Any negative effects on commodities from Trump’s victory effect would only exist in the medium term. The US dollar has rolled back all gains from Trump’s winning presidential election, and appears to have been oversold and this has weakened the investor’s risk appetite and propelled them towards risk aversion. But commodities did not erase all gains from previous expectations of infrastructure construction pushed by Trump as the US dollar fell. After slump in domestic bond market, the People’s Bank of China (PBOC) conducted continuous and small currency injection through open market operation so as to ease year-end cash tightness, improving the market. Nonetheless, with curb in asset price bubble, China’s monetary policy is likely to tighten in the future leading to shrinking of industrial demand. 

On the fundamental side of the supply & demand, there is no major reversal in the scenario with inventories both in China and abroad growing continuously. The proportion of canceled warrants decreased, and spot prices remained below futures prices. The producers are not building stocks actively during low-demand season. The Baltic Dry Index (BDI) which mostly moves in line with metals is falling continuously indicating marginal bearishness existing in the market. The latest rebound in copper prices was due mainly to capital inflows. Commodity markets are witnessing net capital outflows this week after two weeks of growth, meaning shorts leaving are the market after profit-taking. CFTC speculative funds still hold high net longs, reflecting overbought. Net longs increased for the first time in last four weeks. Thus, one can conclude that all is not yet over as per as the businesses in the copper prices are concerned, but one must be cautious if investing for short term gains. Long term investment sentiments are still safe and sound.

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