Despite a slowdown in China, the largest consumer of copper, analysts are still favouring the red metal. But, some hedging may be advisable

Author: Geoff Candy

GRONINGEN -

In 2009, China's portion of global copper consumption sat at about 35%. So, it is understandable that when it comes to determining where the price of the red metal is going, most eyes turn toward China. And, it is also understandable that concerns about a slow down in China's economy tends to weigh heavily. But, despite the incipient slowdown in growth in China, it is important to note that, demand is still growing, albeit at a lower rate.

In its latest edition of Commodity Watch, Goldman Sachs makes this point, writing that in the current environment, where there are seemingly conflicting messages of relatively robust microeconomic data and, more concerning, weaker and mixed macroeconomic data, it is important to focus on levels rather than growth.

"Absolute levels of demand moving back up against supply constraints are key to rebounding commodity prices, not sequential growth rates."

It adds, "It is important to emphasize that the macroeconomic data is not suggesting a downturn, but rather that we are now at the inflection point where the rate of change of growth is beginning to slow... But, all this means is that the level of activity and commodity demand will likely sequentially rise but at a slower rate.

Indeed, Natixis points out Chinese imports of unwrought copper and copper products fell in June to 328,000 tonnes, from 396,000 tonnes in May and 400,000+ tonnes in March and April.

" After briefly declining in May, perhaps in response to tighter customs rules, Chinese imports of scrap copper rose to 350,000 tonnes in June. Although China has been running down its copper inventories since the end of April (down over 70,000 tonnes) the substantial fall in imports does suggest a fall in apparent consumption versus the record highs of March-May, unless domestic copper production rose substantially during June.

But, while the imports have declined, they are coming off record highs, and the longer term fundamentals seem to indicate the likelihood of tight supply down the line.

As Fitch says, in its most recent Base Metals outlook, "Longer term, continued consumption growth in China and recovery in the industrialized nations, coupled with limited new supply, could result in a return of deficits and price rationing."

As a result of this, the ratings agency maintains that prices are expected to remain above the marginal cost estimated at $1.60/lb.

It adds that Chinese copper consumption has been driven by the building of power-generation facilities, the upgrading of urban infrastructure, and opportunistic stocking.

"While urbanization trends will remain supportive of copper consumption," it says, "Fitch expects opportunistic destocking when prices are high. Consumption in later periods should benefit from growth in demand for domestic autos and consumer durables, as well as consumer durables exports.

Goldman Sachs writes, however, that, given the extremely high levels of demand achieved during 1H2010, "demand may decline sequentially during the third quarter to still extremely elevated levels, global demand will likely continue to rise sequentially, in line with our expectations of continued sequential growth in economic activity.

"This is critically important to the commodity outlook," it writes, "as it implies that the global balance for many commodities will continue to tighten as demand levels rise against supply levels even as growth slows. The tighter balance and declining inventories will likely put upward pressure on commodity prices and returns."

But, it cautions, "Although we believe that prices are generally skewed to the upside from current levels, especially for copper and zinc, policy risks in Europe, China and the US are likely to continue to generate volatility and increase the risk of economic disappointments over the short term.

Source: http://www.mineweb.co.za/mineweb/view/mineweb/en/page36?oid=108189&sn=Detail&pid=102055