Copper: The importance of the supply forecast

Current consensus wisdom is that copper prices are likely to perform strongly in 2011 as the market faces structural undersupply issues and continuing demand growth mainly from China.

As the VM group writes in its November Metals Monthly publication for ABN AMRO, "Assuming demand from emerging economies continues to grow, and that of the developed world recovers at present rates, then supply-side fundamentals will ultimately determine price performance.

It adds, "For copper, supply is beset with problems, ranging from declining ore grades at many of the world's major copper mines to the slowing discovery of new replacement mines."

However, it is the assumption about emerging economies that has some commentators a little concerned.

In a note French bank Natixis writes, "More important, for us, was the ongoing rise in developing country inflation data, with November's release from Brazil taking the yoy rate up toward 5.5% yoy. This escalating concern over inflation in developing countries will likely remain a concern for all commodity markets as we move into 2011, with the hope that inflation can be contained without compromising growth set against the fear that countries may need to restrain growth more significantly to bring prices back under control."

Such fears raised their head earlier this month after China raised its interest rates in a bid to cool inflation in the country.

However, Natixis does note, "After the weakness in September, Chinese steel production rebounded slightly in October, rising from 47.9mn to 50.3mn tonnes. This does suggest that Chinese energy rationing has begun to move away from the heavy industries it was initially intended to target, hence the rise in demand for diesel from those smaller energy users that may find themselves subject to electricity shortages.

And ,adds, "The Middle East will remain an important source of demand for raw materials in 2011. Helped by supportive oil prices, many countries are continuing to invest heavily in infrastructure. This week, Trade Arabia reported that construction contracts worth $86bn would be awarded in Saudi Arabia in 2011. In Iraq, four new oil refineries are planned, as international oil companies help to rebuild the country's oil infrastructure."

But, while this all may be the case, it is important to note that Chinese apparent consumption of copper dropped significantly in October, falling from more than 700,000 tonnes in previous months to less than 600,000 tonnes, Natixis says. With Chinese stockpiles of copper high, imports of both unwrought copper and copper products fell sharply, falling by 72,400 and 22,500 tonnes month-on-month respectively.

According to Natixis, "With SHFE stocks continuing to rise, and the SHFE/LME import arbitrage still offside, it is unlikely that conditions in November will have improved. "

Speaking to Mineweb.com's Metals Weekly Podcast two weeks ago, Simon Hunt of Simon Hunt Strategic Services said that in his opinion, there will not be a supply squeeze in the copper market.

He explains that one needs to be careful of how one defines demand. Since 2005 he says, the financial sector has got highly involved in the copper market and, while this demand is real, it differs very much from the industrial demand side of things.

"You have major cable makers saying to the industry that between 2006 and the end of 2010 one million tonnes of copper will be lost to aluminium and fibre optics. How does that square with the tight market? Also across many products, manufacturers through improved design and tighter specifications arte allowing something like 20% to 40% to be used per product. Air conditioning and refrigeration tubes are a fine example, but there are many across the board.

"The second development, which manufacturers have been pursuing with increasing intensity, has been to find new technologies that actually replace copper and the one that is the most prominent is high temperature super conductors, which are either in 2011 or 2012 will start to be put into commercial use."

He adds, "If we're talking real fundamentals there has not been and there won't be any real tightness in the market. Tightness is created by the financial sector, believing that copper is going to be a safer asset than holding dollar assets."

To some extent this view is supported by comments from the VM Group, which writes, "The three copper ETFs now planned (ETF Securities, JP Morgan and Blackrock) can only deepen the deficit, even assuming they receive a lukewarm reception. For a physical copper consumer, the medium-term outlook of a copper market deficit, competing ETF demand, and record high prices can only result in one thing - substitution. Although there is little available to replace copper's superior conducting properties in electrical applications, its uses in piping will certainly be under threat.

"When copper last rallied to record highs in 2007 and 2008, there was a marked and, in some cases, permanent shift to plastic tubing. Should the copper price break and sustain new ground in 2011 and 2012 then we expect a further shift to alternate materials."

The question then becomes, what happens if the continued growth in demand from emerging economies, be it as a result of stubborn inflation or substitution, doesn't emerge?

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