copper report iifl

8/2/2019 Copper Report IIFL

1/14

Copper

Econom ic Bellw ether

June 16 , 2011

LME Cop per

5,000

6,000

7,000

8,000

9,000

10,000

11,000

Jun-10

Aug-10

Oct-10

Dec-10

Feb-11

Apr-11

Jun-11

US$/ton

Source: Bloomberg

MCX Cop per

250

300

350

400

450

500

Jun-10

Aug-10

Oct-10

Dec-10

Feb-11

Apr-11

Jun-11

Rs/kg

Source: Bloomberg

Research AnalystHi tesh Ja [email protected]

Execu t i ve Summ ary

Post-credit crisis in 2008-09, copper prices have managed resurgencefrom abysmal lows of US$3,000/ton in late 2008 to panoramic highs ofUS$10,000/ton in 2011. Hefty restocking by the Chinese, quantitative

easing by the various economies and supply-related issues helped liftprices to life time highs. Copper prices quintessentially coined as abellwether of the global economy, continue to reflect the health of theindustrial and manufacturing activity across various geographies, withthe metal widely consumed across building/construction, electrical &engineering sectors.

In this report we discuss the various aspects pertaining to globaldemand/supply, seasonal trends, macroeconomic indicators andeffectively what is in store for the prices for the next few months. Overthe long term, copper prices are certainly supported by supplyconstraints. However, in the short-medium term, the prevalent

economic backdrop and softening Chinese demand raises questionsregarding the sustainability of such high prices. In this respect, w edeem tha t fundamen ta l s a re no t conduc ive fo r the bu l l s andin fe r LME copper p r i ces to tes t US$8 ,300 -US$8 ,500 / ton t i l l Ju l yend . Ef fec t i ve l y , we advoca te no t go ing l ong and p r e fe r to se l la t h ighs .

Exh ib i t 1 : Copper fun dam enta ls snapshot

15,000

16,000

17,000

18,000

19,000

20,000

21,000

2006 2007 2008 2009 2010 2011(f)

'000 tons

5,000

6,000

7,000

8,000

9,000

10,000US$/ton

Refined Production Consumption LME Avg Pr ice

Source: Bloomber g, Ind ia Infoline Research

Note: 2011 average prices are computed t il l end of May.


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Copper

Com m od i t y Repor t 3

Chronic labour strikes in Latin America

& energy issues thwart the optim umutilization of t he mine pr oduction

capacity.

Global refined copper production rose

at a CAGR of 2.5% during 2006- 10,

which is not comm ensurate with thegrowth in the demand for the metal.

RefinedProduction(000 tons)

% Chg(yoy)

2006 17,291

2007 17,934 3.7

2008 18,226 1.6

2009 18,278 0.3

2010 19,075 4.4

2011(f) 19,724 3.4

As discussed above, global mine capacity utilization rates have beenconstantly declining. In this context, utilization rates have declinedfrom 92.5% in 2005 to 80.9% in 2010.

Chronic labour strikes in Latin America, supply disruptions & energy

issues thwart the optimum utilization of the production capacity. Forinstance, Chile which produces 34% of the world mined copper has aperennial problem of water shortage, which adversely impactsutilization rates. Moreover, frequent earthquakes in the Latin Americanregion also lead to temporary shutdown of mines, effectively impactingproduction.

Exh ib i t 4 : G loba l m ine capac i ty u t i l i sa t ion

71%

76%

81%

86%

91%

96%

2005 2006 2007 2008 2009 2010

Source: I CSG, India I nfoline Research

Global refined copper production has risen at a CAGR of 2.5% during

2006-10, which is not commensurate with the growth in the demandfor the metal. Refined output has grown at a better pace post-2009,thanks to better availability of scrap and increasing share of secondaryproduction in the total refined output.

However, shortage of copper ore and concentrate and dwindling shareof primary production still restrain the growth in the refined output. In2010, global refined output stood at 19.07mn tons, while for 2011 it isforecast to reach 19.72mn tons, a 3.4% rise yoy.

Exh ib i t 5 : G loba l re f ined copper p rod uct ion

16,000

17,000

18,000

19,000

20,000

2006 2007 2008 2009 2010 2011(f )

'000 tons



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Copper


Asian refined output contribut ing 45%to th e global production grew by 7%

year-on-year in 2010.

Latin American output whichcontributes 20% to the global

refined production, declined by

0.9% in 2010, on a yoy basis.

Secondary production has helped in

augmenting the growth in global

refined output, rat her than solelydepending on the mine output .

Asian refined output contributing 45% to the global production grewby 7% yoy in 2010. This can be attributed to adequate refinerycapacity in China, which alone contributes 23% to the global refinedoutput. Here, one needs to understand that healthy growth in Asianoutput gets offset by the rapid growth in demand for the metal from

the Chinese counterparts.

Incongruously, Latin American output which contributes 20% to theglobal refined production, declined by 0.9% in 2010, on a yoy basis. Inthis respect, Latin American region is prone to labour issues andsupply disruptions. Declining output from North America, Europe andOceania was registered in 2010, as compared with the previous year.Europe, North America & Oceania contribute 19%, 9%, and 2% to theglobal output respectively. African output grew at 22.9% yoy in 2010,but contributes a mere 5% to the global output.

Exh ib i t 6 : Reg iona l re f ined copper p roduct io n

0

2,000

4,000

6,000

8,000

10,000

Af rica N.

America

Latin

America

Europe Asia Oceania

'000 tons2009 2010 2011(f )


Refined copper production derived from scrap is known as secondaryproduction, whereas, refined copper production derived from mineoutput is known as primary production. Over the last decade, thecontribution of scrap recycling to the global refined output hasincreased immensely.

In 2001, scrap recycling contributed 12% to the global output, while in2010 it contributed 18%. Hence it signifies to an extent, thatsecondary production has helped in augmenting the growth in globalrefined output, rather than solely depending on the mine output.

Exh ib i t 7 : Grow th i n seconda ry p roduc t i on

0

550

1,100

1,650

2,200

2,750

3,300

3,850

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

'000 tons

10

11

12

13

14

15

16

17

18%

Secondary Production Scrap Contribution (%)



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Copper


Declining rates clearly indicate themagnitude of the refinery bott leneck.

At the end of 2010, global stocks were

equivalent t o 3.5 weeks of

consumption.

There is increasing influence of

exchange warehouses in determiningnature of supply tightness.

Global copper refinery capacity utilization rates have been steadilydeclining. In 2005, refinery utilization rate stood at 86.5%, whichdeclined to low levels of 77.4% in 2009.

In 2010, refinery utilization rates stood at 79.8%. Declining rates

clearly indicate the magnitude of the refinery bottleneck, where themine output is unable to convert into refined output at its optimumlevels.

Exh ib i t 8 : G loba l re f iner y capaci ty u t i l i sa t ion

72

74

76

78

80

82

84

86

88

2005 2006 2007 2008 2009 2010

%


Global refined copper stocks including producer/consumer andwarehouse stocks undergo constant change, depending upon thedemand supply equation. As seen in Exhibit 9, global buffer stocks atthe end of 2009 were equivalent to 29 days of consumption. During

2010, supplies tightened and demand strengthened, with the end ofthe year buffer stocks reported at 3.5 weeks of consumption. Thecomposition of the global refined stocks has also changed to a drasticextent. LME stocks accounted for 10% of the total global refined stocksin 2005, which radically increased to 35% in 2009. At the end of 2010,the contribution of LME stocks stood at 29%. Similarly, SHFE copperstocks weightage has gone up from 7% in 2005 to 10% in 2010.COMEX stocks weightage has changed from 0.79% in 2005 to 5% in2010. Meanwhile, the decline in the weightage of producer/consumerstocks is alarming, from 82% in 2005 to 55% in 2010. Such trendsclearly indicate increasing influence of exchange warehouses indetermining the nature of supply tightness.

Exh ib i t 9 : Globa l re f ined s tock s

0%

20%

40%

60%

80%

100%

2005 2006 2007 2008 2009 2010

10

15

20

25

30

35

Producer/Consumer LME stocks

SHFE stocks COMEX StocksDays of Consumption



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Copper


Global consumption of refined copperrose at a CAGR of 3.2% during 2006-10 .

Asia contr ibuting 62% to t he globaldemand grew at 5.8% in 2010, on a

yoy basis.

Wor ld Consump t i on Ch ina the d r i ve r

Over the past few years, global copper consumption has witnessed anoverall uptrend, except a moderate decline in 2008 and 2009 due toglobal credit crisis. Sustained growth in copper consumption is

attributed to burgeoning economic growth in China. Chinese demandrecorded a CAGR of 20.05% during 2006-10, which effectively liftedglobal demand from 17mn tons in 2006 to 19.3mn tons in 2010.Global consumption of refined copper has witnessed a CAGR of 3.2%during 2006-10. World copper usage in 2011 is projected to reach20mn tons, 4% increase yoy.

Exh ib i t 10 : Globa l re f ined copper consum pt ion

15,000

16,000

17,000

18,000

19,000

20,000

21,000

2006 2007 2008 2009 2010 2011(f )

'000 tons


Region-wise, Asia leads in terms of regional copper consumption,

driven by strong demand growth registered in China over the recentyears. China constitutes 40% of the global demand and 62% of thetotal Asian demand. Asia contributing 62% to the global demand grewat 5.8% in 2010, on a yoy basis. Similarly, European demand grew at8.7%. Europe is the second largest consuming region, contributing20% of global demand.

North American demand grew at 6.5% yoy in 2010, while LatinAmerican demand grew at an impressive 25.9%. Oceania and Africawitnessed a decline in demand by 1.2% & 4% respectively.

Exh ib i t 11 : Reg iona l re f ined copper consum pt ion

0

3,000

6,000

9,000

12,000

15,000

Af rica N.

America

Latin

America

Europe Asia Oceania

'000 tons2009 2010 2011(f)



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Copper


China constitut es 40% of the globaldemand and 62% of the total Asian

demand.

Chinas demand has risen at 20%CAGR during 2006-10

Chinas consumption of copper has witnessed an impressive 20%CAGR during 2006-10. Demand doubled from 3.6mn tons in 2006 to7.4mn tons in 2010. Urbanization and industrialization in mainlandChina has led to rapid escalation in demand for the metal

Statistics clearly prove that the countrys consumption is a key variablein determining growth in global demand. In fact, market participantskeep a constant eye on these numbers, as any variation can impactthe price forecasts to a large extent.

Exh ib i t 12 : Ch ina dem and

0

1,000

2,000

3,000

4,000

5,000

6,000

7,000

8,000

2006 2007 2008 2009 2010

'000 tons



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Copper


Globa l mark e t ba lance

Coppers market balance continuously changes, as either supply ordemand undergoes a drastic change. During the credit crisis period(2008-09), global copper markets had surplus close to 200,000 tons.

However during 2010, market dynamics changed with a previoussurplus transforming into a deficit of 250,000 tons.

For 2011, a deficit of 378,000 tons is forecast. In 2012, the productiondeficit is projected to narrow to 279,000 tons, as growth in refinedcopper production is expected to exceed the growth in demand.

Exh ib i t 13 : Globa l demand -supp ly ba lance

(450)

(350)

(250)

(150)

(50)

50

150

250

350

2005

2006

2007

2008

2009

2010

2011(f)

2012(f)

'000 tons


Globa l demand / supp ly scena r io ( 000 t ons )

2005 2006 2007 2008 2009 2010 2011(f) 2012(f)Supply 16,572 17,291 17,934 18,226 18,278 19,075 19,724 20,686

Demand 16,674 17,034 18,197 18,039 18,090 19,324 20,102 20,965

Balance (102) 257 (263) 187 188 (249) (378) (279)Source: ICSG, India Infoline Research


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Copper


The third quart er of t he calendar yearis traditionally a weak period for

Chinese demand; hence we alsowitness lower import s numbers during

this duration.

LME Copper cancelled war rant s standat abysmal low of 4% percent of t he

total copper stocks, which conveys

signs of low off take from thewarehouses.

Cur r en t dyn amics

Exhibit 14 clearly illustrates that the gap between Chinese demand andsupply is on the persistent decline for the past one year. Effectively,Chinese refined copper imports also reflect the same story. In this

respect, China has imported 756,199 tons of refined copper in the first4 months of 2011, 29% lower as compared with the same period in2010.

We also infer that the third quarter of the calendar year is traditionallya weak period for Chinese demand; hence lower import numbersduring this duration. The first two quarters of the calendar yearregisters the highest quantum of imports, due to Chinese restocking atthe beginning of the year.

Exh ib i t 1 4 : Ch ina s demand - supp ly gap v / s impo r t s

0

200

400

600

800

1,000

1,200

Q108

Q208

Q308

Q408

Q109

Q209

Q309

Q409

Q110

Q210

Q310

Q410

Q111

'000 tons

Supply Deficit Refined Copper Imports

Source: WBMS, Antaike, Bloomberg, India Infoline Research

LME stocks continue to be at comfortable levels of 475,000 tons, ascompared with historical standards. Moreover, the cancelled warrantsratio to LME stocks is at abysmal low levels. Currently, cancelledwarrants are equivalent to 4% of the total LME copper stocks.

Cancelled warrants represent the quantum of stocks booked fordelivery out of warehouses. In this respect, such a low ratio conveyssigns of low off take from the warehouses, which would restrict theupside in LME prices for the near term.

Exh ib i t 15 : LME Coppe r s tocks v / s cance ll ed w a r ran ts

0

100

200

300

400

500

600

Jan

-05

Aug

-05

Mar-06

Oc

t-06

May

-07

Dec

-07

Ju

l-08

Feb

-09

Sep

-09

Apr

-10

Nov

-10

Jun

-11

'000 Tons

0

5

10

15

20

25

30

35%Stocks Can Warrant %

Source: Bloomber g, Ind ia Infoline Research


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Copper

Com m od i t y Repor t 1 0

For th e past few m onths, the gapbetween longs and shorts is dwindling

at a rapid pace, indicating signs that

long positions are being liquidated.

One of the most prominent reasons for

slowdown in Chinese copper imports isunfavorable arbitrage between LME &

SHFE copper prices.

Funds participation has played an active role in driving copper pricesover the recent few years. As seen in Exhibit 16, the magnitude ofnon-commercial/speculative players holding long positions havedramatically increased during the end of 2009. In fact, copper priceshave also witnessed a drastic surge from US$6,500/ton in November

2009 to US$10,000/ton in February 2011. However for the past fewmonths, the gap between longs and shorts is dwindling at a rapidpace, indicating signs that long positions are being liquidated.

Exh ib i t 16 : Non com m erc ia l pos i t ions on COMEX Copper

0

10

20

30

40

50

60

70

Jan-

07

Jun-

07

Dec-

07

Jun-

08

Dec-

08

Jun-

09

Dec-

09

Jun-

10

Nov-

10

May-

11

'000 Lots

0

2,000

4,000

6,000

8,000

10,000

12,000$/ton

Longs Shorts LME Prices

Source: CFTC, Bloomb erg, I ndia I nfoline Research

As discussed above, Chinese imports of refined copper have declinedfor past few quarters. One of the most prominent reasons isunfavorable arbitrage between LME & SHFE copper prices. SinceAugust 2010, LME Copper prices have been trading at premium to

SHFE copper prices, effectively discouraging Chinese traders to importmetal from the overseas markets.

In the first week of June, LME copper was at a premium of Yuan300.Arbitrage is computed by incorporating 17% VAT into LME Copperprices and then figuring out the difference with SHFE prices.

Exh ib i t 1 7 : LME Shangha i copper a rb i t rage

(9,000)

(6,000)

(3,000)

0

3,000

6,000

9,000

Jan-07

Jun-07

Nov-07

May-08

Oct-08

Mar-09

Aug-09

Feb-10

Jul-10

Dec-10

Jun-11

Yuan/ton



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Copper


Macro I nd i cato r s Stagna t i ng & Dec li n i ng Grow th

Exh ib i t 18 : Pu rchas ing m anu factu r e r i ndex Exh ib i t 20 : I ndus t r i a l p roduc t i on

30

40

50

60

70

Jan-09 May-09 Sep-09 Jan-10 May-10 Sep-10 Jan-11 May-11

China US UK Eurozone

(8)

(4)

0

4

8

12

Q1

2009

Q2

2009

Q3

2009

Q4

2009

Q1

2010

Q2

2010

Q3

2010

Q4

2010

Q1

2011

%

US UK Eurozone

China Japan

Source: Bloomberg, India Infoline Research

Exh ib i t 19: Real GDP Exh ib i t 2 1 : US hous ing

-40

-10

20

50

Jan-

09

May-

09

Sep-

09

Jan-

10

May-

10

Sep-

10

Jan-

11

May-

11

Japan China US

Eurozone UK

150

300

450

600

750

900

Jan-

09

May-

09

Sep-

09

Jan-

10

May-

10

Sep-

10

Jan-

11

May-

11

New Home Sales Housing Starts

Source: Bloomberg, India Infoline Research


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Copper


Out l ook

Over the long term, copper prices are certainly supported by supplyconstraints like declining mine & refinery capacity utilisation, globalsupply deficit, perennial labour issues in Latin America and low buffer

stocks. However in the short-medium term perspective, the prevalenteconomic backdrop and softening Chinese demand raises questionsregarding the sustainability of such high prices. Currently, copperprices seem to be influenced by currency-induced movement andpersistent supply issues. However, we reckon that eventually themarkets will shift focus to global economic slowdown concerns, whichcould effectively reduce the demand for the metal.

There are certain variables, which we consider will exert downwardpressure on Copper prices in the coming few months:

Poor macro num bers

Of late, macro-economic indicators across various geographies conveya clear picture of slowdown in manufacturing and industrial activity. Inthis respect, PMI (Purchasing Manufacturer Index) & IndustrialProduction numbers have been stagnant or declining for various majoreconomies like China, US, UK, Japan and the Euro zone. GDP growthfigures also reveal the same story. The housing industry in US, whichis a major source of copper consumption, continues to flounder atabysmal levels. The employment scenario in the worlds largesteconomy is clearly exacerbating economic concerns, withunemployment close to 10% of the total workforce.

Sof t Ch inese dem andChina has imported 756,199 tons of refined copper in first 4 months of2011, 29% lower as compared with same period in 2010. Decliningimports portray a picture of weakening domestic demand, especiallyconsidering the fact that first quarter of the calendar year istraditionally strong period for Chinese imports. LME inventoriescontinue to increase, with stocks reported at comfortable 475,700tons. The SHFE copper inventories have been declining of late with nofavourable arbitrage between LME & Shanghai prices, which iseffectively persuading Chinese consumers to utilise existing stockpiles.In addition, Chinese exports of copper cathode have increased sharplyduring Jan-Apr 2011, up by 124,000 tons as compared with the sameperiod in 2010. In fact, the exports are equivalent to 16% of totalrefined imports, which signifies that a lot of metal which is imported is

re-exported and not necessarily meant for domestic consumption.

T igh ten ing m one ta ry po l i cyInflation appears be a monster. A number of economies are sufferingand are committed to tame it. In this respect, further interest ratehikes cannot be ruled out. Meanwhile, quantitative easing seems to bephased out by various economic regimes and similarly there is lessprobability of an extension of QE2 by United States. Such a scenariodoes not seem congenial for commodity bulls to thrive, which in turnwould effectively facilitate liquidation in the markets.


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Copper


Pr ice Out lookThe third quarter of any calendar year is historically a lull period forbase metals, especially considering the summer slowdown in thenorthern hemisphere (Europe, US), where the industrial activity isreported at very low levels. In a holistic approach, we assert that

fundamentals are not inspiring and suspect LME copper prices wouldtest US$8,300-US$8,500/ton by July end. The global economicbackdrop also seems to be gloomy and less conducive for the bulls;hence we would resist going long and prefer selling at the top.


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