Analysis: Too early to call a bear market for copper

LONDON/HONG KONG Tue May 10, 2011 7:15am EDT

A view of the Chuquicamata open pit copper mine in northern Chile, April 1, 2011. REUTERS/Ivan Alvarado

A view of the Chuquicamata open pit copper mine in northern Chile, April 1, 2011.

Credit: Reuters/Ivan Alvarado

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LONDON/HONG KONG (Reuters) - An exodus of investors from the copper market could see prices slip to the $8,000 a ton mark before heading back toward record highs later this year as stronger demand from China and Japan becomes visible.

Copper prices tumbled with other commodities last week as the dollar strengthened and investors fretted about consumption after disappointing surveys of manufacturing in top consumers China and United States.

LME copper fell to $8,657.50 a ton last week, its lowest in more than 5 months and a 15-percent drop since the all-time high. It was trading around $8,950 a ton on Tuesday.

China's absence from the market for some months now has also taken its toll on sentiment. It accounts for about 40 percent of global demand for the metal used widely in power and construction.

But as Chinese consumers are expected to return later this year, Japan rebuilds its infrastructure after the earthquake in March and inventories fall, confidence in the metal's price prospects will grow.

For now though a lackluster performance is on the cards.

"It could go to $8,500 a ton or perhaps even as low as $8,000 as investors unwind positions," said Stefan Graber, commodities analyst at Credit Suisse Private Banking.

"But copper price weakness will be used by physical consumers who have been waiting to step up their purchases and replenish their inventories ... We expect reconstruction efforts in Japan to boost consumption in the second half of the year."

Analysts reckon Japan normally consumes about 5 percent of global copper supply -- estimated at around 19 million tons last year. It's consumption in 2011 could jump to 10 percent of the total estimated at around 21 million tons this year.

The second half of the year is when many fund managers and analysts think copper on the London Metal Exchange will tackle the record high of $10,190 a ton hit on February 15.

Jing Chuan, chief researcher at Hua Tai Great Wall in Shanghai said demand could pick up quickly as credit became more easily available.

"It's too early to say the bear is coming," he said.

Monetary tightening to restrain inflationary pressures in China have curbed demand and the country's copper imports, which in the first three months of this year fell 21 percent from a year earlier to 595,963 tons.

BEFORE TOO LONG

The spotlight is also on bonded stocks in Shanghai, which analysts and traders last month estimated at between 500,000 and 700,000 tons, about double the levels seen last December.

These stocks are not monitored by the Shanghai Futures Exchange (SHFE) and so are only estimates, but they are used as collateral for loans, for higher-yielding investments elsewhere.

"Any move back to the $10,000 mark in the next few months would again shake loose stocks held by speculators in China," said David Thurtell, analyst at Citi.

"We believe the tight market should sustain the copper price in an $8,000-10,000 range over the next year or so."

A purchasing manager for a large Chinese copper tube producer said it will not be easy for copper prices to fall below $8,000 a ton and that demand for the company's products had been strong since April.

Analysts say other consumers in China have reported better demand for their products -- possibly a reason why stocks in warehouses monitored by (SHFE) have since April 1 fallen nearly a quarter to 123,043 tons.

However, stocks of copper in LME warehouses have climbed more than 30 percent to above 468,000 tons since December 9.

"We think LME warehouse stocks will follow (Shanghai stocks) before too long," Graber said.

DRIVERS

"To see copper back at its peak we would need to see China finished with monetary tightening," said Sean Corrigan, chief investment officer at Diapason Commodities, who thinks there is potential for copper to see $8,000 a ton.

"Conversely we need another set of drivers for speculative activity to push prices higher ... One thing we need to think about is how much more money could the Bank of Japan print for the reconstruction process."

Investors have in recent months and years borrowed and sold cheap dollars to finance potentially higher-earning assets such as equities, corporate debt and commodities.

Those trades have been reinforced by an abundance of liquidity, or dollars pumped into the global financial system by the U.S. Federal Reserve.

"But people could start using the yen again if the Bank of Japan is led into helping to provide extra credit and if that happens all bets are off," Corrigan said.

If people start using yen to finance trades then they will not use dollars, which may mean a higher U.S. currency and more expensive commodities for investors who use other currencies.

A weaker dollar .DXY has been a key factor behind commodity price strength since 2002/2003.

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Global Metal Stocks: link.reuters.com/deg67n

Copper stocks versus prices r.reuters.com/wes49r

Commodity correlations with the dollar:

r.reuters.com/wex39r

Commodities performance: r.reuters.com/nab49r

Is the global economy slowing? r.reuters.com/kej49r

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(Graphics by Vincent Flasseur and Scott Barber)

(Editing by William Hardy)

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