August 15, 2014 / 12:35 PM / 3 years ago

COLUMN-Tight spreads a potential trap for copper bears : Andy Home

(The opinions expressed here are those of the author, a columnist for Reuters.)

By Andy Home

LONDON, Aug 15 (Reuters) - The bears are massing in the London copper market.

On the London Metal Exchange (LME) benchmark three-month metal has this week tumbled out of its tight $6,950-7,200 per tonne range to hit a two-month low of $6,821 on Thursday.

It’s holding there this morning but a rapidly-deteriorating chart picture, specifically a breach of the 100-day moving average around $6,850, is likely to see more black-box technical players join the bear ranks.

Heavy-weight analysts such as those at Goldman Sachs and Macquarie are banging the bear drum. Goldman has just reiterated its three- and six-month view that copper will sink to $6,600 (“Copper, China to rebalance the world”, Aug. 13, 2014), while Macquarie is targeting $6,500 by the end of this year (“10 things we hate about copper in H214”, Aug 4, 2014).

The bear argument is a strong one, predicated on a combination of reduced import appetite from China, the world’s largest buyer, and accelerating supply growth.

But one part of the picture still stubbornly refuses to fall into place. LME stocks are extremely low and the front part of the forward curve remains backwardated. Until that changes, the massing bears will have to tread warily.

******************************************************* Graphic on LME three-month copper price: Graphic on LME spreads and stocks: *******************************************************


At the heart of the bear argument for lower prices in the second half of this year is China, inevitably given its importance to the global copper market.

The most recent slew of economic data have highlighted the headwinds building in the Chinese economy. July’s precipitous drop in new lending may prove to be an outlier, as the central bank was at pains to point out, but it serves to reinforce a picture of slowing underlying growth.

The housing sector, a core pillar of demand for industrial metals, is cooling at an alarming rate with sales dropping 16 percent in July and new construction sliding 13 percent over the first seven months of this year.

A softening macro picture is compounded by copper-specific negatives.

Electricity grid investment, for example, has been a mainstay of China’s copper demand for many years and one that has been relatively immune from broader economic fluctuations. Right now, though, spending has slowed and tenders have been deferred due to an ongoing corruption investigation into the State Grid Corp.

The Qingdao port scandal, meanwhile, has damped demand for copper as collateral in China’s shadow lending sector, and caused stockpiled metal to seep out of the country’s bonded warehouse zone into the domestic market.

Whilst demand signals weaken, domestic supply is expected to accelerate as Chinese smelters lift run rates. Low capacity utilisation in China, in large part due to a flurry of maintenance shutdowns in the first part of the year, has been the single biggest supply bottleneck this year.

One that most analysts now expect to clear as Chinese smelters feast on ample raw material supply and reap the benefits of rising treatment terms.

All of which argues for a significant reduction in China’s call on refined copper from the rest of the world. Goldman, for example, is expecting the country’s imports to decline by 40,000 tonnes to 250,000 tonnes per month relative to the first half of this year.

That displaced copper, it suggests, should start making its presence felt elsewhere, particularly the LME warehouse system, with a 2-3 month time lag.


All of which is eminently credible, but the sting is in the tail of that forecast.

Two to three months is a long time in trading, particularly when it comes to time spreads.

And LME copper spreads remain tight. The benchmark cash-to-three-months period CMCU0-3 ended Thursday valued at $14 per tonne backwardation.

That may partly reflect the existence of a dominant long position holder at the very front end of the curve. The LME’s reports <0#LME-WHC> show one entity holding cash and warrant positions equivalent to 80-90 percent of available stocks.

The tension is plain to see in the tom-next spread CMCUT-0, the shortest dated in the LME system, trading this morning out to $5 backwardation.

But the tightness is also structural. The front part of the curve has been backwardated for most of this year, reflecting the low level of LME stocks.

At a headline level current inventory of 141,300 tonnes is close to six-year lows, while available tonnage, excluding metal that has been cancelled prior to physical drawdown, is lower still at 119,375 tonnes.

It has been stuck at that sort of number for many weeks now with arrivals in the LME system still conspicuous by their absence.

August is traditionally one of the quietest months in the copper calendar as much of the northern hemisphere enjoys its summer holidays. The summer doldrums are currently being reflected in weak physical premiums but not in any significant inflow of metal into LME sheds, bar a trickle into New Orleans.

Particularly noticeable is the lack of any arrivals at any of the LME’s Asian locations. The last, totalling 1,275 tonnes, took place almost a month ago at Busan in South Korea.

Chinese imports have been slowing for a couple of months now. June’s net inflow of 215,365 tonnes was the smallest since April last year. But without any flow-through to regional exchange inventories. So far at least.


The bear case is that this will change over the coming weeks and months with LME inventories rising as Chinese appetite wanes.

But will it require a greater incentive in the form of a wider LME backwardation?

LME spread tightness has been a running discordant theme in the copper market this year but the backwardation has been benign, even at its widest back in May.

The relative calm in the spreads has more recently mirrored the relative calm in the outright price, which spent the last two months trapped in that tight $6,950-7,200 range.

That’s changed this week with bears flexing their muscles. The more they do, however, the greater the potential for a spreads flare-out.

And when it comes to the LME date system with its rolling daily prompts, two to three months, Goldman’s forecast time-lag between Chinese import slowdown and LME stock increases, could turn out to be a long time. (Editing by William Hardy)

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