LONDON (Reuters) - For those who like their market narratives nice and simple Dr. Copper’s message is resoundingly clear.
The metal with the reputation for shining a light on the state of global manufacturing is telling us that demand growth has all but evaporated, thanks first and foremost to China.
Moreover, this is no cyclical aberration. Rather, to quote credit agency Moody’s, which has just put 175 commodities companies on review for possible downgrade, “the effect of slowing growth in China indicates a fundamental change”.
This “unprecedented shift” has happened just as copper producers were unleashing a wave of new production to meet demand growth that is no longer there, swamping the world in surplus material.
Simple really, isn’t it? Too much supply. Too little demand. A price, therefore, that is bombed-out at six-year lows.
The same narrative can be applied to the whole spectrum of industrial commodities with the scale of oversupply the only differentiator.
The only problem with this story is that copper’s own dynamics appear to contradict it.
If Chinese demand growth really has evaporated, why did the country import record amounts last year? And if the world is sinking in surplus metal, where exactly is that surplus?
Is it possible that something else is going on which has nothing to do with the fundamentals of supply and demand?
What, in other words, is Dr Copper not telling us?
There is no doubt that Chinese metals demand growth has just experienced a step-change.
Economists the world over are now scrutinizing the official figures for clues as to what is really going on in China.
But metal markets know and they’ve known for some time. The “hard landing” came early last year when Beijing called time on the property and infrastructure binge that has characterized Chinese growth over the last few years.
The shift towards a more consumerist version of growth has laid waste to those markets, such as iron and steel, that were most dependent on that binge.
Copper has not been immune but it is the nature of the metal that it has multiple usage profiles, not all of them in construction. Growth has slowed but it has not evaporated and even slower growth is coming from a larger base, meaning a still strong draw on extra units.
How else to explain the fact that China’s imports of refined copper rose by 2.5 percent to a record 3.68 million tonnes last year?
In years past such a contrarian signal might have been explained by copper’s use as collateral in China’s shadow finance trade.
But that particular monster is now much diminished due to both a crackdown by the authorities after the Qingdao port scandal and the unraveling of the yuan and interest rate dynamics that made it so profitable.
Maybe it’s the government stockpile agency, the State Reserves Bureau (SRB), buying up all that metal?
The SRB has certainly been active in the domestic market, soaking up 150,000 tonnes of local production in a nod to the pricing pressures affecting Chinese producers.
Its core copper operations are much more opaque and although it makes sense that it has been quietly buying up international metal, no-one’s suggesting that it has done so in sufficient quantities to explain last year’s record imports.
There are other possible factors at work, such as diminished scrap imports and plain old-fashioned bargain-hunting, but these are marginalia in the bigger picture.
Quite simply, China’s continued appetite for copper in such quantities says that demand growth may be diminished but it hasn’t disappeared.
And if there is currently surplus metal seeping around the market, it must be in China.
Because it’s not obvious where else it is.
Stocks of copper in London Metal Exchange (LME) warehouses are hovering around one-year lows.
Open tonnage in the LME network, meaning that which isn’t earmarked for physical load-out, currently stands at 176,850 tonnes, which is also a one-year low and close to levels previously associated with chronic spread tightness.
This is even more surprising given that LME spreads spent much of the fourth quarter of 2015 in backwardation, in theory enticing more metal into exchange warehouses.
Indeed, global exchange stocks, comprising those held by the LME, COMEX and the Shanghai Futures Exchange (SHFE), currently stand at 488,000 tonnes, which by historical standards is not high at all.
They totaled almost 860,000 tonnes as recently as April 2013 before anyone had even thought about a hard landing in China.
Maybe the surplus is still in the form of mined concentrates and is only now working its way through to the refined market?
But that doesn’t fit either with the recent smelter terms agreed for 2016 deliveries or the continuous downgrading of mine supply growth both last year and this.
Unlike oil, or a metal such as nickel, there is no sense that the world is drowning in copper.
Rather, any surplus appears relatively modest and if it is anywhere, it seems to be locked up in China itself.
Graphic on LME copper stocks and spreads:
Graphic on Shanghai copper price, open interest and volume:
If you were to consider just such supply-demand dynamics, you’d be scratching your head as to why LME copper fell to a six-year low of $4,318 per tonne earlier this month.
But there’s another missing part of the story.
Last year was the year of the Chinese copper bear with the London market on several occasions taking its lead from sharp drops in the Shanghai market.
But this trend has been running longer than 12 months. SHFE copper open interest experienced its own step-change in late 2011 and 2012 as more investment money flowed into the copper market. It has been there ever since.
The ensuing four years have coincided with a strong bear trend in both Shanghai and international prices and it’s noticeable that both SHFE open interest and volumes have spiked whenever that downtrend has accelerated.
Investors in China, in other words, have been bearish copper for several years, a stance that has only been abetted by Beijing’s recent clampdown on short-selling the local stock markets.
This new breed of copper bear has emerged just as investment money everywhere else has flowed out of the copper market.
And the really heavy institutional money was always long copper, primarily in the form of passive index investing.
There was a time in 2009 and 2010 when London traders eagerly awaited the beginning of every month to surf the fund money that came flooding into the metal markets.
That flood has since gone into reverse with pension funds losing faith in the commodities story in the face of consistently poor returns.
Analysts at Citi estimate that total assets under management in the commodity space fell by 18 percent last year to below $250 billion. They are now $330 billion below the peak registered in April 2011.
The passive index market, valued at around $125 billion, is a full $100 billion off the commodities supercycle highs.
Where once copper manufacturers bemoaned the financialization of their market, producers can only lament the subsequent de-financialization.
Over the space of five years, investors’ influence on copper has gone from being largely Western and bullish to largely Chinese and bearish.
This tectonic change has to be added as the third, unmentioned, influence on copper prices.
Dr Copper may be able to tell you something about manufacturing demand. He may even be able to tell you something about supply.
But on the question of money, he’s no financial markets guru.
Editing by David Evans