Copper: On Fire or About to Crash and Burn?

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"A serious market deficit is on the cards late next year and into 2011. . ."

We don't believe the near doubling of the copper price since its December low is due to pick up in real global demand. We think it has more to do with restocking in China, and expectations that real physical tightness will emerge due to its medium- to long-term supply side fundamentals.

The LME three-month benchmark copper price has risen more than 90% so far this year, while LME warehouse stocks rose from 336,700t on 1st January to 548,400t in late February, before halving by July.

Such astonishing dynamics should suggest that the global recession is well behind us, but this is not the case. Chinese restocking has been so great it's claimed a huge volume of available copper, providing a platform for traders to seek profit from the positive arbitrage trade between the higher Shanghai price over the LME price.

Short-Term Fall in China's Demand Ahead?

We already suspect that Chinese demand will fall in July, August and September. However, this may neatly coincide with a ramp-up in Western demand. So Chinese oversupply might be shipped abroad.

Copper's strength is not based purely on expectations of continuing Chinese demand and anticipated Western economic recovery. There is additional support from worries about copper's medium- to long-term supply picture. This was already in place before the recession took a firm stranglehold.

The financial fallout forced the postponement of mine expansions and new projects, and this will inevitably mean a tightening of the copper market ahead. A serious market deficit is on the cards late 2010 and into 2011, with the growing possibility of a copper price that will most probably trump previous records, in nominal and perhaps even in real terms.

So the price rise in copper since the start of 2009 has a strong rationality to it in the longer term, but not right now. The market is pricing in expectations of tightness ahead, backed by the belief that demand will exceed supply. This will be common in most commodities, especially as we enter 2010, and will necessitate higher prices to encourage exploration and development of costlier and more risky supply sources.

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