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COLUMN-Through the copper stocks looking glass: Andy Home

(The author is a Reuters columnist. The opinions expressed are his own.)

By Andy Home

LONDON, Oct (KOSDAQ: 039200.KQ - news) 1 (Reuters) - London Metal Exchange (LME) copper stocks (MCUSTX-TOTAL (NYSE: TOT - news) ) fell yesterday. Just as they did last Friday and the day before that. In fact, LME inventory has now fallen for 19 consecutive days. At 533,325 tonnes, it is the lowest it has been since the middle of March.

It's not just the LME. Duty-paid copper stocks registered with the Shanghai Futures Exchange (SHFE) (CU-STX (KSE: 011810.KS - news) -SGH) have fallen to 18-month lows. Those in the COMEX warehouse system in the United States (HG-STX-COMEX) are at levels last seen almost five years ago.

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Against such a backdrop of vanishing physical inventory, producers are positioning themselves for an aggressive round of premium increases on term shipments next year.

Japanese smelters are proposing a 45-percent hike to $123 per tonne over LME cash for Chinese customers. In Europe, German producer Aurubis (Berlin: NDA.BE - news) is going for a 22-percent jump to $105 per tonne.

Codelco, the Chilean producer that sets the global benchmark, is still playing coy but with others already showing their hands, it's really only a question of how hefty an increase it's going to target.

All of which seems a strangely bullish outcome for a market that just about every analyst agrees is entering a period of structural oversupply.

So where has the much-touted surplus gone? Was it ever there? Is it there now? And if it is, why can't we see it?

SHANGHAI GLOOM

The International Copper Study Group's (ICSG) latest assessment is that the global refined copper market notched up a seasonally adjusted surplus of 183,000 tonnes in the first half of this year.

The only problem with that statement is that the world almost certainly didn't record anything like that size of surplus. Indeed, it may not have been in surplus at all.

Once again, the ICSG's calculations have been muddied by the statistical gloom that envelops the metal sitting in Shanghai's bonded zone.

Last year the problem was differentiating between metal heading into China to meet end-user demand and metal simply piling up in Shanghai. Chinese import figures, alas, do not provide a neat breakdown.

At its spring 2013 meeting the ICSG conceded that if it allowed for anecdotal reports of a 600,000-tonne build in such "hidden" Shanghai inventory, its assessment of last year's market balance would shift from a deficit of 400,000 tonnes to a surplus of 200,000 tonnes. Quite a big difference, isn't it?

This year the reverse has happened with Chinese imports collapsing by 30 percent in the first half of the year as mainland users tapped that Shanghai copper mountain.

Apparent, and it's hard to overstate the importance of that word, Chinese demand was therefore assessed as contracting by 0.3 percent in the first half of 2013.

Obviously, factor in unreported stocks draw and that calculation changes. A lot.

If this were another country, it wouldn't make much difference to the global picture. But it's China, the world's largest single driver of copper usage growth.

NOW YOU SEE IT

Compounding the statistical opacity in Shanghai was the fact that visible inventory, particularly that registered with the LME, ballooned over the first half of this year.

LME stocks increased by 342,000 tonnes between the start of January and the end of June, reinforcing a perception of apparent surplus.

Yet this was far from a natural flow of spare units into the market of "last resort". Rather, the metal was drawn to the LME system by the magnetic pull of "freight incentives" offered by LME warehouse operators.

Some 618,000 tonnes were warranted in the LME system in the first half of 2013 but just three locations accounted for almost 90 percent of that flow; Johor in Malaysia (46 percent), New Orleans (26 percent) and Antwerp in Belgium (16 percent).

LME storage in all three is dominated by the new breed of merchant-warehouser so no big surprise that much of what went in was swiftly cancelled to join a queue to leave again.

And as we all know by now, LME queues mean higher physical premiums.

As Chinese buyers found out when the readily available part of the Shanghai bonded stocks mountain was exhausted and the focus shifted back to the international market, resulting in accelerated imports from June onwards.

By the end of July they were paying over $200 per tonne, compared with the $105 negotiated with Codelco on term shipments.

Similarly, with South Korea's state stockpile manager, the PPS, which paid $213.75 at its last tender.

At the start of the year it was buying copper at premiums below $100. *********************************************************** Graphic on exchange stocks of copper in 2013: http://link.reuters.com/mek53v ***********************************************************

NOW YOU DON'T

Not that many producers are going to be complaining to the LME about its warehouse system. All of them are going to reap the benefits in the form of much higher premiums on their sales next year.

The argument for higher premiums is strengthened by the steady downtrend in LME stocks from their incentive-inflated highs around the middle of the year.

But just as the early-2013 mushrooming of visible inventory was a false signal of market surplus, so there is the danger that the current signal of market tightness may be equally misleading.

It's noticeable that fresh warranting in the LME system has dropped several gears in recent weeks. Total inflow over the course of September was just 30,000 tonnes.

More significantly, the flow has become ever more two-dimensional. With the exception of a trickle of metal onto warrant in Rotterdam, just about everything that has "arrived" has done so at Johor and New Orleans.

And as my colleague Josephine Mason has reported, New Orleans is becoming a "black hole" for copper just as it has for many years been for the zinc market.

A physical "black hole", situated as it is away from any major concentration of consumption. And a statistical "black hole", where LME stock movements denote nothing other than the latest move on the global premium chess board.

SHADOW LAND

But then, as Guy Wolf, global head of market analytics at Marex Spectron, wrote in a note on the copper market on Monday: "We merely note that the correlation between warehouse stocks and price changes in recent years has statistically been no different from zero".

In part that's because of the growing importance of what we can't see in the Shanghai bonded zone. And more recently, it's because what we can see is being hopefully distorted through the prism of the queue machinations of the merchant-warehousers.

The combined effect is to mask this market's true dynamics. Was it really in surplus in the first half of 2013? Just possibly, but probably not.

Is it in surplus now? More likely but if it is, the extra units are piling up somewhere they can't be seen and counted.

Will it be in surplus tomorrow? Of that there is no doubt, given the explosive 10-percent growth in mined production over the first half of the year, merely the edge of the coming wall of supply.

It's just a matter of time. Probably just as soon as the world's producers lock in both high conversion charges for treating mine concentrates and high premiums for selling their output.

Now, whether you'll "see" the surplus. That's a different question altogether. (Editing by Jason Neely)