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COLUMN-Dr Copper has left the building: Andy Home

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

By Andy Home

LONDON, April 3 (Reuters) - Markets like a nice, simple storyline. None more so than the copper market, where complexity has historically been distilled into the one-dimensional character of Dr Copper, the supposed repository of all knowledge about global manufacturing.

And at a headline level the spring forecast from the International Copper Study Group (ICSG) duly obliges by providing a suitably neat narrative.

The first of the Group's twice-yearly statistical road-maps reinforces the current consensus of a market that this year finally turns the corner from persistent production deficit to surplus.

This is not exactly earth-shattering stuff. Everyone knows that after years of underperformance copper mine production is finally coming good, up 8.0 percent last year, according to the ICSG.

As increased mine supply trickles down the production chain, it will result in higher refined metal output. The ICSG is forecasting increases of 6.5 percent this year and another 4.3 percent in 2015, underpinning its forecast for two consecutive years of surplus.

The problem with this straightforward story, though, is that it doesn't shed much light on the day-to-day reality of trading copper.

The current copper market is complex, messy and increasingly opaque. And there's little prospect of that changing any time soon.


This is in large part due to the evolution of the copper market itself.

Once there was just COMEX for parts of the North American market, and the London Metal Exchange (LME) for everywhere else. Then along came the Shanghai Futures Exchange to triangulate the two international pricing points with the domestic Chinese market.

All three, however, are now being eclipsed by a fourth market-place for copper, the bonded warehouse zone in Shanghai.

It has become the world's largest single concentration of refined copper inventory, much of it pledged as collateral in China's shadow credit market

There are currently estimated to be around 800,000-850,000 tonnes of bonded copper, almost double the 443,000 tonnes held by the big three exchanges combined at the end of March.

The Shanghai bonded zone has become the copper market of first resort, both for international suppliers and domestic producers, who are currently "exporting" copper into it.

Changes in Shanghai bonded inventory rather than exchange-held inventory have become the most important gauge of real-time supply-demand dynamics.

To be fair, the ICSG recognises this, now including an assessment of such changes, based on the average of three consultants' input.

Factoring in shifts in the size of this statistically opaque copper mountain significantly alters the ICSG's market balance calculations, as shown in this graphic.

^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^ Graphic on ICSG market balances, with and without changes in Shanghai bonded stocks: ^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^

Copper market history suddenly looks a lot less straightforward, particularly over the last couple of years.

This is not just statistical hair-splitting.

The fourth copper market is exerting an increasingly powerful influence on outright price, spreads and physical premiums in the rest of the world.

The collapse in copper prices last month was triggered by fears of contagion from China's first corporate bond default to the credit networks running beneath the Shanghai bonded stocks mountain.

The continued accumulation of free units in Shanghai bonded storage explains why the LME forward curve has been and still is in backwardation.

The physical premium for Shanghai bonded metal is becoming ever more significant a factor in the global premium structure.


Whether the global copper market is in surplus or not becomes of secondary importance to the question of where that surplus is at any point in time.

Right now, it is in Shanghai and until that changes LME spreads are going to remain volatile and physical premiums everywhere else are going to be firmly supported.

This global distortion is exacerbated by localised distortion within the LME warehouse system <0#MCUSTX-LOC>. ^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^ Current distribution of LME open copper tonnage: ^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^

Much of the tonnage previously sitting in Asian locations, particularly Johor in Malaysia, has been sucked into the fourth market-place that is the Shanghai bonded zone.

Open tonnage within the LME system has become increasingly concentrated on just two locations, Antwerp in Belgium and New Orleans in the United States. Between them they account for 91 percent of all "live" LME warrants.

Moreover, the situation at New Orleans is compounded by the fact the 99,700 tonnes of "available" copper are stuck behind 72,800 tonnes of cancelled copper awaiting load-out.

COMEX stocks are not currently offering much in the way of alternative options. Its registered warehouses held just 18,114 tonnes at the end of March.

Buyers beware!

If consumers outside of China need to tap exchange stocks, it's pretty clear that there is going to be a price to pay in the form of physical premium.

This is particularly pertinent since manufacturing demand for copper outside of China is widely expected to improve this year. The ICSG's own forecasts are for demand growth to accelerate from 1.6 percent in 2013 to 2.0 percent this year and to 2.5 percent in 2015.


Such is the current fractured state of the global copper market. It is a landscape that favours physical players over futures players, arbitrageurs over price punters.

Copper is hardly alone in this regard. Aluminium offers an even more extreme example of market volatility shifting from the basis LME price to the physical premium to the point that CME, owner of COMEX, is poised to launch a new "all-in" aluminium price contract.

Moreover, as my colleague John Kemp pointed out in a column on Wednesday, the same dynamics are playing out across the broader commodities spectrum, driving a general retreat by funds and their banking brokers from the arena.

The days of easy investor profits in copper and other commodities are over. Prior to the March shake-out, LME three-month copper had spent months oscillating in a tight $6,900-$7,500 range, the sort of trading pattern that only black-box and algo players can hope to make money from.

The "real" directional price action was taking place in the physical markets and it still is, right now in the form of a sliding premium for Shanghai bonded material.

Which is why a new generation of physical merchants is bidding to join the likes of Glencore, Trafigura and Noble Group (Frankfurt: N2X.F - news) as the Wall Street heavyweights beat their retreat.

And which is why, if you're expecting a nice straightforward story from Dr Copper, that famed professor of global manufacturing activity, you're going to be disappointed.

This is becoming a far more complex and therefore less readable market, one that defies a binary division between deficit or surplus.

Dr Copper has left the building. He may return, but don't hold your breath.

(Editing by Keiron Henderson)