Coming copper supply crunch supportive of strong prices - VM Group

In its latest analysis of metals supply and demand the VM Group, on behalf of BNP Paribas and Fortis Banks, takes a hard look at copper and its price prospects as the month's featured metal.

LONDON - 

The BNP Paribas Fortis/VM Group Metals Monthly for October has just been published giving the Group's analysts' views  of the short and longer term outlook for precious and base metals and price forecasts, as well as an update of hedge fund performance.  

While there is relatively sparse detail on most of the specific metals covered, the latest report takes a particularly close look at the copper sector and concludes, primarily, that copper prices have been supported by continuing strong import figures from China, the key driver of the markets since the bottom dropped out of the metals sector a year ago. 

China likes to surprise, say the analysts, and with unwrought copper and copper products imports increasing month-on-month in September, against consensus forecasts of decline, the copper rally received a welcome boost.  While they feel that OECD demand recovery is still crucial for the copper price to continue its march, at least Chinese

demand will likely cap declines as long as the speculative element in Chinese consumption remains under control.

Metals price performance over the past month, though, has to an extent been dominated by the falling dollar and despite a previously less bearish view of the greenback, the analysts feel that there has been a recent shift in global perceptions towards the dollar.  Now they feel that the dollar decline looks set to continue while the US government's budget remains apparently in considerable turmoil and destined to

get worse.  Even so they feel that a short-term reversal is still likely at some point and metals prices (especially gold and silver) should react negatively accordingly.  Yesterday's gold price dip - and corresponding fall in other commodity prices suggests this may be currently in progress.

VM looks at copper price prospects for the remainder of the year as being uncertain, with a price correction being overdue.  The drivers for continuing strength are the ups and downs in Chinese demand and the strength and rapidity of OECD nations recovery, if indeed it is really happening.  "How these dynamics shape up in Q4 2009 will help determine whether or not copper ends this year with a bang, or a whimper." say the Group's analysts. 

Recently sentiment has been strong which has been an important factor in maintaining high price levels, boosted by China's import figures, even though some observers think that the price levels are not justified by current realities.  But this aside, VM reckons the medium and long term outlook for the metal remain positive.

There is a perception, say the analysts, that the U.S., by far the most important Western copper consumer, is coming out of recession although the shape and speed of any recovery remains, to say the least, uncertain.  They point out that there has been a huge change in sentiment since the beginning of the year when a Reuters poll of analysts suggested the copper price this year would average $3,417/t. The same poll found that the average forecast for the copper market balance in 2009 was for a world

surplus of almost 325,000t. A refreshed Reuters poll in early October saw that average price at a much higher level, approaching $5,000/t, while the projections for a surplus have now turned into a deficit.

But, VM warns, this deficit is a virtual one as it has only arisen because of the huge Chinese restocking programme and, to an extent, a build-up in speculative stocks.

The market is thus gambling on these stocks not coming back onto the market and the longer China holds on to them the tighter the market will be assuming the West truly is coming out of the recession.

Because the mining industry has found it extremely difficult to raise capital for new project development, future supply replacement has been badly hit building up potential output shortages ahead, with many of the few large new projects in areas of much higher risk. 

Also some existing large surface mines will be forced to move underground chasing reserves leading to ever higher capital costs for development and resource maintenance which in turn will require higher prices for the mines to stay profitable.  "The only way" the analysts reckon "of ensuring that these new and much more risky major projects get into production is for copper prices to stay much higher than has previously been the case. But in the short-term, all indicators point to a period in which this rally either pauses for breath, or retreats."

Back to the current situation.  The copper price strength has been almost entirely due to Chinese imports, but there are signs that restocking is beginning to slow down with imports losing some of their momentum which means an OECD nation demand pick-up may be essential to maintain prices in the short term.

"We have argued consistently" says VM "that the copper price rally has overshot underlying fundamentals in 2009. We base this on the premise that at some point Chinese demand will slip below the recent record levels, and that when this happens the price would correct. However, there remains the chance that Chinese demand will stay strong until OECD demand picks up." 

Should western demand continue to disappoint and Chinese demand stabilise, then the analysts feel that the copper price could slip back to around $5,000/tonne ($2.27/lb), but if signals remain mixed, as they appear to be at the moment then speculative buying could maintain prices nearer  the $6,000/tonne level. 

Even though Western recovery may be stumbling along in second gear, as the analysts put it, the lack of investment in new mines and expansions in the recent past, coupled with the current capital raising difficulties being experienced by the mining industry, are paving the way for severe shortages, and much higher prices,  ahead.  Even if all current major planned and proposed projects come on stream, and that is a very big if, at current projected growth rates it is possible the industry could move to a small surplus in 10 years time.  But with the new developments, as noted above, often in areas of far higher risk there remains the likelihood that the supply/demand situation will remain tight leading to a robust price scenario for much of the foreseeable future.

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