Faith in China Remains in Hearts of Copper Bulls

Copper investors are firmly focused on China, rather than Europe, for clues on the red metal’s long-term outlook, but in the near term Europe’s woes continue to bear down on market appetite. The question now is as much about whether Chinese growth can offset declines elsewhere, and what Beijing can and will do to ensure steady growth, as it is about the impact of the Eurozone’s financial crisis on international markets. 

Amid all the uncertainty, one fact remains true: China is still the world’s largest consumer of copper, accounting for over 40 percent of the market, and its position is unlikely to change. In fact, the second-largest importer of copper is Japan, followed by India and South Korea, with Germany coming in at fifth place, according to the International Copper Study Group. That hierarchy, along with expectations that the Eurozone’s debt crisis will have a less significant impact on global copper demand than the Chinese economy, has led many analysts to downplay the ongoing turmoil in European markets. Clearly, the drivers of the copper market are, and will remain, emerging markets rather than the United States or Europe.

Chinese authorities have certainly demonstrated that they are prepared to take concrete steps to ensure growth, moving forward with a quarter percentage point cut in key rates last week. The first rate cut since 2008 was welcomed by investors. The fact that Chinese exports soared 15.3 percent in May from the same period a year ago, compared to a 4.9 percent increase in April, highlights the country’s resilience in the face of a global economic downturn. With further monetary easing expected from Beijing in the coming months, investors see China leading the way in bolstering demand for copper and other base metals.

So while Goldman Sachs and other investment banks lowered their three-month price targets for base metals this week, the outlook is bullish in the longer term as demand for industrial materials is expected to rise. For now, Goldman has reduced its price target for copper to $8,000 per metric ton from $9,000 a ton, while Societe Generale has dropped its copper outlook to $8,000 per metric ton from $8,220 as anxiety about the spillover effect of the Eurozone’s struggles persist.

“The precarious situation in Europe and scope for instability to spread wider afield, together with slowing growth in the U.S. and China, all add up to form a significant headwind to the copper market,” said Societe Generale analyst Robin Bhar.

Yet Goldman expects the copper market to be balanced later this year as supply tightens, stating that “given continuing disappointments in the supply growth of oil and some of the key base metals, this moderate pace of world economic growth is sufficient to tighten markets during the second half of this year, creating the need for higher prices to balance supply and demand.”

That sentiment was echoed by Jeffery Born, a finance professor at Northeastern University’s College of Business Administration in Boston, who argued that “it is important to note that copper inventories have fallen dramatically, particularly in London, in the past year. Thus, when economic growth prospects do improve and firms start increasing orders we should expect copper prices to rebound sharply and quickly. So today’s gloom is setting the stage for a real profit opportunity – perhaps as early as the fall.”

Others, however, are less enthused about the impact of the latest Chinese rate cut and further potential easing.

“The commodities market is most related to construction while the largest construction projects are mostly completed by now in China. The rate cut will help consumption – GM posted strong sales in China in May – but the demand of commodities in China will continue to soften as the economy moves into a new phase of development,” said Linghui Tang, associate professor at the College of New Jersey’s School of Business. She added that “China has invested a tremendous amount of capital in infrastructure in the past 10 to 15 years. As stated in its 13th five-year plan (2011-2016), the main focus now is to increase the quality of life. The main use of copper is in electricity grids. This part of infrastructure has been completely updated in China and its future demand is likely to be weak. Therefore, the rate cut will not lead to a significant increase in demand of copper.”

Tang’s colleague at the College of New Jersey, Susan Hume, cautioned that in the past low interest rates have produced asset bubbles, and said copper prices are likely to remain weak regardless of Chinese action, a trend that “can be seen in commodity-driven countries such as Australia, which have weaker currencies due to reliance on copper.”

At a time when major mining groups including Rio Tinto (ASX:RIO,NYSE:RIO,LSE:RIO) and BHP Billiton (ASX:BHP,NYSE:BHP,LSE:BLT) are looking to cut back on investing in copper mega-projects, the question remains as to whether miners that are holding back from developing new sites are being overly cautious or making sound investment judgments.

Securities Disclosure: I, Shihoko Goto, hold no direct investment interest in any company mentioned in this article.