Copper market fundamentals and its relative position in the commodity space

GEOFF CANDY:  Welcome to this week's edition of Mineweb.com's Metals Weekly podcast.  Joining me on the line is Ben Westmore - he's a commodity economist at National Australia Bank.  Ben there's been a lot of news happening in the copper market.  On the corporate front we've had Barrick Gold which is the largest gold miner in the world, bidding for Equinox Minerals - a copper producer that's raised a lot of eyebrows in both the copper and gold spaces.  We've also had continuing concerns around growth in the US, growth in Europe and particularly the longer term implications of Japan - if we take a step back and look at where we see the copper market at the moment, how does the landscape look?

BEN WESTMORE:  If we look at the landscape there's no doubt that we're facing a pretty wide deficit in the physical copper market through to 2011.  Most analysts put estimates at about a 300 to 500 tonne deficit in the market.  A lot of that has been priced into the market and when we've seen in the last six months the copper price rise very strongly - there have been some concerns on supply side couple with that already very tight market expectation - and those have been listed as main reasons in broad terms why we've seen the seemingly rising copper prices.

GEOFF CANDY:  One of the slightly murkier areas of the copper market is exactly what's going on in China and the level of import, the level of stocking and destocking going on - and perhaps an arbitrage between LME prices and Chinese and/or Shanghai prices - is there any way to gauge exactly what's going on in China at the moment?

BEN WESTMORE:  On the arbitrage opportunity at the moment that we know looks to have closed anyway - it just doesn't look like it's a profitable arbitrage at the moment and that's been evidenced on import data into China and we know although these numbers tend to be influenced by the advent of China's new year - in the first two or three months of this year - China and Japan's consumption of copper eased and then we saw a decline in net imports of both refined copper and copper ores and concentrates - so that's one thing.  On the Chinese data front more generally, the manufacturing sector and industrial production continues to be strong, but we have seen the PMI surveys from China easing since the end of 2010 and all these things culminating in some weakness in the expectation for demand - in the short term anyway for copper demand from China and that's why in the last month you're seeing copper prices being fairly flat.  But the unknown is the size of China's stocks in bonded warehouses and a lot of that's being attributed to non-mining companies holding copper as collateral for financing deals.  We saw at the CESCO (Centre for Copper and Mining Studies) conference in Santiago, putting those stocks at around 500,000 tonnes in China alone - so there are a few unknowns but it does look like demand in the short term for copper has eased somewhat in the last couple of months.

GEOFF CANDY:  How important is what's happening at a macroeconomic level in the US and in Europe in particular - obviously China the big driver of the copper market - but clearly these other markets will have an impact on demand and supply?

BEN WESTMORE:  They do and they're probably likely to have a bigger impact going forward so if we look at the US construction sector, it's still very weak and so demand for copper and demand for other base metals that are intensively used in production has continued to be relatively anaemic.  Also in Europe, although we have seen surprisingly strong growth in the core European economies - those being Germany in particular but also France and to a lesser extent Italy - there is still significant weakness in those fiscal headwinds going forward are likely to cause growth to be pretty weak in the next few years.  But now and given the market seems to have factored in pretty strong demand from China going forward, the swing factor almost becomes those developed world economies and if we were to see a sharper than expected turnaround in the US construction sector, and demand for metals, that would be the thing that is likely to have an upward influence on the copper price.

GEOFF CANDY:  Just one last point on this, if we look at what's been priced into the copper market, there has clearly been a significant deficit being priced in, and that's largely attributable to increasing demand on the one side, and the lack of big projects coming on stream partly as a result of what happened in 2008 and just partly a result of a lack of big projects - where do we sit now given that demand has come off slightly?  Are we still likely to see as big a deficit or as big a supply squeeze on the shorter to medium term?

BEN WESTMORE:  In the last few months you have seen further issues on the supply side - the declining ore grades in many copper mines is well known, but in Peru with the Tia Maria project and also in the Philippines with the Tampakan project - we've seen further delays.  There have also been some operating delays in Chile as a result of heavier than expected rains and I don't think that these events have caused the markets or caused companies to revise their forecast for the deficit too much - but it doesn't help what already looks like a burgeoning deficit over the next year and so although it has been priced in, those sort of continuing supply side issues are what's keeping the copper prices well supported at these high levels relative to history.

GEOFF CANDY:  And do you think that's relative to continue?

BEN WESTMORE:  Yes - there's nothing coming online in the near future that's likely to reverse that deficit situation and over 2012 it's likely to be a smaller deficit than 2011, but we're still likely to see the market being very tight - however, when we get out to 2013 - 2014 that's when the extra supply and extra capacity is likely to come online and that's when you're likely to have a decline in prices as a result.

GEOFF CANDY:  Just looking at the relative value of copper to the other metals, and in particular to the other base metals, but gold as well - given what happened with Barrick and looking at Equinox Minerals, it did raise a few issues with regard to the relative value between gold and copper - is that something you watch and is there anything to read into that or is this nothing more than an opportunistic deal on Barrick's part?

BEN WESTMORE:  It's mostly an opportunistic deal - one thing that we do look at closely is copper's price relative to the other metals that can be used as substitutes - aluminium is a key one.  Look at the copper to aluminium price differential - that's continued to rise in the last six to 12 months and almost at unprecedented levels at the moment.  So at these sort of levels you would expect to see some substitution of other metals, for copper - but we haven't seen that as yet and it's more an academic exercise at the moment than anything we've seen in the physical market.

GEOFF CANDY:  Why do you think that is the case - why do you think there hasn't been as much substitution as people were expecting?

BEN WESTMORE:  It's difficult to say and part of it is - we have seen one thing in LME warehouses in particular - strong build in copper stocks and there may be one indication that we are seeing some sort of substitution.  But if we look at China and if we look at many of the other markets it might just be that because demand is growing so strongly, there is at some level substitution that we can't see in the aggregate data because all these metals are growing at very strong levels.

GEOFF CANDY:  Just finally to close off then - if we look at all these issues that we've been speaking about, so you still like copper in comparison to the rest of the base metals, or is it something that you're thinking is getting a bit toward the peak at this stage?

BEN WESTMORE:  We're forecasting of the base metals, copper to ease over 2012 in terms of prices and that's a similar trend to what we have in our forecast for many of the base metals - but copper and if you just look at the recent price gains as an indication has been the one that probably has had the most to lose.  But we've still got continued demand growth pencilled into our forecasts especially from the Asian region, and as I've said, that deficit over the next two years is likely to continue - we'll continue to support copper prices.  So although we're not expecting a strong appreciation and we are expecting some easing in prices - it's comparatively mild and prices are likely to remain well above their long run average levels.

(Source: http://www.mineweb.com/mineweb/view/mineweb/en/page96985?oid=126231&sn=2010+Detail&pid=102055)