Copper

Economic Bellwether
Executive Summary
LME Copper
11,000
US$ /to n

10,000 9,000 8,000 7,000 6,000 5,000 Oct-10 Dec-10 Feb-11 Jun-10 Aug-10 Apr-11 Jun-11

Post-credit crisis in 2008-09, copper prices have managed resurgence from abysmal lows of US$3,000/ton in late 2008 to panoramic highs of US$10,000/ton in 2011. Hefty restocking by the Chinese, quantitative easing by the various economies and supply-related issues helped lift prices to life time highs. Copper prices quintessentially coined as a bellwether of the global economy, continue to reflect the health of the industrial and manufacturing activity across various geographies, with the metal widely consumed across building/construction, electrical & engineering sectors. In this report we discuss the various aspects pertaining to global demand/supply, seasonal trends, macroeconomic indicators and effectively what is in store for the prices for the next few months. Over the long term, copper prices are certainly supported by supply constraints. However, in the short-medium term, the prevalent economic backdrop and softening Chinese demand raises questions regarding the sustainability of such high prices. In this respect, we deem that fundamentals are not conducive for the bulls and infer LME copper prices to test US$8,300-US$8,500/ton till July end. Effectively, we advocate not going long and prefer to sell at highs. Exhibit 1: Copper fundamentals snapshot

Source: Bloomberg

MCX Copper
500 450 400 350 300 250 Oct-10 Feb-11 Jun-10 Dec-10 Aug-10 Apr-11 Jun-11 Rs/kg

Refined Production 21,000 20,000 19,000 '000 tons

Consumption

LME Avg Price US$/ton 10,000

Source: Bloomberg

9,000

8,000 18,000 7,000 17,000 16,000 15,000 2006 2007 2008 2009 2010 2011(f)
Source: Bloomberg, India Infoline Research Note: 2011 average prices are computed till end of May.

6,000

5,000

Research Analyst
research@indiainfoline.com June 16, 2011

Hitesh Jain

Copper

Supply Bottleneck
As primary copper production starts with the mining of ore, the mine output is considered as an important variable in determining the global supply of the metal.
World mine production has seen a meager CAGR of 1.8% during 200610, which is considered very low as compared with the growth in demand

World mine production has risen at a meager CAGR of 1.8% during 2006-10, which is considered very low as compared with the growth in global demand. In 2010, global production stood at 16.1mn tons, while for 2011 it is forecast to reach 16.83mn tons. Exhibit 2: Global mine production
17,000

2006 2007 2008 2009 2010 2011(f)

Mine Production (000 tons) 14,990 15,483 15,546 15,950 16,097 16,833

% Chg (yoy) 3.3 0.4 2.6 0.9 4.6

'000 tons

16,500 16,000 15,500 15,000 14,500 14,000 2006 2007 2008 2009 2010 2011(f)

Source: ICSG, India Infoline Research

Latin American mine output, which accounts for 44% of the global production declined by 0.4% in 2010, on a yoy basis.

As seen in Exhibit 3, the growth in regional mine production in 2010 has at a very slow rate as compared to the growth in demand for the metal. Latin American mine output, which accounts for 44% of the global production declined by 0.4% in 2010, on a yoy basis. Asian output remained literally stagnant, with growth rate in 2010 as flat as 0.2% yoy. Asia accounts for 20% of the global output. Mine output in North America & Oceania has declined by 0.9% and 16.2% yoy respectively during 2010. Meanwhile, output in Europe & Africa grew at 3% and 10% respectively during the same period. Globally, declining mine capacity utilization, perennial labour issues and other supply bottlenecks are restraining the growth in mine output, hence aggravating the mismatch between demand and supply. Exhibit 3: Region-wise mine production
8,000 '000 tons 2009 2010 2011(f)

Asian mine output which accounts for 20% of the global production remained literally stagnant, with growth rate in 2010 registered as flat as 0.2% yoy.

6,000

4,000

2,000

0 Africa North Latin Europe America America Asia Oceania

Source: ICSG, India Infoline Research

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As discussed above, global mine capacity utilization rates have been constantly declining. In this context, utilization rates have declined from 92.5% in 2005 to 80.9% in 2010.
Chronic labour strikes in Latin America & energy issues thwart the optimum utilization of the mine production capacity.

Chronic labour strikes in Latin America, supply disruptions & energy issues thwart the optimum utilization of the production capacity. For instance, Chile which produces 34% of the world mined copper has a perennial problem of water shortage, which adversely impacts utilization rates. Moreover, frequent earthquakes in the Latin American region also lead to temporary shutdown of mines, effectively impacting production. Exhibit 4: Global mine capacity utilisation
96% 91% 86% 81% 76% 71% 2005 2006 2007 2008 2009 2010

Source: ICSG, India Infoline Research Global refined copper production rose at a CAGR of 2.5% during 2006-10, which is not commensurate with the growth in the demand for the metal.

Global refined copper production has risen at a CAGR of 2.5% during 2006-10, which is not commensurate with the growth in the demand for the metal. Refined output has grown at a better pace post-2009, thanks to better availability of scrap and increasing share of secondary production in the total refined output. However, shortage of copper ore and concentrate and dwindling share of primary production still restrain the growth in the refined output. In 2010, global refined output stood at 19.07mn tons, while for 2011 it is forecast to reach 19.72mn tons, a 3.4% rise yoy.

2006 2007 2008 2009 2010 2011(f)

Refined Production (000 tons) 17,291 17,934 18,226 18,278 19,075 19,724

Exhibit 5: Global refined copper production

% Chg (yoy) 3.7 1.6 0.3 4.4 3.4

20,000

'000 tons

19,000

18,000

17,000

16,000 2006 2007 2008 2009 2010 2011(f)

Source: ICSG, India Infoline Research

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Asian refined output contributing 45% to the global production grew by 7% year-on-year in 2010.

Asian refined output contributing 45% to the global production grew by 7% yoy in 2010. This can be attributed to adequate refinery capacity in China, which alone contributes 23% to the global refined output. Here, one needs to understand that healthy growth in Asian output gets offset by the rapid growth in demand for the metal from the Chinese counterparts. Incongruously, Latin American output which contributes 20% to the global refined production, declined by 0.9% in 2010, on a yoy basis. In this respect, Latin American region is prone to labour issues and supply disruptions. Declining output from North America, Europe and Oceania was registered in 2010, as compared with the previous year. Europe, North America & Oceania contribute 19%, 9%, and 2% to the global output respectively. African output grew at 22.9% yoy in 2010, but contributes a mere 5% to the global output. Exhibit 6: Regional refined copper production
10,000 '000 tons 8,000 6,000 4,000 2,000 0 Africa N. Latin Europe America America Asia Oceania 2009 2010 2011(f)

Latin American output which contributes 20% to the global refined production, declined by 0.9% in 2010, on a yoy basis.

Source: ICSG, India Infoline Research

Refined copper production derived from scrap is known as secondary production, whereas, refined copper production derived from mine output is known as primary production. Over the last decade, the contribution of scrap recycling to the global refined output has increased immensely. In 2001, scrap recycling contributed 12% to the global output, while in 2010 it contributed 18%. Hence it signifies to an extent, that secondary production has helped in augmenting the growth in global refined output, rather than solely depending on the mine output. Exhibit 7: Growth in secondary production
Secondary Production
Secondary production has helped in augmenting the growth in global refined output, rather than solely depending on the mine output.

3,850 3,300 2,750 2,200 1,650 1,100 550 0

'000 tons

Scrap Contribution (%) % 18 17 16 15 14 13 12 11 10

2001

2002

2003

2004

2005

2006

2007

2008

2009

Source: ICSG, India Infoline Research

Commodity Report

2010

Copper

Global copper refinery capacity utilization rates have been steadily declining. In 2005, refinery utilization rate stood at 86.5%, which declined to low levels of 77.4% in 2009. In 2010, refinery utilization rates stood at 79.8%. Declining rates clearly indicate the magnitude of the refinery bottleneck, where the mine output is unable to convert into refined output at its optimum levels. Exhibit 8: Global refinery capacity utilisation
88
Declining rates clearly indicate the magnitude of the refinery bottleneck.

86 84 82 80 78 76 74 72 2005 2006 2007 2008 2009 2010

Source: ICSG, India Infoline Research

At the end of 2010, global stocks were equivalent to 3.5 weeks of consumption.

Global refined copper stocks including producer/consumer and warehouse stocks undergo constant change, depending upon the demand supply equation. As seen in Exhibit 9, global buffer stocks at the end of 2009 were equivalent to 29 days of consumption. During 2010, supplies tightened and demand strengthened, with the end of the year buffer stocks reported at 3.5 weeks of consumption. The composition of the global refined stocks has also changed to a drastic extent. LME stocks accounted for 10% of the total global refined stocks in 2005, which radically increased to 35% in 2009. At the end of 2010, the contribution of LME stocks stood at 29%. Similarly, SHFE copper stocks weightage has gone up from 7% in 2005 to 10% in 2010. COMEX stocks weightage has changed from 0.79% in 2005 to 5% in 2010. Meanwhile, the decline in the weightage of producer/consumer stocks is alarming, from 82% in 2005 to 55% in 2010. Such trends clearly indicate increasing influence of exchange warehouses in determining the nature of supply tightness. Exhibit 9: Global refined stocks
Producer/Consumer SHFE stocks Days of Consumption 100% LME stocks COMEX Stocks 35 30 25 20 15 10 2005 2006 2007 2008 2009 2010

There is increasing influence of exchange warehouses in determining nature of supply tightness.

80% 60% 40% 20% 0%

Source: ICSG, India Infoline Research

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Copper

World Consumption China the driver

Over the past few years, global copper consumption has witnessed an overall uptrend, except a moderate decline in 2008 and 2009 due to global credit crisis. Sustained growth in copper consumption is attributed to burgeoning economic growth in China. Chinese demand recorded a CAGR of 20.05% during 2006-10, which effectively lifted global demand from 17mn tons in 2006 to 19.3mn tons in 2010. Global consumption of refined copper has witnessed a CAGR of 3.2% during 2006-10. World copper usage in 2011 is projected to reach 20mn tons, 4% increase yoy. Exhibit 10: Global refined copper consumption
21,000 20,000
Global consumption of refined copper rose at a CAGR of 3.2% during 200610.

'000 tons

19,000 18,000 17,000 16,000 15,000 2006 2007 2008 2009 2010 2011(f)

Source: ICSG, India Infoline Research

Region-wise, Asia leads in terms of regional copper consumption, driven by strong demand growth registered in China over the recent years. China constitutes 40% of the global demand and 62% of the total Asian demand. Asia contributing 62% to the global demand grew at 5.8% in 2010, on a yoy basis. Similarly, European demand grew at 8.7%. Europe is the second largest consuming region, contributing 20% of global demand. North American demand grew at 6.5% yoy in 2010, while Latin American demand grew at an impressive 25.9%. Oceania and Africa witnessed a decline in demand by 1.2% & 4% respectively. Exhibit 11: Regional refined copper consumption
15,000
Asia contributing 62% to the global demand grew at 5.8% in 2010, on a yoy basis.

2009 '000 tons

2010

2011(f)

12,000 9,000 6,000 3,000 0 Africa N. Latin Europe America America Asia Oceania

Source: ICSG, India Infoline Research

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Copper

China constitutes 40% of the global demand and 62% of the total Asian demand.

Chinas consumption of copper has witnessed an impressive 20% CAGR during 2006-10. Demand doubled from 3.6mn tons in 2006 to 7.4mn tons in 2010. Urbanization and industrialization in mainland China has led to rapid escalation in demand for the metal Statistics clearly prove that the countrys consumption is a key variable in determining growth in global demand. In fact, market participants keep a constant eye on these numbers, as any variation can impact the price forecasts to a large extent. Exhibit 12: China demand
8,000 '000 tons

Chinas demand has risen at 20% CAGR during 2006-10

7,000 6,000 5,000 4,000 3,000 2,000 1,000 0 2006 2007 2008 2009 2010

Source: ICSG, India Infoline Research

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Global market balance

Coppers market balance continuously changes, as either supply or demand undergoes a drastic change. During the credit crisis period (2008-09), global copper markets had surplus close to 200,000 tons. However during 2010, market dynamics changed with a previous surplus transforming into a deficit of 250,000 tons. For 2011, a deficit of 378,000 tons is forecast. In 2012, the production deficit is projected to narrow to 279,000 tons, as growth in refined copper production is expected to exceed the growth in demand. Exhibit 13: Global demand-supply balance
350 250 150 50 (50) (150) (250) (350) (450)
2005 2006 2007 2008 2009 2010 2011(f) 2012(f)

'000 tons

Source: ICSG, India Infoline Research

Global demand/ supply scenario (000 tons)

2005 Supply Demand Balance 16,572 16,674 (102) 2006 17,291 17,034 257 2007 17,934 18,197 (263) 2008 18,226 18,039 187 2009 18,278 18,090 188 2010 19,075 19,324 (249) 2011(f) 19,724 20,102 (378) 2012(f) 20,686 20,965 (279)

Source: ICSG, India Infoline Research

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Current dynamics
Exhibit 14 clearly illustrates that the gap between Chinese demand and supply is on the persistent decline for the past one year. Effectively, Chinese refined copper imports also reflect the same story. In this respect, China has imported 756,199 tons of refined copper in the first 4 months of 2011, 29% lower as compared with the same period in 2010. We also infer that the third quarter of the calendar year is traditionally a weak period for Chinese demand; hence lower import numbers during this duration. The first two quarters of the calendar year registers the highest quantum of imports, due to Chinese restocking at the beginning of the year. Exhibit 14: Chinas demand - supply gap v/s imports
Supply Deficit 1,200
The third quarter of the calendar year is traditionally a weak period for Chinese demand; hence we also witness lower imports numbers during this duration.

Refined Copper Imports

'000 tons

1,000 800 600 400 200 0

Q1 08 Q2 08 Q3 08 Q4 08 Q1 09 Q2 09 Q3 09 Q4 09 Q1 10 Q2 10 Q3 10 Q4 10 Q1 11

Source: WBMS, Antaike, Bloomberg, India Infoline Research

LME stocks continue to be at comfortable levels of 475,000 tons, as compared with historical standards. Moreover, the cancelled warrants ratio to LME stocks is at abysmal low levels. Currently, cancelled warrants are equivalent to 4% of the total LME copper stocks. Cancelled warrants represent the quantum of stocks booked for delivery out of warehouses. In this respect, such a low ratio conveys signs of low off take from the warehouses, which would restrict the upside in LME prices for the near term. Exhibit 15: LME Copper stocks v/s cancelled warrants
600
LME Copper cancelled warrants stand at abysmal low of 4% percent of the total copper stocks, which conveys signs of low off take from the warehouses.

'000 Tons

Stocks

Can Warrant %

35 30 25 20

500 400 300 200 100 0

May-07 Mar-06 Oct-06 Feb-09 Jan-05 Dec-07 Aug-05 Nov-10 Sep-09 Apr-10 Jun-11 Jul-08

15 10 5 0

Source: Bloomberg, India Infoline Research

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Funds participation has played an active role in driving copper prices over the recent few years. As seen in Exhibit 16, the magnitude of non-commercial/speculative players holding long positions have dramatically increased during the end of 2009. In fact, copper prices have also witnessed a drastic surge from US$6,500/ton in November 2009 to US$10,000/ton in February 2011. However for the past few months, the gap between longs and shorts is dwindling at a rapid pace, indicating signs that long positions are being liquidated. Exhibit 16: Non commercial positions on COMEX Copper
Longs
For the past few months, the gap between longs and shorts is dwindling at a rapid pace, indicating signs that long positions are being liquidated.

Shorts

70 60 50 40 30 20 10

'000 Lots

LME Prices $/ton

12,000 10,000 8,000 6,000 4,000 2,000

0 0 Jan- Jun- Dec- Jun- Dec- Jun- Dec- Jun- Nov- May07 07 07 08 08 09 09 10 10 11
Source: CFTC, Bloomberg, India Infoline Research

As discussed above, Chinese imports of refined copper have declined for past few quarters. One of the most prominent reasons is unfavorable arbitrage between LME & SHFE copper prices. Since August 2010, LME Copper prices have been trading at premium to SHFE copper prices, effectively discouraging Chinese traders to import metal from the overseas markets. In the first week of June, LME copper was at a premium of Yuan300. Arbitrage is computed by incorporating 17% VAT into LME Copper prices and then figuring out the difference with SHFE prices. Exhibit 17: LME Shanghai copper arbitrage
One of the most prominent reasons for slowdown in Chinese copper imports is unfavorable arbitrage between LME & SHFE copper prices.

9,000 6,000 3,000 0 (3,000) (6,000) (9,000)

Yuan/ton

May-08

Oct-08

Feb-10

Mar-09

Jan-07

Jun-07

Nov-07

Source: ICSG, India Infoline Research

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Aug-09

Dec-10

Jun-11

Jul-10

10

Copper

Macro Indicators Stagnating & Declining Growth

Exhibit 18: Purchasing manufacturer index
70 China US UK Eurozone 12 60 8 4 0 40 (4) (8) 30 Jan-09 May-09 Sep-09 Jan-10 May-10 Sep-10 Jan-11 May-11
Source: Bloomberg, India Infoline Research

Exhibit 20: Industrial production

US China % UK Japan Eurozone

50

Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 2009 2009 2009 2009 2010 2010 2010 2010 2011

Exhibit 19: Real GDP

50 Japan Eurozone China UK US

Exhibit 21: US housing

900 750 New Home Sales Housing Starts

20 600 450 300 -40 Jan09 May09 Sep09 Jan10 May10 Sep10 Jan11 May11 150 Jan09 May09 Sep09 Jan10 May10 Sep10 Jan11 May11

-10

Source: Bloomberg, India Infoline Research

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Copper

Outlook
Over the long term, copper prices are certainly supported by supply constraints like declining mine & refinery capacity utilisation, global supply deficit, perennial labour issues in Latin America and low buffer stocks. However in the short-medium term perspective, the prevalent economic backdrop and softening Chinese demand raises questions regarding the sustainability of such high prices. Currently, copper prices seem to be influenced by currency-induced movement and persistent supply issues. However, we reckon that eventually the markets will shift focus to global economic slowdown concerns, which could effectively reduce the demand for the metal. There are certain variables, which we consider will exert downward pressure on Copper prices in the coming few months: Poor macro numbers Of late, macro-economic indicators across various geographies convey a clear picture of slowdown in manufacturing and industrial activity. In this respect, PMI (Purchasing Manufacturer Index) & Industrial Production numbers have been stagnant or declining for various major economies like China, US, UK, Japan and the Euro zone. GDP growth figures also reveal the same story. The housing industry in US, which is a major source of copper consumption, continues to flounder at abysmal levels. The employment scenario in the worlds largest economy is clearly exacerbating economic concerns, with unemployment close to 10% of the total workforce. Soft Chinese demand China has imported 756,199 tons of refined copper in first 4 months of 2011, 29% lower as compared with same period in 2010. Declining imports portray a picture of weakening domestic demand, especially considering the fact that first quarter of the calendar year is traditionally strong period for Chinese imports. LME inventories continue to increase, with stocks reported at comfortable 475,700 tons. The SHFE copper inventories have been declining of late with no favourable arbitrage between LME & Shanghai prices, which is effectively persuading Chinese consumers to utilise existing stockpiles. In addition, Chinese exports of copper cathode have increased sharply during Jan-Apr 2011, up by 124,000 tons as compared with the same period in 2010. In fact, the exports are equivalent to 16% of total refined imports, which signifies that a lot of metal which is imported is re-exported and not necessarily meant for domestic consumption. Tightening monetary policy Inflation appears be a monster. A number of economies are suffering and are committed to tame it. In this respect, further interest rate hikes cannot be ruled out. Meanwhile, quantitative easing seems to be phased out by various economic regimes and similarly there is less probability of an extension of QE2 by United States. Such a scenario does not seem congenial for commodity bulls to thrive, which in turn would effectively facilitate liquidation in the markets.

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Copper

Price Outlook The third quarter of any calendar year is historically a lull period for base metals, especially considering the summer slowdown in the northern hemisphere (Europe, US), where the industrial activity is reported at very low levels. In a holistic approach, we assert that fundamentals are not inspiring and suspect LME copper prices would test US$8,300-US$8,500/ton by July end. The global economic backdrop also seems to be gloomy and less conducive for the bulls; hence we would resist going long and prefer selling at the top.

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