Why the base metal rally won't last
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Associate Editor
David Stevenson Apr 03, 2009
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In some circles, copper is known as Dr Copper – the metal with a PhD in economics.
It's earned the nickname because the price tends to be a leading indicator of trends in the global economy. As one of the most important and widely used base metals in construction (it's in everything, from electric cables to plumbing), demand rises and falls along with the health of the wider economy.
So the metal's recent strong rebound – it's up by nearly 50% since last Christmas – has lots of investors very excited. And it's been great news for copper miners too.
But is this rally the real deal, or is it a bull trap?
Why the big surge in copper?
The rebound in copper prices has helped to drive the current stock market rally.
Three of the top six contributors to the near-600 point gain seen in the FTSE 100 since the most recent low in March 9th are in the metal extraction business. And it's the copper kings who have done best, with both Kazakhmys and Xstrata soaring by more than 70%. Small wonder – within the Reuters-Jeffries commodity index, a bellwether for raw material costs, only petrol prices rose more than copper prices in the first quarter of this year.
So why the big surge in copper? As you might expect, it's down to the Chinese, the world's biggest users of the red metal. China's copper imports in the first two months of 2009 were up 71% on last year.
Copper bulls are understandably excited. Santiago Gonzalez, Mining Minister for Chile, the world's largest copper-producing country, said yesterday that December's four-year price low of $1.25/lb is "in the past", and that "systematic" gains will now be seen as China is buying "large".
Meanwhile, corporate heads are now starting to appear above the parapet for the first time in a good while. Charlie Sartain, head of Xstrata's copper division, told Bloomberg that his company is now looking to buy smaller producers whose stock valuations have collapsed over the last 18 months.
Xstrata certainly has the spare cash to do it, having tapped its shareholders for £4.1bn in last month's rights issue. And it could even be a target itself – rumours are circulating, says the Telegraph's Ben Harrington, that a large rival such as BHP Billiton or Vale might like to snap up the copper group.
This is quite a turnaround. Less than a month ago, the world was apparently approaching Armageddon. Now it seems we have a genuine long-term copper-bottomed rally on our hands.
Or maybe not. Because there are still some big snags.
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This base metal rally won't last
In marked contrast to his Mining Minister, the boss of Chile's state-run copper producer Codelco - the world's largest, with 10% of global production – is much more downbeat.
He warned this week that it's not yet clear if US demand has bottomed out – the housing market there is still in dreadful shape - while Europe is "pretty depressed" and going nowhere. Despite the cheerleading over yesterday's 1.8% climb in US factory orders for February, this was only the first rise for seven months, while January's drop turned out to be twice as big as first announced (a fact which wasn't given quite as much prominence by the bulls).
Further, the sudden bounce in Chinese demand is just too good to be true. The extra buying has been driven by a shortage of scrap copper, says the president of BHP Billiton's base-metals unit Diego Hernandez, which has forced China to buy from mines instead of scrap merchants.
And just because the country is buying copper, doesn't mean it's actually being used up. Much of the buying is down to "stockpiling by a secretive Chinese state organization – the State Reserves Bureau", said the FT's Chris Flood last week. "Traders estimate that the SRB is in the process of securing 300,000 tonnes". That's heading for 2% of world copper output.
Indeed, SRB buying has been the main copper price driver, according to David Wilson at Société Générale, as "real demand remains notably weak as global manufacturing activity continues to decline".
Why now's the time to take your profits
Why the secret copper stashing? Well, because at less than half last year's record $8,940/tonne price, the metal's been dirt cheap. The Chinese are in the lucky position of having the reserves available to take advantage of low prices when they see them. But after the recent price surge, how long will that stockpiling continue?
The answer is not very long at all, if you look at what's going on in the shipping world. Freight rates – the cost of hiring ships to haul metal around the globe – are often a good forward indicator of metals prices. And while metal prices have risen, shipping costs have slid 40% in the last month.
This big divergence should wave a warning flag to metal investors, says John Reade at UBS. "It seems hard to make a case for jumping into industrial metals right now".
That could be a bit of an understatement. For any traders canny enough to have bought shares in the copper producers in the past month, my view's quite clear-cut. It looks like time to take profits.
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