Copper will eventually break through the 10,200$/t barrier

For the second time within this month, LME 3mth copper made a new record high and came close to the 10,200$/t mark. But copper again fell back and lost almost 500$/t to ended the week at 9,827.75$/t at the LME Select platform. Copper traded below the low made during the preceding correction. Technical analysts would argue that copper completed a double top formation and would head lower. However, as support at 9,700$/t has held, the downside for copper might be limited.

China is the major factor for the development of copper prices and there are two conflicting forces at work. On the one hand, the expansion of the Chinese economy is still strong. The HSBC PMI has risen further and is now at 54.5 while it had been below the 50 mark just some months ago. Industrial production expanded at 13.5% according to the latest available figures in December 2010. Therefore, the restrictive monetary and credit policy of the People’s Bank of China has not yet slowed the economic growth that it would have a significant impact on the demand for copper.

On the other hand, however, CPI inflation remains at a high level. In January, the inflation rate rose again from 4.6 to 4.9% but was far below the consensus forecast of 5.3%. Nevertheless, the PBoC has lifted interest rates again by 25bp to 6.06% and has increased the minimum reserve requirements by another 50bp last week. The copper market fears that monetary tightening would eventually lead to lower demand for copper, especially if the monetary policy hits the construction sector severely. The Chinese central bank is concerned about rising CPI inflation. Thus, the key for further interest rate movements is the development of the consumer price inflation rate.

Not only in China, but in many other countries, independent if they are belonging to the group of emerging markets or are industrialized, the major driver of the consumer price indices are two segments, food and energy. The severe cold winter season in the Northern hemisphere has driven energy prices higher. In the US, the crude oil sort WTI has traded up to 93$/bbl but came back to 84$/bbl a few days ago, a level it also traded at the end of November last year. However, in Europe, Brent traded higher and reached the 100$/bbl mark. Beside shortfalls in North Sea production, also the political tensions in the Middle East have pushed the price of Brent higher. Oil reserves in the USA are abundant and this should keep WTI in a trading range. But, the price for Brent will also depend on how the situation in the Middle East develops further. However, as long as higher energy costs don’t spill over to domestic price pressure, a central bank would be well advised to look through this development.

The rise of food prices was triggered by surging agricultural commodity prices since July last year. The reasons were supply shortfalls due to drought and wildfires in Russia and the Black Sea region. Also grain harvests in the US remained below expectations. Monsoon rains had an impact on sugar prices. Weather conditions also had an impact on cotton prices. The La Nina weather pattern has an impact on harvests in Australia and Latin-America. Food prices would have to increase further to keep year-over-year inflation rates at the current level. Otherwise, food price inflation would edge lower in the second half of 2011.  However, agricultural commodity prices saw already sharp corrections last week. Speculative net long positions in grain futures are close to record high levels. The probability of profit taking by speculators is increasing if agricultural commodity prices don’t rally further or even enter a correction. Then profit taking could lead to sharply falling food prices, which would have a positive impact on inflation rates.

The conclusion we draw is that food price inflation is likely to come down in H2 2011 at latest but sharp corrections in agricultural commodity prices could lead to easing inflation pressures already in Q2. With falling food price inflation, the pressure on central banks to increase interest rates would also ease. In the case that Chinese CPI inflation would decline as food prices come down in the yoy comparison, the copper market would no longer fear that the PBoC might overwind the screw. It would be supportive for copper.

The second factor is the supply and demand balance. Inventories at LME warehouses have increased from below 350,000 tons in mid-December to almost 408,000 tons. The World Bureau of Metal Statistics reported last week that the copper market was in a supply deficit of 20,000 tons last year. However, the International Copper Study Group estimated in its latest monthly report that the copper market was in a supply deficit of 404,000 tons during the first ten months of 2010. It is unlikely that this gap had been almost closed in the final two month of last year. For 2011, the ICSG estimates a supply deficit in the magnitude close to last year’s deficit. Relative to this excess demand, the current copper inventories in LME warehouses are still at a rather low level. Therefore, we expect that copper prices will be well supported and that the medium-term trend to higher prices will prevail.