Global Metals Weekly:Hedging China trust default with copper

Mine supply overshot expectations; market is balanced

    For more than a decade, the copper market has been affected by a string of supplydisruptions (Chart 1) that gave substantial support to fundamentals. In contrast 2013was a notable exception to this trend, as miners including Anglo American had astellar year operationally. As a result, the copper market has been rebalancing andwe do expect a small surplus for 2014, suggesting that copper is fairly priced at ouraverage FY forecast of $7,013/t ($3.18/lb). Changing tack slightly and lookingfurther out, a repeat of last year’s mine supply increases looks unlikely, which is onereason we have the copper market switching back into high and rising deficitsbeyond 2017.

    Prices did not react to China’s January record imports

    Even though China’s economy is changing, the country continues to have asignificant impact on short-term price movements, for instance through stockingcycles. After China drew heavily on domestic copper stocks last year, expectationsrose that some restocking could boost prices in 1H14. Record imports in Januaryare a reflection that inventories have indeed been building. Yet, despite the increasein shipments, copper prices fell on LME year-to-date. This was driven by aconfluence of factors. We note for instance that a significant part of January’sshipments may have been booked last year, which is an issue insofar becauseactual copper purchases from China have been much more muted so far in 2014.

    China’s copper market less tight than World ex-China

    In our view, copper availability in China has been better than in World ex-China.

    This has perhaps been best reflected in price differentials between the LondonMetals Exchange and the Shanghai Future Exchange, which do not incentivisecopper imports at present. Against this backdrop and keeping in mind also some ofthe recent soft macro data, we are increasingly concerned that China’s governmentmay focus on reigning in the significant credit growth seen in recent years. Notbailing out trusts products and actually letting some vehicles default in 2Q14 couldbe a policy tool of choice for the administration. In our view, there is a risk that acredit event may further reduce China’s commercial copper purchases. As a result,we maintain our 2Q14 average price forecast at $6,750/t ($3.06/lb) and wouldhedge any downside risk through puts or put spreads.