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China Trip Notes: Copper Conditions Soften

China Trip Notes: Copper Conditions Soften

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Published by Nicola Duke
BARC 28March2012
BARC 28March2012

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Published by: Nicola Duke on Mar 29, 2012
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Copper conditions soften
Gayle Berry+44 (0)20 3134 1596gayle.berry@barcap.comNicholas Snowdon+1 212 526 7279nicholas.snowdon@barcap.comwww.barcap.com
We visited China last week and met with copper fabricators, smelters and physicaltraders and attended the Shanghai Metals Market (SMM) Copper and Aluminiumconference in Shanghai. We summarise our key conclusions from the trip below:
The key takeaway from our meetings was that spot demand for copper in China isweak, the improvement in Q2 may be tepid and imports are likely to remain strongin March and possibly April before trailing off until later in the year.
Sentiment amongst Chinese fabricators and manufacturers is negative. Orders havebeen slow to improve following the Chinese New Year and in some sectors arebelow year-ago levels. Inventories of cathode at consumers are low, but inventoriesof finished product are higher than usual for the time of year.
Fabricators and some manufacturers increased production strongly in January-March in expectation of a pick up in demand during the seasonally stronger Q2. But,so far, demand has been softer than they expected.
The current state of Chinese demand is varied across industries. White goodsdemand is particularly weak due to an end of the stimulus and a slower occupationrate of new real estate because of slower sales. The slowing in residentialconstruction activity has also resulted in a weakening in demand for building wire.Transport demand has improved moderately in 2012 so far. Infrastructure demand,and in particular power-related demand, remains firm.
Bonded warehouse stocks of copper have continued to increase. From ourdiscussions we understand copper bonded warehouse stocks to be around 600Kt,in line with the 2011 peak.
March and April copper imports could be stronger than the market expects. Webelieve that metal that had been booked in October/November 2011, when the arbon six-month forward prices was open, will continue to flow into the country. Weare also likely to see a pick up in exports. Chinese smelters have been deliveringmetal into bonded warehouses from which traders have been exporting metal ontothe LME, attracted by the backwardation.
Overall, we believe Chinese demand in the short term is likely to disappoint beforebeginning on a recovery trajectory later in Q2. Subsequently, we think that importswill weaken until bonded stocks are run down to more normal levels, possibly in Q312. With the market already expecting a drop in Chinese imports, we doubt thisalone would have a significant negative impact on LME prices. That’s more likely tobe determined by the market’s evaluation of how long imports will weaken for andwhether it's the result of short-term dislocation or longer lasting core weakness.The LME backwardation meanwhile is likely to continue unless Chinese exports arebig enough to begin offsetting the draws in LME inventories, in our view.
Barclays | China trip notes: Copper conditions soften
28 March 2012 2
Chinese copper market dynamics
Chinese copper smelters, fabricators and end-use product manufacturers entered 2012expecting another year of double-digit growth. What they have encountered is weaker, butstill a level of growth most countries would be envious of.The combination of industrial manufacturers operating in anticipation of strong growth onthe one hand and a government targeting slower more sustainable growth on the other hasresulted in a short-term dislocation between supply and demand in the Chinese coppermarket. It will take a little time for balance to be restored and inventory, both cathode andproduct, to be consumed. This looks most likely to begin later in Q2 once economic growthimproves from the current trough.
Softer-than-expected orders are partly a function of excess capacity 
It is clear that the Chinese industrial sector is suffering from overcapacity and this factorshould be borne in mind when digesting producer reports of weaker orders. As capacity hasgrown ahead of demand, market share at the company level is being lost. We believe that,over time, the Chinese market will consolidate its disjointed manufacturing industries. Butsuch a process will take time, be painful in parts and involve periods of disequilibrium.
Chinese copper fabricator sentiment is negative
Sentiment towards the short-term outlook for copper demand amongst China’s fabricatorsis negative. In our discussions with pipe and tube manufacturers, wire and cablemanufacturers, sheet and plate manufacturers and upstream at smelters, the feedback wasunanimous; that orders had been weaker than expected, in some cases lower y/y and theimprovement in buying after the Chinese new year holiday had been slow. Sentimentamongst pipe and tube manufacturers, who primarily service the air-conditioner market,was particularly weak. White goods demand (which accounts for 24% of Chinese copperconsumption) in general was described as soft due to a combination of slower constructionactivity, weaker export demand and an end to the stimulus package for white goods sales.That said, export demand, particularly to the US was reported to have noticeably improvedin recent weeks and was expected to continue improving in Q2.
Figure 1: China’s copper demand by end-use Figure 2: Chinese bonded copper stocks have risen rapidly
China's copper demand by end-use
0100200300400500600700Dec-10Mar-11Jun-11Sep-11Dec-11Mar-12Chinese copper bonded warehouse stocks (Kt)
Source: Brook Hunt, Barclays Research Source: CRU, Barclays Research
Barclays | China trip notes: Copper conditions soften
28 March 2012 3
Demand for other types of products used in construction (which accounts for 21% of Fabricators also reported that Chinese copper consumption, such as wire, hadunderperformed expectations with the slowdown in construction activity cited as the mainreason. It should be noted, however, that the feedback from the fabricators we spoke to mayhave been skewed by the particularly aggressive slowdown in private residential constructionwhich was their primary market. Fabricators in central provinces, however, are believed to bebenefitting more from the build out of social housing. China is, after all, a vast country.The transport market (which accounts for 9% of copper consumption) was reported byfabricators to be showing moderate signs of improvement after a weak 2011. However,there was uncertainty amongst fabricators as to the sustainability of this improvement.Demand for copper used in power cables was reported by fabricators to be firm, thoughfeedback on demand from other infrastructure-related sectors was mixed (infrastructureaccounts for almost 40% of Chinese copper consumption). Concerns over the changingstructure of Chinese economic growth, from infrastructure-driven to consumption-driven,weighed on sentiment amongst market participants in this sector in particular.One interesting trend highlighted to us by the fabricators was the growing use of cathode intheir raw material mix. Wire manufacturers typically use very high levels of cathode, giventhe metallurgical demands of their product, but pipe and tube manufacturers said that theyare increasingly using more cathode in their production for two reasons. The first is becausethis price risk is hedgable on the SHFE. Scrap prices cannot be hedged. This is a particularproblem because of the volatility in prices and supply of scrap and the impact this has onP&L. Although the pool of domestically-generated scrap in China will rise, for the timebeing, it remains far too small to play a significant role as a source of supply. The secondreason is that a higher quality of product can be manufactured when more cathode is usedin the production mix and this is more commonly being demanded by manufacturers.
Copper bonded warehouse stocks are part of the import mechanism
The strength in Chinese copper imports since October 2011 has appeared at odds with theanecdotal reports of softer end-use demand and slower economic growth. From our discussionwe understand that copper bonded warehouse inventories have risen to 600-650Kt (with thesplit being around 500-550Kt in Shanghai and 50-100Kt in Guangdong). This is a big increase inbonded inventories from the low of 200Kt in November 2011 and means that these stocks haverisen to similar levels in early 2011. The perceived logic in the market is that much of this build inbonded copper inventory is simply due to copper being imported as means of raising finance.However, as we understand it, the picture is more nuanced than that.
Bonded stocks have risen to600-650Kt 
China is net short of copper and has to import copper to feed domestic demand. However,the timing of when this marginal copper is imported is very much determined by pricingsignals; in particular, the arbitrage between SHFE and LME prices. When the arbitrage ispositive (SHFE prices trade above LME prices), large volumes of copper will be purchasedfrom international suppliers with futures exchanges used to hedge the physical risk. In otherwords, exchanges will be used to lock in the arbitrage.
Copper imports arbitraged across the forward curve
In September 2011, the arbitrage between SHFE and LME prices turned positive andremained positive through some of October. The arbitrage on forward prices (six monthsforward) was also open for periods in November. We understand that the surprise strengthin February 2012 imports was partly due to metal being booked using the arbitrage in theseforward prices. It is for this reason we think that copper imports could remain strong inMarch and possibly April.
March and possibly April importscould remain strong

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