Slackening Copper Demand in China Hurts Commodities Investors


Over the last few months, many small investors have piled into commodities, especially copper, on the assumption that ever-growing demand from developing countries would keep sending prices skyward. Now they are learning a drop in demand is also possible, and prices have been plummeting. It turns out not only China was pushing prices higher, but all those investors piling in to exchange-traded funds back in the U.S. were driving the metal higher, too.

On Thursday, copper fell nearly 1% on the London Metal exchange to $9,191 a ton. On the Shanghai Metal Exchange, it fell even further, by 2.9%. Back in December, the metal had topped $10,000 a ton as investors piled into commodity funds like the PowerShares DB Commodity Double Long ETN (DYY). But on Thursday the ETN (like an exchange traded fund but a debt security) was down 3.23%.

Mideast Unrest, Lower Import Figures Both Factors

"Investors have almost certainly pushed the price up to record highs over $10,000 and you're probably seeing some of those positions trimmed," says Dan Major, a commodity strategist at Royal Bank of Scotland in London. "I think we're seeing some of that investor enthusiasm having pains."

Major says there are two causes of the sudden dissatisfaction with copper: a general flight from risky assets, because of the unrest in the Middle East, and concern about demand from China. Commodity and equity markets began wobbling Thursday after there were reports of gunfire at a demonstration in Saudi Arabia, the largest oil exporter in the Middle East.

Equally worrying were the latest import figures out of China, which has imported an average of 335,000 tons a month for the past two years to feed the hungry maw of both Chinese industry and its huge programs to build housing. But in February, China only imported 235,000 tons, which was down 35% over January and 27% over the imported amount in February, 2010.

China's Role

China is a key player in the world market for copper. It accounts for 7.15 million tons a year out of a world total of 18.7 million tons, about 38% of the entire globe's production. With a dramatic decline in copper demand, economies as widespread as Australia, Indonesia and Chile could be affected.

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One explanation for the fall was that some industries stopped ordering in February, because of the Chinese New Year holiday. But Major says a more likely explanation is the price of copper is cheaper on the Shanghai Metal Exchange than on the London Metal Exchange, the main source of copper trading. As a result, he says, many industries preferred to fill their copper needs domestically and imports were cut back.

But the investor component in the price swing can't be discounted. There are more than half-a-million tons of copper stockpiled in Shanghai alone; most of it being used as investment collateral, according to analysts.

And according to one New York-based metals trader, who asked not to be identified, annual copper production falls short of demand by 500,000 tons a year. But that figure could dramatically increase when J.P. Morgan (JPM) and Blackrock (BLK) start new copper ETFs.. They applied to the Securities and Exchange Commission for permission to start the funds last October but have not yet received approval. Up until now there has been only one copper-only ETF, based on the London Stock Exchange, while the remainder combine several industrial metals like lead and zinc as well.

Another factor that could affect the long-term outlook is that China may be scaling back its economy. In a recently-released five-year plan, China says it expects its GDP to grow only around 8% a year going forward, down from the 10.3% it shot up in 2010.

But there was also some good news for commodities buried in the report. China plans to build 36 million low income apartments, 10 million of them in the next 10 months alone -- and that takes a lot of copper.

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