The more China-leveraged metals, copper in particular, have suffered an early-year sell-off: prices are down 14% from this year’s high, while the LMEX, a basket of LME metals, is down only 8%, said Barclays in a snippet. China’s first bond default has triggered fears that the country’s financial sector clampdown will force copper inventories to be liquidated since imports have been used to be turned into credit.
Huge portions of early 2014’s commodity imports were used to generate financing after the December “cash crunch”, and without strong underlying demand, inventories soared. Copper market sentiment turned bearish in January, and China’s copper indicators have not looked healthy. The price differential between London and Shanghai has been deeply negative, the premium that buyers are willing to pay has fallen, and inventories have been rising fast. However, Barclays thinks fears that China’s financial sector clampdown will force copper inventories to be liquidated are overblown, though financing flows will likely fall, which means Chinese copper imports would weaken from early-year highs.
Taken in a wider context, Barclays thinks it would be positive if China stopped importing more copper than it needs. It would help to chip away at bulging inventories, especially if it coincided with a seasonal pick-up in demand in Q2. Feedback from our meetings in China last week suggests that the worst may be over (or close to it) and that end users, such as power cable makers, have very low raw material inventories, so physical buying could accelerate quickly if industrial activity normalises.
Barclays also thinks macro concerns and stock overhang take some of the potential upside off their Q2 forecast of $7,300/t. However, the recent sell-off looks overdone, in our view, since micro trends have likely bottomed. It reminds us of 2013, when copper prices sold off in Q2 due to China hard landing fears, only to bounce back when Chinese demand surprised to the upside. Our economists believe Q1 14 marks the nadir for Chinese growth and forecast a strong sequential pick-up over the next few quarters. If the government again leans on targeted investment to protect growth, it would be positive for metals demand. With that, we expect more volatility this year and think the risk/reward of buying copper at these lows is attractive.