Commodity Strategy - Copper: Downside Risks Increasing - FEB 2015

BMI View: A decisive break of three-month LME copper below USD6,000/tonne would suggest additional price declines over the coming quarters, leading to a downgrade of our already below-consensus 2015 forecast.

We have long expected copper prices to face continued weakness following their multi-year peak in Q111, forecasting three-month LME prices would average USD6,800/tonne in 2014 since October 25, 2013 ( see 'Copper To Average USD6,800/tonne in 2014,' October 25, 2013). Copper prices eventually averaged USD6,832/tonne in 2014 and we forecast prices will average USD6,500/tonne this year ( see ' Copper To Average USD6,500/tonne In 2015 ,' October 20, 2014). Market consensus for 2015 has steadily moved our way, heading down from USD6,900/tonne as of October 20, 2014, to USD6,712/tonne as of January 12. More broadly, we remain bearish towards the wider industrial metals complex and have been playing this through the S&P GSCI Industrial Metals Index since September 22, 2014 (currently up 10.9%, see ' Bearish Industrial Metals ,' September 22, 2014).

Crucial Test Ahead
Three-Month LME Copper, USD/tonne (monthly chart)

Yet copper prices may weaken even more than our below-consensus outlook. A decisive break below USD6,000/tonne in the weeks ahead would suggest further prices declines through 2015 and lead us to revise our core view. We believe USD6,000/tonne represents a key technical level as it is the bottom of a multi-year range and therefore remains a crucial gauge of market sentiment. This view is additionally supported by the concentration of put options around both USD6,000/tonne and USD5,500/tonne levels. The exercise of these options would add impetus to a market selloff, further reinforcing bearish sentiment at a time when fundamentals indicate solid copper supply and weak commercial and industrial demand.

Supply Side Looking Resilient

Our long-held bearish view on copper prices remains predicated on the following:

  • We forecast real GDP growth in China, the world's largest consumer of copper, will come in at 6.7% in 2015, below market consensus of 7.0%. Therefore, we expect slowing demand growth from Chinese copper end-users, particularly those in the infrastructure and construction sectors which will be hit hardest by a moderation in fixed asset investment growth.

  • A combination of mine output growth and profitable copper refining operations will lead to copper supply outpacing demand. As a result, the global copper market will see surpluses in 2015-2018 following a deficit in 2014.

While our view towards copper demand continues to play out well, we see growing risks to prices from the supply side. Specifically, severe emerging market (EM) currency weakness in the face of continued US dollar (USD) strength has shifted down the global cost curve in USD terms, boosting domestic output prices relative to input costs in key producers. Indeed, we expect continued currency depreciation among various top-ten copper producers, including Chile, Peru, and Australia, on the back of further USD appreciation in 2015. In Chile for example, currency trends have led to a widening divergence between copper priced in USD and Chilean pesos (CLP). Producers such as Chile will therefore be less inclined to cut back production at current price levels, potentially allowing the global refined copper market to stay in surplus at lower prices than was the case six months ago before the USD had seen significant appreciation.

USD Strength Leading To Widening Divergence
Three-Month LME Copper, USD & CLP/tonne