Metal Detector Update
Why are Chinese copper imports falling?
Max Layton, Roger Yuan, Jeffrey Currie
Lower Chinese copper imports do not equal weak consumption
Chinese unwrought copper imports for April fell by 7% mom, and dropped 21% yoy over the same period, implying a 20-25kt mom fall in refined copper imports in April, to c.195-200kt. The mom fall reflects China’s ability to draw on domestic SHFE and Chinese bonded copper stocks accumulated in 2012, as well as lower Chilean exports owing to the port strike in late March/early April. Owing primarily to the large Chinese stock draws, the early indications are that Chinese apparent demand rose significantly in April, following a small pick-up in March (apparent demand equals refined production plus net imports minus estimated stock change). This estimated pick-up in apparent demand is line with strong semi-fabricated output growth in 1Q13 and industry anecdotes of a further pick-up in demand in April.
The large decline in copper imports year over year for the most part reflects an inflated base, driven by a very high level of Chinese copper financing deals, which declined in mid-2012 and have not been implemented in a similar scale since. Higher domestic refined output on higher concentrate imports has also dragged down import demand.
In our view, Chinese copper imports are likely to increase in May, as the import arbitrage has been open since March 2013 (as a result, the recent LME cancellations are in large part expected to flow into China). There are already signs that the positive import arbitrage is having an impact on the ex-China balance, as LME stocks have stopped rising in recent weeks. Overall we remain bullish on the copper price outlook in the near term, as described in Metal Detector: Copper volatility spikes, published May 7, 2013.
The outlook for Chinese copper imports beyond May has recently become more questionable, given we do not yet know what impact new banking regulations announced by SAFE on May 5 will have on copper financing deals. The scenario of Chinese financing deals coming to a complete halt – a risk, rather than the base case at present – would likely lead to a fall in refined net imports (including higher exports to LME), as well as be bearish for Shanghai bonded physical premia and result in the closing of the LME/SHFE arbitrage. While this scenario does not change the fact that global inventories are expected to continue to draw in the near term, and deals involve long physical positions which are hedged (short futures), the above developments could be bearish for copper market sentiment.
Why are Chinese copper imports falling?
Chinese unwrought copper imports for April fell by 7% month on month, and dropped 21% yoy over the same period, implying a 20-25kt mom fall in refined copper imports in April, to c.195-200kt (Exhibit 1). The month on month fall reflects China’s ability to draw on domestic SHFE and Chinese bonded copper stocks - which fell by c.150kt mom - as well as lower Chilean exports (we estimate this may have reduced Chinese imports by c.30-40kt in
April) owing to the port strike in late March. In this way, the early indications are that Chinese apparent demand rose significantly in April (Exhibit 2), following a small pick-up in March (apparent demand equals refined production plus net imports minus stock change). This pick-up in refined demand is in line with solid semi-fabricated output growth in 1Q13 (i.e. copper wire, rod, shape output or “first use” copper demand) and industry anecdotes. More structurally, we continue to believe that underlying demand for imports is 260-265ktpm for 2013, meaning, if net imports are below this level, stocks should draw sharply as it appears they have been.
The large decline in copper imports year over year for the most part reflects an inflated base, driven by a very high level of Chinese copper financing deals, which declined in mid-2012 and have not been implemented in a similar scale since. Higher domestic refined output, owing to higher concentrate imports/availability, has also dragged down import demand more broadly.
As background, Chinese copper financing deals are increasingly complicated transactions using copper imports to raise RMB finance, in order to arbitrage interest rate differentials between domestic Chinese rates and Western interest rates (such as Libor interest rates, usually plus a premium) or to arbitrage the differential between the USD letter of credit discount rate and the onshore RMB short-term lending rate. These transactions are being made in order to raise Chinese domestic funding, and in some cases to lower the finance costs of small to medium-sized companies (particularly those in the copper industry). For more details on Chinese financing deals please see Metal Detector: High Chinese copper bonded stocks point to regional imbalance, published April 19, 2012.
In our view Chinese copper imports are likely to increase in May, as the import arbitrage has been open since March 2013 (as a result the recent LME cancellations are in large part expected to flow into China). There are already signs that the positive import arbitrage is having an impact on the ex-China balance, as LME stocks have stopped rising recently.
Overall we remain bullish on the copper price outlook in the near term, based on an expectation of continued declines in overall inventories (global inventories drew in weeks of consumption in April, see Exhibit 4 in Metal Detector: Copper volatility spikes, published May 7, 2013) and an expected continued improvement in sentiment towards Chinese demand (specifically we are looking for a significant improvement in yoy growth in Chinese power output for April – data to be published May 13). However, we note that the window for higher prices is in our view shortening as time passes.
The outlook for Chinese copper imports beyond May has recently become more questionable, given we do not yet know what impact new banking regulations announced by SAFE on May 5 will have on copper financing deals. The scenario of Chinese financing deals coming to a complete halt – a risk, rather than the base case at present – would likely lead to a fall in refined net imports (including higher exports to LME), as well as be bearish for Shanghai bonded physical premia, and result in the closing of the LME/SHFE arbitrage. While this scenario does not change the fact that global inventories are expected to continue to draw in the near term, and deals involve long physical positions which are hedged (short futures), the above developments could be bearish for copper market sentiment. As such, we are watching developments here closely.
Investors should consider this report as only a single factor in making their investment decision. For Reg AC certification and other important disclosures, see the Disclosure Appendix, or go to www.gs.com/research/hedge.html.
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