Today's 1.75% rally in copper (ripping vertical at the US open) broke a record 14-day losing-streak after COMEX futures tested towards a '1' handle numerous times for the first time since March 2009 (when the S&P 500 traded around 800). The metals market appears to be increasingly pricing concurrent and/or future weakness in China’s old economy, according to Goldman, as China futures open interest surges, but discussions at the 2015 Shanghai CESCO conference last week exposed the extremely bearish views of Chinese market participants regarding Chinese metals demand in 2016 (notably sentiment was worse than that expressed by investors outside of China) specifically citing a Fed rate hike before year-end as a further bearish factor for metals.
Today's "bounce" broke the losing streak...
This was the longest losing streak on record (based on Bloomberg data) and is the worst 14-day loss (down 13.8%) since October 2011...
The last time copper traded here, S&P 500 was around 800...
And as we previously noted, Goldman Sachs warns that rising SHFE open interest may flag China demand deterioration
Metals prices have declined by 12%-17% since late October. Over this period, China’s economic data for October has disappointed, the US dollar has strengthened on a trade weighted basis, and the broader commodity complex has moved lower, including most notably, energy prices.
What has also occurred since late October has been an eye catching rise in Shanghai Futures Exchange open interest across the metals complex – for copper, it has been the largest increase in Shanghai open interest in 12 months – since the 1Q15 collapse in Chinese metals demand.
In our view, this development raises a red flag regarding ongoing and near term activity in China’s ‘old economy’ and metals demand growth, as measured by our GS China Metals Consumption Index (see chart below). Indeed, over the past five years, periods of rising SHFE open interest and falling metals prices have been associated with concurrent or imminent weakening in China’s commodity intensive ‘old economy’.
Meanwhile, though LME and Comex net speculative positioning has also declined over the period, it remains well above its August 2015 lows.
Overall, the metals market appears to be increasingly pricing concurrent and/or future weakness in China’s old economy, and related metals demand. To the extent that the metals market positioning predicts ongoing and potential future China growth weakness – since mid-2011 SHFE open interest has given a correct bearish signal on four out of five occasions – the latest metal market developments have bearish implications for China’s upcoming activity data releases and asset classes dependent on this data.
However, it is anything but close to being over. As Goldman notes today, China-led demand concerns point to further downside risk
Our discussions with market participants at the 2015 Shanghai CESCO Conference last week highlighted the extremely bearish views of Chinese market participants regarding Chinese metals demand in 2016. We continue to see that the risks surrounding our metals demand and price forecasts, in particular our Chinese demand forecasts, are skewed to the downside.
Chinese participants were generally at least as concerned as us, if not more so. Participants generally anticipated no improvement in Chinese activity at least before 2Q2016, with persistent weakness expected in property and manufacturing in particular. Participants saw the potential Federal Reserve rate hike before year-end as a further bearish factor for metals.
Demand weakness saw 2016 annual contract premiums decline
Conference participants are most worried about the Chinese demand outlook. We view the slashed 2016 copper premium by Codelco ($98/t for 2016 term shipments from $133/t in 2015) as further proof of demand weakness from China’s ‘old economy’. There was general belief from Chinese participants that the slowdown of credit growth and currency depreciation (via less financing deals) would place further downside risks on Chinese copper demand growth in 2016 (c.0-1% refined growth was considered realistic vs. our base case of 3%). Were this lower Chinese growth to materialize, our projection for a c.500ktpa copper market surplus through 2019 would rise to a c.700-800ktpa surplus, all else equal.
Sharp depreciation or devaluation present further downside risks
While China’ SDR inclusion was not at the top of discussions, the potential for sharp RMB/USD depreciation or devaluation in 2016 is high according to participants. We believe that the timing and range of deprecation is a significant risk to metals prices in the next 12 months, while placing renewed downside risk to pricing in the LME metals complex, as the overall marginal cost of Chinese base metals production would be lower, in dollar terms, and for aluminium particularly.
Copper-aluminium substitution underestimated
There was some discussion about copper-aluminium substitution in China. From the topend users (large SOEs) we believe the impact is generally limited given copper’s high quality in terms of electricity conduction and those top end-users see the current copper-aluminium price ratio (3x) not significantly economic. However, substitution at lower-end users could be substantial and the actual substituted amount is likely more than generally known (participants believe it could be between c.600kt-1mt in 2015), which would be a potential negative factor for copper pricing and leaves risks surrounding our forecasts as skewed to the downside.
Zinc still the least bearish overall
Given Glencore’s zinc output cuts and 500kt aligned production cuts from Chinese smelters, which is roughly 7% of global supply, the zinc supply and demand balance is set to tighten. However, overhang of the stockpile in the form of both concentrates and refined zinc and ongoing demand weakness left most market participants we spoke with negative on zinc prices.
Chinese aluminium cuts are not significant
The price sell-off of Chinese aluminium prices since late October was driven by the bearish supply dynamic in aluminium and the surge in open interest on the SHFE. Further cost reduction via government subsidies and power tariff cuts is making sufficient Chinese cuts more difficult and shifting burden to ex-China producers. We believe aluminium will stay lower for longer and see the risks surrounding our price forecasts as increasingly skewed to the downside.
Chinese market participants turn bearish on nickel
Given increasing concerns over Chinese stainless production in 2016 and ramp-up of Indonesian ferronickel supply, participants that we talked with expect the nickel market to remain loose in addition to the current overhang of nickel stockpiles. Even if Chinese NPI and refined nickel production continues to decline through 2016, high stocks and pressure on currency depreciation suggest that nickel is a risky long trade with both demand and supply deteriorating.
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Does this trend look over?