According to Barclays:
After nearly seven months of increasing mined supply, it is now consensus to be negative on copper prices. Very often consensus is correct. However, three factors have made investors nervous on ‘putting their money where their mouth is’ more aggressively and being negative on copper: 1) a macro recovery trade as investors get more positive on recovery in demand; 2) threats of supply disruptions; and 3) a demand recovery (especially in China).
On the first point – copper as a macro ‘risk-on’ trade has started to lose the appeal it had earlier. The correlation between the S&P 500 and the copper price has been well in excess of 75% for the five years prior to October 2012 (when the issue of increasing supply started to become apparent). Since then, the S&P 500 index is up 22% while the spot copper price is down 15%. The correlation seems to be breaking down, and hence, the rationale for the macro traders to go into the stock is declining. Net short positions are still high in copper and closing of that could support the price, but those are temporary effects unlikely to sustain for more than a few trading sessions.
Second – the threat (actual manifestation) of supply disruption events are not having the same impact it had earlier. The pictures of (and the impact from) the dramatic landslip at Rio Tinto’s Bingham Canyon mine would have been sufficient to give copper a substantial boost in the past 6-7 years (see: MINED MATTERS 15/4/13: The straw (or rock slip) that breaks the camel's back or storm in a tea cup? KUC pitwall failure and what it means for copper (and moly) market). However, the picture has remained just that – and after a mini rally for a day, copper began its downward leg. The key driver for the change in reaction has been the inventory level. When the visible exchange/warehouse inventories were 300-400kt (as was the case for most of the time through 2004-2011), a 100-200kt copper supply disruption was hugely material. However, when the inventories are 1.5-2mn tonnes, the same magnitude of disruption looks small by comparison.
Which brings us to the third risk of being underweight – a demand recovery (especially in China). The indicators are actually looking good – bonded warehouse inventories are falling, and cathode premiums are picking up. Of course, one could interpret these as outcomes of other factors (bonded warehouse inventories falling because copper financing getting more difficult and the import arbitrage with the LME prices declining; the copper premiums because the warehouses are offering incentives to attract metal etc). However these top-down data points in combination with anecdotes like pick up in air conditioner and vehicle production suggest that demand is picking up.
However, is this enough to salvage a supply glut in the medium term? Probably not. Copper demand in China last year was about 8.2mn tonnes and a 100-200bps pick-up in demand (80-160kt of copper) is not large enough to offset the inventory already built up, let alone keep up with the increased mined supply. There are other smelting and refining constraints (e.g. the shutdown of the Tuticorin smelter in India), which could keep refined copper supply off the market, but these effects are temporary. At the end of the day, one needs a significant slowing of mined supply growth in copper to get more constructive on a 6-12 month view, and we are not there yet. On our estimates, the equities are pricing in commodity prices very close to the spot price (Jiangxi Copper pricing in US$2.95/lb of copper for example on our estimate); hence, it is difficult to make a undervaluation case for the equities as well.