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China’s Stimulus Will Not Have a Major Impact on Copper Demand

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Copper prices tumbled in the first quarter amid concerns over a slowdown in China. Indeed, the Chinese economy has been rebalancing and as a result demand for raw materials such as copper is expected to weaken even as miners such as Freeport-McMoRan Copper & Gold (NYSE: FCX  ) and Southern Copper (NYSE: SCCO  ) plan to increase production this year. The sharp slowdown, though, raised the prospects of stimulus from China in the form infrastructure investment. A large stimulus package would be positive for copper prices, but China has instead opted for "mini stimulus;" this means that the outlook for copper remains bearish.

China slowdown hurts copper prices
Copper prices continued to get battered in March amid concerns over economic slowdown in China. Copper prices were down by about 5% in March. The metal is down about 9.7%, year to date.

The official Chinese manufacturing PMI, released earlier this week, showed that the economy continued to expand at a very sluggish pace in March. More worryingly, the HSBC's PMI, which tracks small-sized firms, fell to 48 in March from 48.5 February. Any reading below 50 indicates contraction.

The sharp decline in copper price due to a slowdown in China doesn't come as a surprise, given that China accounts for 40% of world's total copper consumption. It wasn't just a slowdown in Chinese economy that was hurting copper prices, though.

Back in March, copper prices plunged to a multi-year low after the news emerged that a Chinese solar panel manufacturer defaulted on its bond. In China, industrial metals such as copper are accepted as collateral against loans under trade financing deals. This financing method is generally used by companies that cannot secure funding from banks. Market participants were worried that if these companies started defaulting on their loan, it would lead to large scale liquidation of copper and other metals that are used as collateral, which would hurt prices even more.

However, copper prices recovered toward the end of March after Chinese premier Li Keqiang hinted at possible economic stimulus measures to bring the economy back on track.

Stimulus not big enough
Lately, speculation was rife that China could provide some sort of fiscal measures to shore up its slowing economy. Market participants were anticipating stimulus in the form of large scale infrastructure investment, a move that would have boosted copper demand. Earlier this week, China did announce some stimulus measures.

However, the measures which are in the offing will be a sort of "mini stimulus." As a result, it is not likely to have a major impact on copper demand. Thus, any upside potential in copper prices looks difficult in the mid-term. At the same time there is likely to be a supply glut, as I noted in a previous article. As a result, there will be sustained pressure on copper prices, thereby hurting the margins of copper miners.

Supply glut
Global copper miners are continuing with mining activities this year and as a result supply will once again outstrip demand. Freeport-McMoRan plans to increase its copper output by 7% this year. Southern Copper is also planning to boost its output from 637,068 tons in 2013 to 672,400 tons this year.

Supply is also expected to get a boost as Indonesia is moving to relax its law pertaining to export bans on copper concentrates. Local units of Freeport-McMoRan and Newmont Mining Corp. (NYSE: NEM  ) have received approval for big increases in copper sales this year.

All these factors would mean a significant supply glut in 2014, while demand from China is expected to be weak. It is important to note that while China has announced a stimulus package, it is not going all out to shore up its economy. This signals that Chinese policymakers are determined to rebalance the economy. A Chinese economy relying more on consumption and less on investment means that demand for copper will be weak in the world's second-largest economy. As a result, copper prices are likely to remain under pressure.

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Varun Chandan

I have a Master in Finance degree from IE Business School in Madrid. I use the top-down approach when it comes to investing. I like to analyze macroeconomic factors and how they impact individual companies.

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