Russell: China copper price flip to discount vs LME raises red flag amid rally

London Metal Exchange (LME) benchmark three-month copper traded as high as $9,780 a tonne in early Asian trade on Tuesday, the most since August 2011 and a 124% rally since the 2020 low of $4,371 in March last year, at the height of lockdowns to combat the coronavirus pandemic.

Copper is benefiting from both bullish supply and demand factors, with concerns over industrial action in top exporter Chile matching expectations of strong global demand as the world recovers from the worst of the pandemic.

Inventories in LME-registered warehouses are also dropping, having fallen about 10% in recent weeks to 155,100 tonnes, while cancelled warrants are soaring, meaning more of the industrial metal will be drawn out of stockpiles in coming weeks.

China, which consumes about half of the world’s copper, has also seen robust demand, with imports of unwrought metal up 11.7% in the first quarter of this year compared to the same period in 2020, while imports of ores and concentrates have risen 7.7%.

Add in the increasing expectation of global action to speed up decarbonisation of energy systems, a process that will boost copper demand, and there is a strong short-term and longer-term case to be made for the metal.

But even though copper’s positive outlook appears rock solid, it’s always worth examining factors that may give pause for thought, or warrant exercising some caution.

Recent developments in pricing in China may be just such a case in point.

In November the Shanghai International Energy Exchange (INE) launched bonded copper futures, yuan-denominated contracts open to international investors with delivery into warehouses prior to the application of customs duties and taxes.

These contracts are different to the existing Shanghai Futures Exchange derivatives, which include the cost of duties and taxes and are mainly aimed at the domestic copper market.

The INE futures are therefore more closely aligned with the LME contract, and price differences between the two would normally be a result of variances between the strength of Chinese and global demand.

Since inception, the INE three-month contract has largely traded at a premium to its LME counterpart, reflecting stronger Chinese demand for copper.

For example at the end of last year the INE contract, converted into US dollars, was $152.77 a tonne above the LME equivalent, and at the start of this month the premium was $81.96.

However, it has recently reversed to trade at a discount to the LME benchmark, ending at the equivalent of $9,684.78 a tonne on Monday, a discount of $66.22 to the LME close of $9,751.

China copper concerns?

What the INE flip to a discount to the LME contract suggests is that traders in the Chinese market are selling copper into the rally, perhaps to take advantage of the current high price.

Chinese traders have been known to buy metal when they deem the price cheap and then hold it in so-called dark warehouses, which are stocks not visible to trading exchanges, and then release their inventories when prices rise.

This process may account for the current end of the premium of INE futures to LME contracts, but there may also be some concern in China about the relative strength of the outlook for copper.

There are signs that China is already tightening credit, which may result in slower spending on copper intensive infrastructure and construction projects.

Local government bond issuance to fund infrastructure projects has slid in the first four months of 2021, and the authorities in Beijing have also taken steps to cool the property market.

If China is tightening monetary conditions, it will be out of step with what the rest of the world is doing.

This means that copper’s ongoing rally will likely have to be built around the expected economic recovery in the rest of the world.

(Editing by Muralikumar Anantharaman)