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Has the China RRR cut put a bottom in copper?

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By Jasper Lawler, Market Analyst, CMC Markets – In a week that sees reports from major mining companies including BHP Billiton and Vale, Jasper Lawler looks at the outlook for copper given the recent sharp decline in prices and the action taken by the Chinese central bank.

Copper rebounded from five and a half year lows in February on the back of new stimulus measures in China and a bounce back in oil prices. In the first week of February copper recorded its biggest weekly gain since August but the price has flat-lined since on reduced Chinese demand in the run up to the Chinese New Year holiday.
The People’s Bank of China cut the reserve requirement ratio (RRR) by 50 basis points to 19.5% on February 5 as part of an effort to spur lending in the nation’s banks and rekindle growth in the slowing Chinese economy.
China is the world’s biggest consumer of copper so monetary and fiscal stimulus polices, particularly anything that breathes life back into its deflating housing bubble could create new physical demand for the industrial metal.
China’s attempted transition from an economy driven by manufacturing exports built around the cheapness of its labour force to one driven by domestic consumption coming from its rising middle class will take decades to play out. In the meantime, Chinese growth is inevitably slowing and demand for copper could well continue to stall without substantial government intervention.
At the same time, miners have improved efficiency and lower oil prices enable them to increase production at a lower cost. Supply has overwhelmed demand leaving an imbalance which has pushed copper prices to the lowest levels since mid-2009.
Mining giant BHP Billiton releases interim results on February 24th. BHP’s ongoing investment into its production capability and operational efficiencies is a positive but there’s only so much damage limitation possible when commodity prices have fallen so far so fast. The impact on earnings of the change in copper, oil and iron ore prices relative to non-core assets including aluminium, manganese, silver and nickel is of particular importance ahead of the demerger of the newly-formed company ‘South32’.
Copper prices held up for three years but USD3 per lb gave way in November 2014 when the metal was no longer trusted as collateral for loans in China after it emerged local warehouses had been overstating inventory levels. A barrage of selling ensued and in January 2015, copper prices dropped by 12% with Chinese hedge funds supposedly shorting the metal in large volume. Since then, the price has started to recover and open interest in Shanghai, London and Chicago futures markets is drying up in what is fast becoming a short-covering rally.
The Chinese central bank cut the reserve ratios for small rural banks in the summer followed by a national interest-rate cut in late 2014 and has now cut the national RRR. If, like the earlier measures the 50 basis point cut in the reserve requirement ratio doesn’t have the intended effect of boosting the Chinese economy; more cuts are likely from the PBOC, perhaps by another 100 basis points by the end of 2015.
Whether the cut in Chinese RRR rates ends up increasing physical industrial metal demand or not, persistent and determined action from the People’s Bank of China would discourage speculators and could put a floor under copper. For now, the measures from the PBOC are only an adjustment so until cuts to the RRR come a bit more thick and fast; copper could remain under pressure alongside Chinese demand.
Copper prices don’t trade in isolation, trends in the US dollar, oil and gold prices also have an influence as investors reallocate between dollar-denominated assets. There have been some signs of a rebound in oil and gold prices so if the US dollar can also stabilise, this could provide a backdrop in which copper prices can recover back towards USD3 per lb. But if other commodities start to roll over, copper may end up taking out its recent low at USD2.45 per lb and head towards USD2.

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