By: Bentley Atteberry | Myst Metals Team May 26, 2023
The volatility tremoring throughout the global economy continues to send a variety of high frequency and micro indicators in diverging extreme directions. Everything from US and European PMI surveys showing an increase in services activity with deep contraction in manufacturing activity last printed in May 2020 to a pickup in auto manufacturing with continued slump in real estate and construction activity.
While those are interesting in their own right, there is one oddity in the copper markets that recently lead to an internal memo stating, “...there is a potential opportunity to arb the import arbitrage window via forward arbing future import arbitrage.” Huh? I will attempt to unwrap a portion of this one.
This week (May 22-26), the benchmark prompt spread for Copper on the LME loosened to a contango beyond 66c (meaning spot prices of copper were $66/mt below that of the 3-month forward prices). This extreme of contango in Copper was last seen in the early 80s. Typically, contango is a sign of a market that is oversupplied and/or the current demand is weak. Interest rates do play a role in this as well as higher interest rates make it more expensive to hold inventory.
Well okay, that seems to make sense given the current manufacturing and construction environment in Europe and North America. Combine that with a weak China and it appears like a rational structure, however, further evidence is showing a different story.
The onshore China Copper premiums are pointing in a completely different direction. Since the end of the first quarter, visible exchange inventories outside of China have risen by over 50%. Additionally, the percentage of metal earmarked for removal from warehouses, referred to as cancelled warrants, dipped to rare territory at nearly 0% last week.
Over the same time period, social inventories in Mainland China have dropped about 30% including a 25% decline in bonded warehouse inventories.
While a part of this is seasonality, it is worth pointing out that Chinese bonded inventories are down a whopping 58% over the same period last year and total social inventories on the Mainland are down about 3% as well.
It gets even more confusing. The demand for importing copper cathode into China via bonded warehouses is beginning to pick up, however, the forward demand has jumped far above the spot demand. This is shown with the divergence between the Yangshan Copper Warrant Premium and Yangshan Copper premiums under Bill of Lading (imported material typically 3-4 weeks out). It is very rare the Bill of Lading premium have jumped over Yangshan Warrant premiums, but that is what recently happened with the spread bursting out to a record differential.
To sum up the previous few paragraphs, immediate demand outside of China appears to be weak via the discount of Cash copper compared to forward copper as well as the build in visible inventories. Meanwhile, rhetoric of weak demand in China is contradicted by the near cash prices for Copper shooting up over forward dated Copper, while the demand to import Copper and deliver on that metal now is not as strong as the demand to import in the near future.
So what is going on here?
Well, it is tough to say with certainty, but there are few possible explanations. Chinese producers picked up exporting activity early this year as the arbitrage window shifted deep into negative territory making it possible to profit on delivering to warehouses outside of China.
Realistically, this could only be done either by smelters/refiners that have tolling licenses where they refine blister or concentrate into cathodes and then export the refined product without having to pay the import/export tariffs or if a merchant held copper in a bonded area and simply just re-exported it to a regional LME shed. There certainly was some of this going on in the early parts of 2023 as supply issues persisted throughout Chile, Peru, and Panama sparking some downstream panic buying in the US and Europe.
Reports have shown an increase in Chinese brands in LME warehouses from just 925 tonnes at the end of January to 26,675 tonnes at the end of April, so both of the above explanations are have some supporting data.
Another factor is the ex China slowdown happening while Chinese smelters and refiners enter a heavy maintenance season throughout May and June. This would mean that producers of semi-finished goods may need to import copper from outside of China to replenish their inventories (it would also be cheaper vs buying last resort stocks onshore). This would help explain the large differential that popped up in the Bill of Ladings vs Yangshan Warrant Copper premiums.
While this all paints a very murky picture, it just continues to show the widening divergence in various parts of the global economy. Forward looking indicators continue to show signs of above average/expanding demand on Mainland China while export orders have remained in contractionary territory.
As shown above, forward looking survey data points to the greatest divergence in export orders vs onshore orders coming from the construction and power industries. Furthermore, the electronics sector is the only one where export orders are in expansionary territory.
The data may lack clarity by painting a diverging picture, but that also means the current situation may not be as dire as some common rhetoric may make it seem. Where this leads in the short to medium term remains to be seen, however, as the world moves forward in the energy transition, materials such as Copper will undergo secular fundamental shifts causing unpredictable market dynamic volatility.
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