Copper slump continues amid waning Chinese demand

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Copper used to be considered one of the relatively bright spots in the recent downturn of commodity prices. But now it is becoming yet another victim of China's slowing economy, and the future looks bleak.

"There was always this belief that the deceleration in the Chinese manufacturing sector was going to not just stabilize, but there was this hope that we would see a modest reacceleration," said John Mothersole, a research director with consultancy IHS, who specializes in metal price analysis and forecasting. "Markets are coming to realize that those expectations were falsely held," he said.

Copper, like other commodities, has been on a decline since 2011. This year, the red metal is down 20 per cent.

The metal, used in power generation, cars and construction, has dropped as low as $2.20 (U.S.) a pound – the break-even price for some producers.

The main problem is the surplus of copper in the market along with excess capacity in the Chinese copper industry.

Another problem is the amount of copper that has been used as collateral in financing deals. Analysts speculate that at least half the copper in China's warehouses is being used as collateral. If those deals are unwound, it would flood the market with copper and further drive down prices.

On top of all this, China's heavy-handed response to the rout in its stock market fuelled fears that the Asian government was mismanaging its economy.

Last week, China cut interest rates for the fifth time in less than a year. This followed a surprise devaluation of its currency earlier in August. Those moves have roiled markets and led investors to believe that China's economic slowdown was worse than previously thought.

"Their credibility is really destroyed. It seems that they really don't know how to handle the rout in the stock market. Apart from that, the main concern is that the slowing economy is going to hurt demand for copper," said Yvonne Li, a research analyst with CPM Group, a commodities advisory firm.

Ms. Li said China's attempts to shore up its economy are a short-term solution and would not sustain the country's growth in the long run.

China is the world's largest consumer of metals and responsible for about 40 per cent of the world's copper consumption. But the two sectors that use the bulk of the copper – real estate construction and power generation – have been declining.

Demand is waning just as new mines are starting to produce. Over the past three years, production has jumped 17 per cent to 18.8 million tonnes from 16 million tonnes, according to the International Copper Study Group.

Just as in the iron ore industry, the companies that invested the capital to expand operations are loath to stop mining because copper prices have weakened. It is expensive to suspend production or shut mines down.

Instead, companies are starting to reduce spending. Freeport-McMoRan Inc., one of the biggest copper companies in the world, announced plans to trim production and slash capital expenditures. Freeport is now the target of activist investor Carl Icahn, who wants to talk to Freeport about its spending, executive compensation and higher cost operations.

"This is the beginning of the poor demand for commodities. It is going to get so much worse," said Tim Murray, managing partner with investment adviser J Capital Research Ltd.