By Yaser Anwar, CSC of Equity Investment Ideas

This week I’d like to talk about: Copper (The Chinese Factor & Demand) & Chile (Economic environment) alongside Risks & Short-Covering (slow US growth & more).

Synopsis

• Economic expansion in Emerging markets- BRIC, especially India and China, alongside the US housing market have fueled strong copper demand. Copper is used in nearly every major industry- from transportation to machinery and equipment, and housing to autos.
• Over the course of last few years, price has skyrocketed from 50 cents to $6 and change (this run up has benefited Chile the most, which accounts copper as 50%+ of its exports and about 20-23% of GDP), but will this run continue & what does it mean for Chile?

The China Factor & Demand

• China is expected to import more copper from Chile in 07 due to continued strong economic growth, a senior Chilean copper official said on Wednesday. China is the world’s biggest copper consumer and a top export market for Chile.
• Chile produces about 35% of the world’s copper and earned $33 billion from exports of the metal in 06, up 88% from 05 due to soaring world prices. Copper provided 57% of Chile’s export revenue last year. China’s industry is growing at a rate of double digits annually and will need a lot of copper to sustain this process.
• BHP Billiton, the world’s biggest miner, said on Monday it saw copper prices staying firm this year, although it preferred not to offer precise projections. Billiton Base Metals President Diego Hernandez said the price would likely be supported by demand from China, which is seen going back to the market after depleting its copper inventories last year amid record prices.
• Power cables (especially high-voltage sector), continued to represent a growth market for copper, as did optical fibers used in communications, magnet wiring in motors and wiring harnesses used in the auto industry.
• The IWCC attributed copper’s resilience to a unique combination of properties it has that is very difficult to repeat. Copper has an unrivaled collection of properties that makes substitution difficult.
• Underlining the versatility of copper is the fact that global consumption growth continues to rise. According to ICSG, demand for refined copper in 06 reached 17.16 million tones (3.3% higher than 05) and is expected to rise by 4.2% to 17.88 million tones in 07.

  

Chile’s Economic Environment

• The demand for copper has contributed to Chile’s advancement towards many bi-lateral agreements and regional trade pacts like the GATT, MERCOSUR, and NAFTA. The government is running a net fiscal surplus, setting aside funds for public pensions and accumulating assets to protect itself in a downturn.
• According to the CIA Factbook– Chile’s real GDP grew 4.2% in 06 and is expected to remain in the 4-5% range, inflation remains low (2.5-3%) and unemployment has exhibited a downward trend, dropping to 7.8% at the end of 06 vs. 8.2% in 05.
• Despite high income taxes, corporate tax rates are low at 17%. Total government spending as a proportion of GDP is also moderate. Inflation is low, but the state maintains certain price controls. The rule of law is transparent and fair.

Risks & Short-Covering

• Macro concerns over slowing US economic growth coupled with the fallout from the subprime sector continue to dominate sentiment. The slowdown in US housing (a big user of copper for wire, electricity and pipes), has led to a steady rise in global copper inventories already. If these conditions lead speculators to abandon the copper market, the correction could be sizeable.
• In the past week, copper drifted lower on light speculative selling in the wake of weak durable goods data and Bernanke’s comments to the Senate House Committee. Also, price action has remained choppy, and we’ve seen short covering giving support alongside speculative liquidation into the rallies.
• From a recent peak of 303.6 Kt at the end of December 06 the net speculative short position on the Comex copper market has been reduced by 34%. In the week to 20 March the net short stood at 200.8 Kt, 48.6 Kt down on the previous week as short positions were cut by 11.7 Kt and new longs to the tune of 36.9 Kt were established.
• Some analysts that I’ve talked to tell me that the start of the 2nd Q should see a pick up in speculative inflows into the base metals sector as a whole, and are anticipating higher prices as physical demand increases. However, commodities are known to be very volatile, so I’ll be keeping an eye on London Metals Exchange to monitor inventory and price action.

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