London, 6 November 2010

Standard Bank: Copper has rallied strongly in the wake of the Fed’s latest QE measures, with fresh buying interest and short covering activity propelling copper above $8,700 during Friday morning, for the first time since July 2008. The prospects of a weaker dollar environment, combined with tight fundamentals, suggest copper may even be set to break its record highs this year, a full quarter sooner than we had initially anticipated.

In dollar terms, LME 3-month copper is now only around 2.5% below its all time record highs, also reached in July 2008. In euro terms, copper is back above EUR 6,100, but still remains around 9% below its all time record, achieved in May 2006.

Interestingly, after gradually edging higher over the past week or so, the SHFE copper market has also burst into life, gaining nearly 4% following the FOMC announcement and the subsequent rally in LME price. Even aside from today’s move however, the SHFE-LME arbitrage ratio has started to move back towards neutral in recent days, with SHFE copper gaining 8% on the week compared to a ~5-6% gain in LME prices.

With the Rmb element of the arbitrage calculation no longer static, the historical ratio figures are likely to have shifted, with the physical arbitrage channel moving lower in line with the stronger Rmb. We are still yet to see the ratio settle down and a new trading pattern emerge, however the increase in the ratio is a positive sign in terms of Chinese activity, with the sustained strength in LME prices perhaps panicking some participants back to the market.

The picture from the physical market is less rosy however, with a marked disconnect still in place between the performance of copper prices and the underlying physical market. The physical picture is not terrible by any means, but can be described as being stagnant at best. Physical premiums are generally well below the summer highs, particularly in Asia, but have stabilised in recent weeks.

The lack of activity is, in part, likely related to various power curtailments impacting on downstream fabricators, while expectations of further yuan strength are also removing any element of urgency in terms of acquiring metal. SHFE inventories have also continued to increase over recent weeks, suggesting availability isn't an issue, though unlike zinc and aluminium, there is nothing yet to suggest that government reserves are being drip fed to the market.

Looking ahead, investor flows appear to be in the driving seat for the moment and we expect to see prices remain well supported. While the lack of physical activity removes some of the background support for copper prices, meaning any sell-off may be quite aggressive in nature, we expect that physical activity to return over the coming months. We maintain our bullish stance towards copper and, once both the physical and futures market start to move in sync again, we expect copper to smash its record and push on towards $9,000 and above.

Ends --

By Leon Westgate,

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