London, 11 March 2011

China's copper imports dropped sharply in February, according to the preliminary trade figures out this morning. This was in line with expectations, an increasingly rare occurrence with this monthly data-set. Actually, it was the scale of the 26.9-percent year-on-year decline that seems to have surprised this time around. At 235,469 tonnes, aggregated imports of refined copper, alloy, anode and semi-manufactured products were the lowest monthly total since January 2009.

Based on the ratio between categories in recent months, imports of refined copper alone were probably around 160,000 tonnes in February, which would be the lowest monthly figure since late 2008. It's almost certain the reduced February import figure was primarily a function of the timing of the Chinese New Year holidays.

Metal imports across the board dropped month-on-month and year-on-year in February with those of steel, both products and billet, registering even sharper drops than those seen in copper.

Graphic on exchange stocks:

http://graphics.thomsonreuters.com/10/GLB_MTLSTK10.html

That seasonal quirk undermines any simplistic extrapolation about actual Chinese demand for copper last month. The most useful comparison is between the first two months of this year relative to last year and on that basis the 2.4 percent decline looks a lot less dramatic. Indeed, at 599,709 tonnes the two-month total was the second highest ever. And last year, remember, was a record-breaking year for copper imports. That doesn't mean, however, that all is fine with the Dragon's appetite for the red metal.

FOCUS SHIFTS TO EXPORTS

But we'll have to wait for the full trade report later this month to find out more because the figure for exports is not included in the preliminary trade report. It's been a long time since the copper market had to worry about what was coming out rather than going into China.

The shift in focus says everything about the current problematic dynamic in the copper price, namely the disconnect between the heat coming off the futures market and a distinctly tepid physical market.

In short, Chinese buyers have been almost totally absent from the spot market for several months and the London- Shanghai arbitrage has been accordingly closed for profitable imports.

The result has been a build-up in "limbo" stocks in Shanghai, copper that has passed through customs and therefore appeared on the import figures but which has got stuck in bonded warehouse waiting a return of an import-friendly arbitrage.

The latest estimates, and sadly in the absence of any official figures we only have estimates to go on, suggest that this "limbo" mountain may have grown to 600,000-700,000 tonnes. That equals the total amount of stock held by the world's three main exchanges, the LME, the Shanghai Futures Exchange and COMEX.

Since such copper hasn't yet been sold onto a mainland buyer, no VAT has yet been paid. And that means that it can readily be re-exported if the arbitrage numbers stack up for a profitable delivery to LME warehouses in South Korea.

Exports, or more correctly "re-exports", of refined copper jumped to 23,193 tonnes in January. It was a modest figure relative to the 246,000 tonnes that flowed in the opposite direction. But it was the largest monthly total since July 2007 and a useful reminder that China's trade in refined copper does not have to be unidirectional.

Indeed, there is accumulating evidence that more of this "limbo" stock might be freed up for re-export. With Chinese buyers still reluctant to commit at current price levels and banks turning the stocks financing screws, physical premiums for such metal have dropped to nominal levels, or even discounts in the case of some SX-EW copper brands.

The seepage of metal back out from Shanghai has been a major factor in the gentle rise in LME warehouse stocks since the start of the year with locations in South Korea, the easiest shipping destination from Shanghai, playing a prominent role.

TIMING IS EVERYTHING

The trend of rising visible exchange stocks has dented the bull narrative for copper. Dented but not negated. There is still a firm consensus that China's copper manufacturing sector will return as spot buyers sooner or later.

There is nothing to suggest that the country's usage growth is going to fall off a cliff any time soon. Indeed, Tongling Nonferrous, China's second-largest copper producer, told Reuters that consumption will notch up a robust 7-percent growth rate this year. The company's chairman Wei Jianghong even joined the bull chorus with a prognosis that prices are likely to hit record highs (again) this year.

But timing is everything, given the assumptions about copper's underlying deficit dynamics built into the current copper price. The market outside of China remains firm in its conviction that China will resume "normal service" in the second quarter as fabricators restock ahead of what is their busiest time of year. The question is whether the country's copper manufacturing sector will stick to its part of the bull script or will carry on de-stocking and thrifting in the face of today's elevated outright price levels.

Might we see a re-run of the 2007-2008 stand-off, when Chinese buyers stayed away from the spot market much longer than anticipated, a key factor in the stalling of the bull rally of those years? Any further build in these Shanghai "limbo" stocks is going to test the collective bull resolve. It also risks turning the current seepage of re-exports into a heavier flow with potentially important consequences for LME stock levels.

That is why the export component of China's trade is now almost as important as the import figure in terms of defining the physical dynamic of the copper market. It's the first time that's been the case since at least 2008 and look no further to understand why copper's bull march has lost momentum in the last few weeks.

Ends --

Andy Home, Reuters Columnist - for Commodities Now.

The opinions expressed are his own.