London, 10 October 2011: Reuters

Dazed and confused. If the mood in London during LME Week can be summed up in a couple of words, it is those. Dazed because the collective psyche was still reeling from the ferocious sell-off that preceded the annual gathering of the global metals business.

And confused because the market is now trying to navigate an alien landscape, where visibility is poor and danger lurks everywhere. None is so confused as the copper market. While others such as aluminium, nickel and zinc can draw support from their proximity to the upper end of the cost curve, copper at $7,300 this morning, basis three-month metal , is still some way above it.

Does this mean another relapse? Or recovery? Or just sideways churn while the market waits for the mists to lift?

THREATS

Greece was the word on everyone's lips during LME Week. Not whether it will default. When it will default and what the impact will be on the European banking system. The threat became tangible on Tuesday when France and Belgium were forced to come to the rescue of collapsing lender Dexia . Again. It was bailed out in 2008.

European banks wobble and European leaders bicker. U.S. President Barack Obama called the uncertainty about Europe "the biggest head-wind" facing the American economy "because it's affecting global markets". The ripple effects of the tragedy that is Greece are becoming stronger and fears of European banking failure more pressing.

In micro in the insular world of the LME, beneath the surface discourse of seminars, analysts briefings and price forecasts hummed the rumour mill. Who took the pain in the September price collapse, when copper slumped from over $9,000 per tonne to under $7,000? Who took the hit on all those put options that were triggered on the way down? Who was the wrong way round on the spreads? Bank capitulation without and within the copper market poses the biggest downside threat to the copper price.

STABILIZERS

There are stabilisers already at work, though. Those lucky enough to have called the market right, such as metals fund Red Kite, will be keen to take some profit off the table.

CTA systematic black box funds are still massively short, having fed off the downwards momentum of the last few weeks. Short-covering reaction could be huge, with delta hedging by options traders likely to kick in just as strongly on the upside as it did on the downside.

Optimists talk of a correction all the way back to $8,000 or even above in the very short term. Dead-cat bounce or the start of a bigger rally? The jury is divided. Much will depend on the fundamental stabilisers that are also now coming into play in the lower price environment.

The U.S. scrap business has come to a virtual standstill. No-one wants to book a loss on material bought $2,000 higher.This isn't just a U.S. phenomenon. It is global. Scrap supply everywhere is extremely price-sensitive. That's good news for police forces the world over, given the likely sharp decline in thefts of copper wiring from railways and power lines.

It's bad news for copper smelters, which have enjoyed two years of good scrap availability and must now rely more on a tightening concentrates market. Lower prices have also stimulated Chinese buying interest. China was on holiday last week, but a potential sign of things to come was Monday's 27,825 tonne surge in cancellations of LME stocks.

Featured locations were South Korea (14,550 tonnes) and Singapore (12,775 tonnes). Just as China's de-stocking capped copper's upside this year, so might its restocking define the downside. It would be the same pattern as 2008-2009, albeit at a higher price base. Waiting for copper to return to below $3,000 could be a long wait.

Even from these levels, any further price weakness will simply whet further the Dragon's appetite. The State Reserves Bureau, China's stockpile manager, is being mentioned again as a lurking buyer at lower prices, the first sighting of the secretive copper buyer of last resort since 2009.

OPPORTUNITIES

It wouldn't be the only one. Plenty of hedge funds are waiting to get back into the red machine, just as soon as they can be sure they have seen the bottom. Why?

Because, as just about everyone agreed in London, the metal's supply-demand dynamics are still robust. Producers lined up to reject any suggestion they had seen cancellations of contracted tonnage through the end of this year. Chilean producer Codelco has dropped its European premium for term 2012 sales but only from $98 to $90 per tonne over LME cash. It will still be higher than the $75 charged in 2010.

Demand growth may be slowing, but it has not stopped, at least not yet. Italy-based copper product maker Prysmian said it saw no evidence of a "drastic slowdown" in demand for its products next year.

Supply disruption, meanwhile, proliferates, including strikes at the giant Grasberg mine in Indonesia, at the Cerro Verde mine in Peru and at Chinese mines in Zambia. Unless we're in for a full re-run of the events of 2008, Global Financial Crisis II, the copper market will remain in statistical deficit for a while yet.

The International Copper Study Group (ICSG) issued its biannual forecast last week, assessing the deficit at 200,000 tonnes this year and 250,000 tonnes next year. Within the base metals space copper remains a compelling story, particularly at these sort of price levels.

Indeed, just as high prices masked the underlying deficit by triggering de-stocking and accelerated scrap supply, so could low prices bring it back into sharp relief by stemming scrap flows and spurring restocking.

There is a strong consensus that copper will go higher. The only problem is knowing whether it will go lower first. The core question is one of timing. And timing will be determined not by the growing number of striking copper miners in South America, Zambia and Indonesia but by a small group of bickering politicians in Europe.

Ends --

By Andu Home, Reuters market analyst – for Commodities Now with permission.

The views expressed here are his own.