Soaring China copper premiums

As reported here in the FT, copper premiums into China have soared to record levels. Refined copper imports were also very in July, with the arbitrage from LME prices into Shanghai supporting import demand.

All this suggests that Chinese copper demand is pretty strong.  But while this may appear bullish for flat prices, there are factors at play driving this that aren't necessarily supportive of sustained gains.

Part of the reason why the China premium has been so strong comes down to the aggressive hoarding of copper stocks in certain warehouses.This appears appears to be a ploy to take advantage of seasonally stronger demand for copper in China.

LME stocks rose sharply earlier in the year and this oversupply was concentrated into certain warehousees.  In particular, Glencore's Malaysian warehouse in Johor saw a huge run up in stocks earlier in the year, with the Trafigura owned NEMS warehouses in Antwerp also accumulating more metal (as Vlissingen was taken off the LME list of warehouses for good delivery).

This has created queues to get metal out of warehouses that are longer than if the metal was distributed more evenly.  As the chart shows, a huge percentage of total LME cancelled warrants are for Johor.

Because the queues are longer, warehouses can cover the initial cost of premiums for delivery, which at the time were lower than today.   And because it takes longer to get metal out of a single location, it means premiums can be squeezed higher when demand is seasonally stronger, which is exactly what has happened.

To be sure, the absolute level of LME stocks is still much higher than any point in the last few years.  While stocks are coming down, the speed of the decline is being hindered by the concentration of metal in certain warehouses.

It is also argued that some of this metal for import is not for "real" consumption, but as a source of cheaper international financing where imported refined copper acts as the collateral for a letter of credit.  The impulse from this trade may have faded given the SHIBOR squeeze has cooled.

Another key factor to consider is that while there has been a squeeze for refined metal on the SHFE arbitrage,  China has been able to import a huge amount of additional concentrate from international markets in 2013.  All this suggests that on an apparent basis, Chinese copper demand has been very strong.  But then again, so has supply and subsequently prices have been lower.

The tipping point on this trade will be where LME inventory pushed into China is ultimately just shifted into a Chinese warehouse, with metal not being consumed.

This will depend largely on estimates on movements in bonded warehouse stocks, which are opaque.  But if SHFE stocks are any guide, we are perhaps getting closer to that point, with inventories no longer declining over the last couple of weeks.

So in the very short term copper may be squeezed higher by short covering and some tightness in refined demand.  But this doesn't look particularly sustainable from a 3-month point of view.