Copper joined other commodities in rallying last night. This was in response to a possible lightening of one of the weights around its neck: the strong US Dollar. The Dollar is now being sold based on a growing view that the Fed won’t lift rates until December. Ironically, this change of heart on the Fed is due partly to the fact that commodity prices are falling with negative implications for inflation.

While it’s possible that a weaker $US could trigger a corrective rally in copper prices, the current supply surplus will remain as the key driver. Over the medium term this looks set to remain a negative influence.

At $US 2.31 per lb, the copper price has halved since its $4.65 peak in 2011. It scaled this height after bottoming out at around 60c in 2001.

Much of this rally was about the opposite situation to that which currently applies. Fuelled by growth in China, demand grew faster than miners were able to increase production. When there is a supply deficit, prices rise.

The basic landscape of the copper market is that China now accounts for more than 40 % of world demand. The major uses of copper are in construction and electricity which account for about one third of total demand each. Other significant uses are for industrial machinery and vehicle manufacture.

This profile makes it pretty clear that China and in particular China’s construction industry, are the key swing factor for copper demand. Here of course, the news hasn’t been great. The slowdown in China has meant that notwithstanding improving US housing construction, overall world demand is plateauing. The World Bureau of Metal Statistics (WBMS) estimates that world copper consumption declined by about 1% in the 6 months to June 2015 compared to the same period last year.

There are glimmers of hope as far as China’s property market is concerned. The latest statistics show that average housing prices have been rising for the last 3 months. However, major property gluts typically take several years to work through and are often characterised by a long basing or trough period. This could easily be the phase that China is now entering. While overall average prices have stopped falling, the gains are patchy and confined to major capital cities.  The greatest supply overhang is in second tier cities which have accounted for 70% of total property investment and there is little sign of relief here.

In the longer term, China’s rebalancing towards domestic consumption and services and away from infrastructure development and heavy manufacturing will also be a relative negative for copper demand. This suggests that future demand growth won’t be as great as it was a few years ago, even after the current cyclical downturn eventually ends.

While demand growth has stalled, copper supply has been rising. WBMS estimates that world mine production rose 3.8% in the first half of this year. The net effect of rising supply and stalled demand was an estimated supply surplus of 151k tonnes for the 6 months to June. This follows a 295k surplus last year. This is a recipe for rising inventory and falling prices and is precisely what we have been seeing.

Surpluses are generally expected to persist and 2016 looks like being another surplus year. On that basis, the risk remains to the downside for the copper outlook although there will doubtless be corrective rallies along the way.

Copper chart 

The chart below is a monthly chart where individual candles display the high; low; open and close for a month’s trading.

The first obvious resistance to the upside on this big picture chart is indicated by the dashed blue line around $2.90 per lb. Any move above this would be a real sign of strength, presumably requiring a paradigm change in the demand supply fundamentals. $2.90 seems a long way from current prices but copper was at this level only 3 months ago. A corrective rally back towards this zone couldn’t be ruled out. However, if the supply surplus persists, any corrective rally should top out below $2.90

Looking for potential support levels, Fibonacci analysis brings the $1.85/$2.00 zone into focus. This represents a 78.6% retracement of the whole post GFC rally. A projection that the “C to D” down swing I’ve labelled on the chart might be 127% of the size of the “A to B” swing, also finds this price zone. These measures frequently define the end of a major corrective down trend.

If the supply surplus persists and $1.85 is taken out, the next obvious chart level is right down at $1.25. This picks up the 1997 peak and the GFC low.

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