Bullish story brewing here

The marginal cost debate for the copper mining industry has flagged up a target price for bears

Since early February, base metal prices have been falling, as perceptions of global growth and metal demand have deteriorated. Copper prices have led the retreat, plunging from the $8,300 a tonne level to below $6,800 a tonne in the second half of April. At times like this when the selling is relentless, it is easy to get carried away by the bearish sentiment.

However, a sober look at the big picture shows the global economy is relatively stable and, although risks exist and previously overambitious forecasts have been downgraded, growth is on the path for continued improvement in 2013. Metal consumption is still expected to expand. Oversupply estimates for copper are being reduced in the light of supply disruptions and cutbacks in recent months that have reined in production expectations. And, any surplus material is not sitting around, drowning the physical markets and depressing premiums - it is being hoovered up by major traders and warehousing companies, who are locking the metal up in stock financing deals and, in doing so, keeping availability tight. When viewed like this, the fall in prices seems overdone.

The copper futures market is now extremely short. Recent data from the US Commodity Futures Trading Commission reveal record levels of speculative short positions in Comex copper. To put this in perspective, positioning in April was more bearish than during the global financial crisis of 2008-09, unwarranted, as the global economy is in nowhere near as precarious a situation as it was then. The large overhang of short positions in copper leaves prices primed for potentially aggressive short covering rallies, which could move quotes back into the mid-high $7,000s in weeks. Meanwhile, we cannot rule out further weakness while the downward momentum continues to dominate.

One of the interesting things at the copper industry gatherings at the annual CESCO Week in Santiago, Chile, earlier in April, was a focus on marginal costs for the copper mining industry. The $5,000-6,000 range was viewed as where production cutbacks might start to come in and new projects deferred. This marginal cost debate has flagged a target price for copper bears. So, it wouldn't be surprising to see prices briefly dip to the low $6,000s in the short term, in search of this marginal cost support.

We would reserve this for a worst case scenario. Prices might have already found a base and there is a potentially bullish story brewing, which could be the short covering trigger to launch the price rebound.

At least in part, this sell-off had its origins in China, as a disappointing pace of economic recovery there this year initiated the downgrading of investors' view on copper demand growth, before CTAs and black boxes pounced on the trend. However, ironically, it is China we are pointing to as the source of optimism that the sell-off has been overdone. The LME-SHFE arbitrage window is open, premiums are rising fast, stocks are falling on both the SHFE and in bonded warehouses and anecdotal evidence suggests that fabricators serving key copper-intensive sectors, such as appliances, autos and power, are raising output and stock levels amid growing confidence and order books. Official data show total output of semi-fabricated copper and brass products in China reached an all-time high in March and was up over 18 per cent year-on-year during Q1.

Such indicators keep us from getting too bearish on copper, especially given the spate of supply disruptions. Overall, we forecast a recovery in cash prices to average $7,966 a tonne this year (low case scenario is $7,700 and high case is $8,250). If, as we expect, the global economy continues to improve through 2014, we see scope for prices averaging as high as $8,338.

The author is managing director, Metal Bulletin Ltd, London