METALS INSIDER:Stockpiling can be bad for your health

-- Andy Home is a Reuters columnist. The opinions expressed are
his own --

By Andy Home

LONDON, Mar 11 (Reuters) - China, as every reader of this
column should know by now, is snapping up metals at the recent
cycle lows to add to its "strategic reserves."

For a current list, click on [ID:nPEK179560].

The government stockpile manager, the State Reserve Bureau
(SRB), has already bought copper, aluminium, zinc and indium and
has most recently turned its attention to nickel. [ID:
nPEK202679]

However, there are "strategic reserves" and there are
"strategic reserves". The result may be the same but the
difference lies in the motivation and, correspondingly, the
likely outcome.

STRUCTURALLY SHORT

Copper, for example, is an obvious target for the SRB.

Copper is an industrial metal that lies at the heart of
China's recent economic growth and it is a metal of which China
is structurally short.

The country has in recent years been a massive net importer
of copper cathode, copper alloy, copper anode, copper
concentrates and copper scrap, i.e. at every stage of the supply
chain.

For this reason the SRB has long been a major player in the
copper market, historically buying during times of surplus and
selling at times of deficit.

There has, it is true, been the occasional hiccough, such as
in 2006, when the Bureau had to deliver a significant tonnage
back to LME warehouses against problematic short positions put
on by disgraced trader Liu Qibing.

However, the "strategic reserve" has generally fulfilled its
function of maintaining supply to Chinese consumers during times
of tightness and ultra-high prices.

The Bureau is back in the copper market, once again
hoovering up units at what it evidently feels are
bargain-basement prices. It may or not be right on the last
point but its key advantage is that it can wait until it is
right.

Even now, in the trough of recession, analysts are fretting
about what low copper prices will mean for already dysfunctional
mine supply going forward. There were already too few new mine
projects in the pipeline and even fewer in China.

At some stage in the future, whether 2, 3 or 5 years, the
copper currently being bought by the SRB is going to come in
useful.

STRUCTURALLY LONG

Aluminium has played an equally important role in China's
industrialization and urbanization but the SRB has not been an
active player in the international aluminium market in recent
years.

That's because it hasn't needed to be.

Far from being structurally short of aluminium, China has
become the world's largest producer and, in the most recent
period, the fastest-growing producer of the light metal.

The country has been a significant net exporter of primary
aluminium, aluminium alloy and aluminium products.

Why then has the SRB already bought 590,000 tonnes with more
buys expected to come ? Not to cushion a country that is already
self-sufficient from the vagaries of international supply,
surely ?

The answer was given to Reuters by Zhang Yuanxin, director
of the Guangxi branch of the all-powerful economic planning
ministry, the National Development and Reform Commission.

Guangxi and other provinces are following in the central
government's footsteps by creating "mini strategic reserves."

"Right now demand is not so good, production is below cost.
Smelters are not making any profit. So they don't want to
produce and if they're not producing they may cut jobs," said
Zhang.

In other words, "strategic" purchases in this context equate
to keeping key producers in business during the current price
trough.

It's noticeable that the SRB's purchases have been from a
relatively small, elite group in the aluminium smelter sector,
the same elite that have just been granted the right to
negotiate power prices directly with producers as a means of
securing potential cheaper power [ID:nHKG187374].

Beijing's intentions are clear but the results may not be
what the Chinese authorities intended.

BUYER OF FIRST RESORT

The SRB has paid above market rates for its aluminium, a
premium of 15 percent in the first auction in December and one
of 5 percent in the second auction in February.

That has no doubt been of great assistance to the
cash-strapped sellers but it has also dragged local prices
higher, creating an arbitrage opportunity with London.

This is reversing historical trade patterns.

China switched to net importer of primary and alloy in
January for the first time since March 2007. The snapshot of
February's trade figures suggests the country remained a net
importer last month.

More metal is on its way to China with locals expecting a
surge of up to 130,000 tonnes to hit the country over March and
April, pretty much the same amount that entered Chinese customs
over the whole of last year [ID:nHKG108709].

The Chinese government is rapidly becoming the aluminium
market of first resort. Rather than protecting its core
producers, it risks exposing them to the full force of global
surplus as imports add to existing domestic market surplus.

In other happier times Beijing could simply adjust its
import taxes to discourage the flow of metal into the country
but after lambasting the United States for the "buy American"
component of its fiscal stimulus package, any move towards
protectionism is politically risky.

As such, the Bureau may have to be prepared to buy up a lot
more surplus aluminium in the coming period to keep its national
favourites afloat.

It may also have to do so for much longer than it might have
hoped, since subsidized pricing, which is what the current
buying programme amounts to, will do nothing to resolve the
underlying problem in the aluminium market, which is one of
surplus smelter capacity, particularly in China.

The combination of surplus production capacity and massive
surplus stocks overhang is not a happy one for the aluminium
market and it may turn out to be a very unhappy one indeed for
both the Bureau and the very producers it is seeking to shield
from the aluminium price collapse.