ANALYSIS-Western troubles may knock China, drive copper down

Wed Sep 14, 2011 11:44am BST

* The party's over, but no one has recognised -consultant

* China's move away from export-led growth just started

* Situation looks weaker on the ground in China

By Pratima Desai

LONDON, Sept 14 (Reuters) - Economic troubles in Europe and the United States are likely to shrink China's exports, harm its economy, reduce its demand for copper and possibly trigger a price drop in the industrial metal over the coming weeks.

Jitters about debt default in Greece and worries about the health of the world's largest economy, the United States, have in recent weeks combined to send many markets including equities hurtling lower.

So far, the price of copper has held up on expectations of strong demand from China, which is estimated to consume about 40 percent of global demand, which is forecast at around 19 million tonnes this year. [ID:nL5E7JM1WF]

"China's economy is still export-led. Where are they going to sell their stuff? Where is the demand for their goods going to come from in a recession?" said Ian Morley, chairman of Wentworth Hall consultancy.

"It's like a Tom & Jerry cartoon. They rush into the air, suddenly look left and right, realise there is nothing holding them up and crash to the floor. In the short term to medium term the party is over, and no one has recognised it."

Data from the International Monetary Fund show China's exports of goods running at about 30 percent of its gross domestic product this year, 26.9 percent in 2010 and 31.7 percent in 2008.

The country is trying to move away from being an export-led economy to one in which growth is related to domestic spending, but fund managers say China is at the beginning of this cycle and the transition will take years.

China's exports have cooled recently to $173.3 billion in August from July's record high of $175 billion. [ID:nL3E7KA00X]

"This (exports) could be the beginning of a trend," a hedge fund manager who trades copper said. "The cliff-edge scenario is a very real one; we could be facing a 2008 situation."

Copper prices plunged below $3,000 a tonne in December 2008 as talk of a 1930s-style depression climaxed.

The risk of contagion from Greece to other euro zone countries and renewed growth concerns have this week helped push benchmark copper prices CMCU3 down on the London Metal Exchange. On Wednesday they were around $8,700 a tonne from $8,821 on Friday.

TANGIBLE ASSETS

Copper is down about 15 percent from a record high of $10,190 hit on Feb. 15. Over the same period the pan-European FTSEurofirst 300 .FTEU3 index of top shares has tumbled about 25 percent to around 900 points.

"At some point, finally, weak demand in the real world will win out," said Andrew Cole, a fund manager at Baring Asset Management. "You might hold copper for investment purposes, but unless somebody actually wants to buy it from you to utilise it, prices will weaken."

Much of the momentum behind higher prices at the start of the year was shaped by demand from investors looking for safety in hard tangible assets such as commodities. They were worried about inflationary pressures fuelled by the large amounts of money pumped into the global financial system by central banks and governments to boost growth.

The prospect of further quantitative easing by the U.S. Federal Reserve may not, as in previous times, help buoy copper prices.

"It seems that QE definitely has diminishing returns. The first round had a big positive effect, the second one had less of an effect," said Frances Hudson, global thematic strategist at Standard Life Investments.

"There may be a third round, but the law of diminishing returns will kick in. There is limited opportunity for asset prices to bounce. People may sell into it unless the currency argument completely overwhelms it."

Commodities are priced in the U.S. currency, and its weakness in recent years has helped boost demand from investors in other currencies. Many are betting that a squeeze on margins for producers who account for costs in currencies other than the dollar will lead to higher prices for comodities.

SLIPPERY SLOPE

Western economies, meanwhile, are vulnerable to a shock that could affect the strength of Chinese exports and push copper onto the slippery slope.

"Some sort of a shock. We are not far from this shock, there are a lot of things -- debt default, growth data, banking sector traumas -- that could hit western demand," said Ashok Shah, chief investment officer at fund firm London & Capital.

"There is a great deal of uncertainty everywhere in the west. Deficit-cutting plans are being approved. That will cut demand, which means lower production."

Fund managers say they are watching the monthly surveys of purchasing managers in China, the United States and Germany, the euro zone's largest economy, for clues to prospects for manufacturing and demand for industrial metals.

On the ground in China, an executive at a copper smelter expects demand to weaken in the fourth quarter because of slower economic growth, while a manager at a large copper tube producer said his firm’s export orders had fallen about 40 percent from the first half of this year in the past two months.

"We feel export orders are not (going) very well. U.S. and European economy may be having problems," the manager said. <^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^

Copper vs. PMI r.reuters.com/nab73s

Copper correlation with equities r.reuters.com/geb73s

Copper price vs. U.S GDP r.reuters.com/heb73s

Copper price vs Chinese exports r.reuters.com/jeb73s

For story on survey of fund managers [ID:nL9E7HO0AN] ^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^>

(Additional reporting by Polly Yam in Hong Kong; editing by Jane Baird)

((pratima.desai@thomsonreuters.com)(00 44 207 542 5113)) Keywords: COPPER CHINA/

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