Copper unwinds: copper markets have been unwinding, influenced by the world economy and hedge fund activity.

Whether a long expected correction or a minor blip, the price of copper has been declining throughout the past several months. While disconcerting for some, most copper market observers had been expecting the drop for quite some time. These observers are now asking how low the price will go and how long the decline will last.

According to estimates, copper prices have dropped by nearly 40 percent since the middle of last year. Despite the modest price improvement lately, copper has been on a steady decline, which accelerated during rile first month of 2007.

PRODUCTION FIGURES. Despite the sharp decline in copper prices, copper markets are in fairly decent shape globally. The global economy continues to hold up; inventory levels, which have helped to propel copper prices far above record highs last year, have been increasing; and new capacity is still not dampening the market.

However, more recent indications from the London Metal Exchange (LME) show that LME-monitored warehouse inventories have declined recently, though they, are up significantly from one year ago and more than eight times higher than July 2005 lows.

One source says that copper inventories are presently at approximately 200,000 pounds (roughly two weeks of supply). While having increased slightly from tighter levels, one-month's worth of inventory would be preferable, lending more stability to the market.

According to Lisbon, Portugal based International Copper Study Group (ICSG) data, global production of refined copper in 2006 was close to 17.4 million metric tons, an increase of 5.4 percent compared to 2005 production. Consumption rose 3.3 percent in 2006 to 17.16 million metric tons. Thus. there was a surplus of about 0.24 million metric tons of copper in 2006. The surplus of copper is expected to reduce to 0.16 million metric tons in 2007 as usage outpaces production, which ICSG estimates at 18.06 million metric tons. ICSG estimates that nearly 17.9 million tons of copper will be consumed in 2007. This tightening in supply should serve to raise prices according to microeconomic models.

However, activity by hedge funds, investment houses and other financial houses has also contributed to the decline in copper prices as they unwind their positions in copper (as well as a number of other base metals), As a result. prices have pulled back.

The long-lasting price decline was painful for companies that had expected a quick rebound in prices by the early part of the year, but instead saw further price erosion. The question many are now asking is whether the decline will drive down prices to "historic" averages, or if prices will start to turn around.

A SLUGGISH MARKET. Regardless of where prices are heading in the short term, most copper market observers say that the global environment for copper is fairly positive, though a few areas present concern. One problem spot is the U.S. housing industry. A booming U.S. residential housing market earlier this decade helped to propel domestic copper demand. Currently, however, the sharp decline in new housing starts has served to cool domestic demand for the metal.

Throughout the past several months, many copper scrap dealers have said that the sluggish housing market is their primary concern. Recent information from the U.S. Census Bureau may lend credence to the slow housing market and its affect on copper markets. According to recent Census Bureau reports, during the final three months of 2006, about 2.1 million vacant homes were for sale. The national homeowner vacancy rate was at 2.7 percent, a sharp jump from the prior year. This increase indicates that housing sales are becoming more challenging. It then follows that the decrease in new housing starts has led to a reduction in copper demand.

While there are concerns about the health of the domestic copper industry, Susan Bates, with CRU, a U.K.-based metals consulting firm, says that despite a sluggish U.S. copper market, Europe and China are showing signs of improvement, which should more than balance out any problems in the U.S. copper market. She estimates that global copper demand should grow by from 3 percent to 4 percent this year.

David Threlkeld with Resolved Inc., a consulting group based in Scottsdale, Ariz., says financial houses are causing the volatility in the copper market. "The market is being [hijacked] by speculators right now."

Threlkeld says the influence of hedge funds and financial houses that propelled copper markets to price levels far greater than historic highs is now causing the sharp price reduction.

The news that Red Kite, part of a $1 billion hedge fund run by RK Capital Management LLP that had been very active in copper trading, has seen its position decline significantly has exacerbated copper's price slump. According to some business reports, the Red Kite Metals fund lost around 30 percent of its value during January, following a decline of around 10 percent the previous month.

This slide tracks copper price declines throughout the past six months. While some industry watchers fret that the sharp decline in prices could create greater havoc in the market, Red Kite's shareholders have decided to wait before making redemptions, which has softened the copper market.

STAYING UPBEAT. While Red Kite's move has helped to accelerate the decline in copper prices, it is uncertain how many of the funds that poured money into various commodities, helping to drive up prices, are now looking to move their money to other investment vehicles.

While investors who chased cop per's high prices may be thinning, in the short term, Chinese buyers are expected to renew their buying, which should give copper prices a floor.

Copper prices also appeared to have rallied during the first half of February. Reports have indicated that there is healthy interest from a number of larger buyers who are snapping up copper at these lower prices, which could keep prices from declining much further.

Plenty of new copper capacity is expected to come online next year, which should reduce the chance that shortages could crop up. At the same time, with mixed signals about inventory levels, any new capacity would also keep a lid on prices.

Finally, several vendors express concern that the sharp jump in copper prices has given some consumers the impetus to substitute other, less expensive materials. In the housing industry, the use of plastic pipes in plumbing has had a major impact on copper markets. With prices now coming off their record highs, some are asking whether there are enough end markets to sustain copper.

However, copper still remains fundamentally sound, and demand from consumers continues. As investment houses begin to unwind their positions, many dealers of the material say that much of its volatility has been wrung out, resulting in more stability.

POSITIVE ATTITUDE

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The author is Internet and senior editor of Recycling Today and can be reached at [e-mail].