Copper won't defy gravity forever but crash unlikely

The blistering rally in copper prices may start to cool later this year as new production finally comes on stream, but most analysts are not expecting a big correction anytime soon.

As miners from Chile to China ramp output to grab a piece of the commodities boom, supplies of copper could begin matching demand later this year and next.

Because of high demand for the industrial metal, thanks to the relatively robust world economy, copper has appeared resistant to any downside risk.

The world's big investment funds, who have no intention of ever taking delivery of the metal, have been piling in to grab big returns for their portfolios, and driving up the prices in the process.

Indeed on Thursday, precious metals suffered a correction with gold sliding 4 percent and silver losing 14 percent. But while copper wobbled, it ended the day only a fraction lower and by Friday was up $54 at the bid price of $6,350 a ton.

But most market players don't believe copper can defy gravity forever.

"We won't see a massive correction in copper prices but I will be surprised if it goes much higher from here," said Mike Komesaroff, managing director of Urandaline Investments, a consultancy specializing in power-intensive industries in China.

"I think we are probably somewhere near the peak," he added.

Some market players are nervous with copper rising so far so fast. The red metal had risen nearly 50 percent this year before hitting a high of $6,545 a ton this week.

"There has to be a correction soon," said Rohit Shah, president of the Bombay Metal Exchange. "The market cannot bear the burden anymore. People might be planning to exit the market."

Matthew Hope, a copper analyst at AME Mineral Economics, agreed: "I think currently we are running outside of fundamentals."

WALKING TALL

Because copper is used in everything from utensils to construction, it tends to be in high demand when economies are expanding.

So the metal, aided by the froth of the speculative buying, has walked tall on the London Metal Exchange because of the strong economies of North America and the rapidly industrializing countries of China and India.

Analysts believe that fundamentals do support high prices in the current range because of concerns about supply.

The mining industry has suffered for several years of under-investment in new projects, leaving the market scrambling for supplies when demand began to surge to feed Asia's economic boom.

"There was no incentive to build capacities all these years. But now is the time to make money," said Komesaroff.

Some of the biggest producers are already getting their act together. Codelco, the world's largest copper producer, is expected to bring its new Gaby mine on line by the end of next year, in addition to plans to expand smelting at its Chuquicamata mine and production at its Andina mine.

The International Copper Study Group said world refined copper consumption was in surplus by 60,000 tons in January, against a deficit of 25,000 tons in the same month last year.

"But small surpluses won't do anything to the market. There is an underlying deficit. Surpluses will start to come in later this year and next year. It is taking some time to catch up," Hope said.

But it will also be a challenge to bring a lot of new production on stream as miners face many bureaucratic and political hurdles before can they boost output and start filling up the shelves with the red metal.

Miners around the world are dealing with high costs, shortages of many materials, including tires. Workers are in short supply and increasingly eager to strike for better wages.

A number of mines are under threat from restless local populations. Freeport-McMoRan Copper & Gold Inc. (FCX.N: Quote, Profile, Research), holding the world's third-largest copper reserves at its Grasberg mine in Indonesia, is under growing threat from violent local protesters.

THE CHINA FACTOR

The global market is also keeping one eye on demand from China, which consumes 22 percent of the world's copper but mines only 5 percent of the ore. But with world copper prices rising sharply since the beginning of 2006 -- a period in which Bejing's refined copper imports fell -- the market is getting increasingly convinced that Chinese demand is not the biggest factor.

"The demand from Europe and countries like Japan, which is coming out of a recession, is very good," Hope said.

But another cap on market prices is the fact that manufacturers will try to pass on the rise in the cost of raw materials to customers, and that in turn would hit consumption.

"Are prices reaching a level at which they will constrain economic growth?" Komesaroff said. "It's just getting difficult for producers to absorb the costs."

Hope added: "These price levels are dangerous for consumption and can kill the market. It's taking enormous amounts of money to maintain copper stocks and this is hurting their cash situation."