The recent drop in copper prices has coincided with the People's Bank of China allowing the yuan to depreciate.
Even though the weaker yuan makes Chinese copper imports more expensive, it adds stimulus to the economy, which is positive overall for China's copper demand.
Hence, the yuan depreciation limits the downside risk to copper prices this year from the risk of a further deceleration in Chinese growth.
Over the past couple of days, copper prices have declined, erasing the gains since the beginning February and losing more than 2% since last week’s high. Signs of weakness in the global economy, in particular the slowdown in the Chinese economy, have been the main factor pushing prices down. Adding to downward pressure could be the recent move from the PBOC to allow the Chinese yuan to depreciate (see Flash Comment: Weaker yuan suggests PBOC easing bias and widening of trading band, 25 February 2014).
China has allowed the yuan to depreciate around 1% over the past week. A weaker yuan makes Chinese copper imports relatively more expensive, which weighs on China’s demand for copper and thus copper prices. Around a third of China’s total copper demand, which was close to 10mt last year, is covered by imports. However, it is important to note that the currency weakening is the result of the central bank easing monetary policy to stimulate the Chinese economy to mitigate the recent growth deceleration. This is positive for China’s demand for copper, which should support prices. We view the net effect on copper prices of these two opposing effects as positive, although the negative effect via the currency channel may dominate in the short run.
The yuan previously depreciated significantly in 2012. At that time, the 1% weakening was followed by more than a 10% drop in copper prices. We do not expect to see a similar effect now, as the depreciation in 2012 correlated with a substantial downturn of the global economy, for example, the euro debt crisis was escalating at this point.
A further deterioration in Chinese growth poses the main risk to copper prices in particular in 2014. However, if it is starting to address the growth deceleration by easing monetary policy, this will remove some of the downside risk although prices could fall further near term on the back of the currency depreciation.
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