Chinese Hedge Funds Bearish on Copper Ring Alarm Bells for Bulls

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Nobody may be more bearish on China copper than Chinese hedge funds.

That should be a warning to investors who’ve ridden the metal’s rebound from a five-year low into a bull market. Gains of as much as 20 percent since late January haven’t convinced the money managers that demand is improving in the world’s biggest copper-consuming country, where the economy is growing at the slowest pace in a generation.

“The outlook for China’s demand will be worse, not better,” said Shen Haihua, a senior portfolio manager at Hong Kong-based HFZ Capital Management, a joint venture of U.K. hedge fund Red Kite Management Ltd. and Maike Metals International, a Chinese metals trader. HFZ Capital says demand will weaken in the second half of the year.

Because China uses half of the world’s copper to build new power lines, cars and appliances, investors piled into the metal this year as the government took steps to revive the economy. Some of that cash is flowing into Chinese hedge funds that have expanded after regulatory changes in 2013, helping to fuel domestic trading of commodity derivatives that now outpaces the growth of legacy markets like the London Metal Exchange.

But for some Chinese commodity funds, with holdings that have grown by as much as a third this year to $90 billion, copper looks increasingly like a rally that won’t last. Policy makers in Beijing have cut interest rates three times since November in a bid to reverse a property-led slowdown. As much as half of the copper used in the country is related to housing and real estate, according to Goldman Sachs Group Inc.

Replacing Demand

“If you don’t have good property sales and property consumption, can you find another industry that can replace copper demand?” said Mary Wang, managing director of commodities research at Hangzhou, China-based DH Fund Management Co., which has 10 billion yuan ($1.6 billion) in assets. A weaker property market means demand will fall like it already has for steel, she said.

DH and HFZ are among an increasingly influential class of investors in China. The country had 6,174 hedge funds managing 873 billion yuan ($141 billion) at the end of April, according to Hong Lei, vice chairman and Communist Party secretary at the Asset Management Association of China. Growth has been rapid, and the funds’ strategies are becoming “more mature,” Hong said at a conference in Hangzhou on May 16.

Market Influence

Trading across the Shanghai Futures Exchange, China’s biggest commodities bourse, surged 31 percent last year while activity on exchanges in Zhengzhou and Dalian grew by 29 percent and 10 percent, respectively. That compares with a 3.5 percent increase on the LME, according to data from the Futures Industry Association.

While investment in China’s commodity markets has grown, domestic use of raw materials is slowing. The International Monetary Fund predicts China’s 2015 economic expansion will cool to 6.8 percent after growing 7.4 percent last year, the weakest since 1990. China is the world’s biggest buyer of everything from metals and energy to pork and soybeans.

“The Chinese funds are still pretty bearish, and they have been quite a negative factor in the market,” said Jim Lennon, a senior commodities consultant at Macquarie in London.

Copper bulls say falling inventories and increased spending on infrastructure projects will support prices. Stockpiles monitored by the Shanghai Futures Exchange have fallen 14 percent this month to the lowest level since February.

Copper Optimists

LME copper has surged since its low in January, entering a bull market and reaching $6,480 a metric ton on May 5, the highest settlement this year. The metal slid 0.9 percent to settle at $6,106.50 a ton on Tuesday in London. By the fourth quarter, Standard Chartered Plc forecast $6,850, while Barclays Plc predicts $6,500.

Chinese demand will rise more than 5 percent this year to almost 11 million tons, Standard Chartered analysts including Nicholas Snowdon said in an April 28 report. Global use will increase 4.5 percent this year. Smaller inventories at SHE-monitored warehouses and orders for power cables from the State Grid Corp. point to improving demand, the analysts wrote.

“China’s response to the slowdown in growth has been to sanction a large number of previously delayed infrastructure projects and grid spending is also set to grow rapidly over the rest of the year, both of which should add to its copper demand,” Kevin Norrish, a Barclays analyst, said in a May 18 report.

Demand Pessimism

Any renewed optimism over the past three months is misplaced because Chinese stimulus measures won’t be enough to prevent demand from weakening in the second half, HFZ Capital’s Shen said.

“People tend to underestimate China’s copper consumption during an economic downturn and overestimate demand when the economy strengthens,” he said.

Pessimism about the country’s raw-material use has already had an impact. The Bloomberg Commodity Index of 23 items slid 17 percent last year and fell again in 2015. While the gauge has rallied 5.3 percent from a 12-year low in March, it’s still down 2.2 percent for the year.

“China’s investment community, focusing on the macro-economic backdrop, concluded a long time ago that copper is destined for a drop as dictated by the weak fundamental demand and supply picture,” said Lin Ruhan, general manager at Shanghai Futures Investment Management Co., a Chinese hedge fund. “The situation has become very interesting with the bulls and bears locking horns with no clear winner yet.”

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