By Andy Home, Reuters columnist

LONDON, Jan 30 (Reuters) - After spending the previous three years desperately looking for surplus metal to alleviate super-high prices, the copper market is now having that surplus rammed down its throat.

LME stocks of the red metal are soaring. They have surged by 150,975 tons so far this month to a five-year high.

This highly visible build in surplus metal is acting as the major depressant on prices right now but it may be misleading, providing both too much and too little information about the underlying dynamics of the copper market.


TOO MUCH VISIBILITY

 

There is no doubting that the copper market is in surplus.

It often is at this time of year. The copper market has its own marked seasonal pattern and the November-February period is normally characterised by weak demand with many fabricators taking downtime around the Christmas and New Year (both calendar and lunar) holidays.

Overlaying that "normal" seasonal weakness this year is the well-documented collapse in metals demand resulting from the implosion in global manufacturing activity.

Each passing day brings with it fresh evidence of the carnage that is taking place in the real economy. Overnight, for example, Japan reported a headline-grabbing 9.6 percent month-on-month decline in industrial production in December.

So there should be no surprise that metal surplus to immediate requirement is making its way to the market of last resort, the London Metal Exchange.

But something doesn't ring quite true about the scale of this month's increase. Projecting January's stock rise across the rest of the year would generate an implied surplus of around 1.8 million tonnes.

That's off the scale of current consensus thinking.

The average surplus forecast for this year from the annual Reuters poll of analysts was 324,500 tonnes. Factoring in a 5,194-tonne build in copper stocks held by the COMEX warehouse system, January's build is almost half-way there.

A possible explanation for this conundrum is that this month's stocks build is masking a driver other than underlying supply-demand dynamics.

The world has changed a lot in the last few months.

Collapsing metals demand and prices are part of that change. But both phenomena are second-round symptoms of the original crisis in the financial sector.

The root cause of the current metals industry distress was the collapse of the wholesale credit markets. They have not yet recovered, functioning only partly and only with artificial central bank life support.

The state of the credit markets affects the whole copper market from producer to consumer to trader.

Excluding a small number of players who have pristine credit ratings and unusually understanding banking partners, holding stocks of metal, or anything else for that matter, is at best prohibitively expensive and at worst financially impossible.

Therefore, there is a strong financial incentive for commercial metal stocks to be transferred to the LME, a trend that is reinforced by wary lenders insisting funds are guaranteed against LME warrants as liquid receivables.

This is a pattern that has been most pronounced in the aluminium market, where "old" surplus that was hidden from the market in the form of big off-market stocks has been dumped into the LME system for want of affordable financing.

There is less evidence in copper that "old" surplus has found its way to the market in this way, although locals have been eyeing the particularly fast build in Rotterdam stocks with a degree of caution.

However, what it does mean is that the LME warehouse system is now accounting for a much bigger ratio of the overall stocks picture, i.e. we're seeing far more of the surplus than we would in other less credit-straitened times.


TOO LITTLE VISIBILITY

The dramatic build in headline LME stocks is misleading foranother reason. This is not a uniformly-distributed global build.

It is one that is heavily concentrated on Europe and the United States. LME-registered stocks in Europe have ballooned by 74,000 tonnes in January. At 236,000 tonnes they account for 48 percent of the tonnage in the LME system.

Stocks of copper in LME warehouses in the U.S. have increased by 57,325 tonnes to 163,250 tonnes, accounting for 33 percent of the global total.

However, the rise at core Asian locations such as Singapore, Johor and the South Korean trio, has been a relatively modest 19,150 tonnes.

For explanation look no further than the third component of the global reported stocks picture. Stocks registered with the Shanghai Futures Exchange (SHFE) actually fell last month by 1,255 tonnes and at 16,587 tonnes they are ultra-low by any historical yardstick.

That has ensured that the Shanghai market remains in backwardation and that it trades at a  premium to the LME, keeping open the arbitrage window for profitable imports.

The result has been a flood of copper imports into China.

Net imports in September-December 2008 were almost 590,000 tonnes, more than double the 286,000 tonnes imported over the prior four-month period, i.e. May-August 2008.

The surge culminated in December's record 210,600 tonnes of net imports of refined metal, a level that has left commentators both inside and outside the country scratching their heads.

There may well have been a combination of one-off factors in that December surge, such as greater use of primary metal over scrap, the "usual" stock-building prior to this week's national holidays and even some speculative positioning ahead of the fiscal stimulus package taking concrete form.

But what is certain is that the flood of metal into China in the closing stages of 2008 has not found its way to SHFE warehouses.

And as long as SHFE stocks do not rebuild, there is every possibility that the arbitrage window with London will stay open and stimulate further accelerated flows of metal into the country.

That of course has implications for the global market surplus this year. If it disappears into stocks build in China, whether commercial or government, fundamental market surplus could give way to commercial market balance.

So beware the surplus currently being implied by the LME stocks build. Surplus it definitely is, but not necessarily surplus as we've known it in the past and certainly not global surplus, or not just yet.