LONDON, Aug 20 (Reuters) - A rare burst of Chinese

exports has deflated bull spirits in the copper market, with

funds dumping long positions and prices down by 16% from the

record highs seen in May.

The world's largest buyer of copper shipped out an

unprecedented 158,000 metric tons of refined metal in June.

First-half exports of 302,000 tons were already higher than any

full calendar year since 2019.

This break of normal trade patterns has punctured a bull

narrative of constrained supply and cyclical demand recovery.

Weak Chinese purchasing managers indices show that activity

in the country's manufacturing sector sank to a five-month low

in July, reinforcing Doctor Copper's gloomy message.

Yet demand weakness is only part of the story.

Fast-rising domestic production and a flood of African

imports have saturated the local market. And then a ferocious

squeeze on the CME contract in May opened an equally

unusual export arbitrage window for that excess to flow out.

TOO MUCH COPPER

China produced 5.9 million tons of refined copper in the

first half of the year, according to local data provider

Shanghai Metal Market. That represented year-on-year growth of

6.5%, equivalent to an extra 359,100 tons.

The robust growth rate runs counter to expectations that

domestic production would fall after the country's smelters

committed in March to curtail output due to tight raw materials

supply.

It's true that many smelters have taken maintenance downtime

in recent months, but the cumulative impact has simply been a

moderation of the supercharged rate of expansion.

Rising smelter output has coincided with a period of high

refined copper imports.

Although the export burst has significantly reduced China's

net call on the international market, the country's imports have

remained strong. Volume rose by 16% year-on-year to 1.9 million

tons in the first six months of 2024.

China also imported significantly more scrap copper, volume

increasing by 18% year-on-year to 1.2 million tons in

January-June.

Chinese demand would have had to be super-strong to absorb

the simultaneous combination of more domestic and more import

supply. Clearly, it wasn't strong enough.

THE RISE OF THE CONGO

The core driver of China's higher metal imports has been the

Democratic Republic of Congo (DRC). The country last year

overtook Peru as the world's second-largest copper producer and

shipped more metal to China than top producer Chile.

Trade flows between the two countries continue to

accelerate, with China's imports jumping by 91% year-on-year to

698,000 tons in January-June. The June tally of 150,000 tons was

a new monthly record.

Given China's dominant role in DRC's copper-cobalt mining

sector, trade flows between the two countries are unsurprising.

However, it's also the case that there is no other

equivalent market for Congolese copper, including the world's

big three exchanges.

The London Metal Exchange (LME) currently has only one

Congolese brand on its good delivery list - "SCM", produced by

La Sino-Congolaise Des Mines with annual capacity of 82,400

tons.

DRC copper is not deliverable against either the CME or

Shanghai Futures Exchange (ShFE) contracts.

With Chinese demand insufficiently strong to absorb surging

imports, Congolese metal has washed around the domestic market,

dragging down both premiums and prices to the detriment of local

smelters.

(NOT) GOOD DELIVERY

CME's limited good-delivery list of copper brands is one

reason the U.S. contract got squeezed so badly in the second

quarter.

Stocks fell to just 8,117 tons at the start of July, as

shorts found their capacity for physical delivery largely

confined to U.S., Canadian or Latin American brands.

Inventory has since rebuilt to 23,620 tons, but it has been

a painfully slow process.

When the squeeze was at its most acute in May, CME copper

was trading at a premium of $1,100 per ton over LME copper. Both

were priced much higher than the well-supplied Shanghai market.

The net result was a rare export window for Chinese

producers to ship surplus metal.

China shipped 16,000 tons of refined copper to the United

States in June, which is an extremely unusual phenomenon. But

the metal can't be delivered against CME shorts since the

exchange has no Chinese brands on its good delivery list.

However, Chinese metal can be delivered to the LME, which

currently accepts 22 Chinese brands of copper.

Most of what China has exported has headed to South Korea

and Taiwan, both LME good-delivery locations.

LME stocks included just 400 tons of Chinese copper in

February. That mushroomed to 121,700 tons at the end of June,

with Chinese metal accounting for almost 54% of total registered

inventory.

Were there seamless physical arbitrage between the CME, LME

and ShFE, China could have shipped directly to the CME, or

diverted excess Congolese copper to the United States.

The reality has been a tortuous reconciliation of regional

imbalances. Chinese surplus is moving to the West but largely

via LME warehouses in Asia.

The LME at least is emerging as a potential market of last

resort for Congolese copper. It received its first 500 tons of

"SCM" brand metal in June. Other Congolese producers, including

China's CMOC, are seeking to list their brands.

The CME good-delivery list, by contrast, accounts for a

shrinking share of global production.

Analysts at BNP Paribas calculate the volume of deliverable

copper has shrunk from seven million tons in 2010 to around four

million.

The CME has the disadvantage of operating only domestic

good-delivery points, leaving it exposed to broader U.S. trade

policy against China, Russia and other countries deemed

problematic.

But while physical delivery options remain constricted, a

repeat of the May squeeze is not inconceivable.

OPTICAL ILLUSION

Reading Chinese copper exports as a simple signal of weak

demand misses the impact of the extraordinary squeeze on the CME

and the divergence in good-delivery options on the three

exchanges.

Chinese copper demand may be slower than expected but it

hasn't fallen off a cliff. State research house Antaike is

forecasting 2.5% growth in usage this year.

China's export burst, meanwhile, appears to be winding down,

with outbound shipments falling to 70,000 tons in July.

ShFE stocks have been sliding since the start of July, and

at 262,206 tons are now 75,000 tons below the June peak.

The Yangshan import premium , which fell into

negative territory in May, has risen to $53 per ton.

It may not be too long before some of what China has

exported turns around and heads home.

The opinions expressed here are those of the author, a

columnist for Reuters.

(Editing by David Holmes)