Copper: prices are set at the margin
Tom Traill - 21 March 2019
Copper, famously credited with having a PhD in economics, used to be lauded for its apparent ability to forecast turns in the business cycle. Its wide range of industrial uses meant that slowing economic demand often showed up promptly as weakness in the copper price. That all came to an end when copper became the loan collateral of choice for China’s shadow banking system from around 2012. Massive over-ordering of the physical metal brought a phase of exaggerated demand and bulging warehouses, followed by a phase of collapsing prices. More recently, China’s crackdown on shadow banking has generated another slump in copper prices, from which it is making a tentative recovery. India’s voracious appetite for the red metal, coupled with an improved outlook for China’s consumption, in the light of VAT rate cuts that take effect on 1 April, are tipping the scales in favour of firmer prices.
Copper endured a rough time between 2011 and 2016 with the price falling by over half, from over US$10,000/MT to less than US$5,000. By the start of 2019 the price had struggled to a little under US$6,000 rising smartly by more than 8 per cent year-to-date. Given that copper remains an important ingredient in many industrial and construction processes and a vital electrical and electronics component, a reconnection of the market with its fundamental uses is in prospect. Other sources of demand may also emerge, for example if electric cars enjoy exponential growth, then they could drive a significant increase in demand as electric cars require around three times more copper than a combustion engine car. We laid out some of our investment arguments for Copper in the January edition of Market Focus (24/1/2019).
Bloomberg reported that this week has seen the biggest trading volume in copper call options on record, indicating expectations of supply problems ahead. Citigroup analysts suggested in December that production will lag demand by 116 thousand metric tons in 2019, the second consecutive annual deficit. The mining company Coldeco has two smelters that are currently offline, with their return reportedly delayed until April, causing further congestion in the supply chain. At the same time copper inventory on the London Metal Exchange have been very low. Ten days ago they were in the eighteenth percentile within the range since 1970, down more than 60 per cent from a year before, though they have since jumped to the 42nd percentile.
In many minds, the copper and China economy narratives have become conflated. The strong Chinese demand for the metal in recent years, and the alleged stockpiling, mean that fears over a China slowdown are rapidly expressed as weak copper pricing. However, China slowing phase looks to be over and there are other countries that could make a material difference to the demand-supply balance. One of the most rapidly growing sources of demand for copper is India.
Not only has India recently contributed to interruptions of supply, having shut some mines in Vedanta due to pollution concerns, but they also represent a massive potential source of demand. Goehring & Rozencwajg, the natural resource investors, reported that in October last year Indian copper demand surged by 13,000 tonnes, or by 33 per cent year-on-year, to 50,000 tonnes per month. Their analysis shows that India is comparatively under-developed in its absorption of copper, with per capita less than a third relative to China at the same stage of economic development.
Prime Minster Modi has previously announced an intention to connect every village to the power grid. While the terms of this offer seem to have become lax, the premise would require large investments in their copper stock. Further promises to shore up the electrical capacity just seem to highlight further Indian demand for copper. The Goehring & Rozencwajg article suggests that Indian demand may double to around 100,000 tonnes per month, a similar sized jump to that in China when they were at the same phase in their development.
Copper is a global commodity, suffering from weak supply dynamics and the potential for significant demand growth, particularly from India. For copper producers, better times lie ahead.
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