The copper price is on a roll having risen roughly 50% over the past three months to $1.95 lb (Fig.1 below). Unfortunately for analysts and specialists, the fundamentals driving copper pricing are opaque at best and therefore subject to a variety of interpretations and predictions. Here’s my take.
A number of factors are responsible for the $4.00/lb copper price of last year with true consumption increases being only one of many causes. It is now clear that in 2007 and into 2008 10’s of billions of dollars managed by index and hedge funds left the stagnant bond and stock market chasing higher returns in commodities-- copper being one. This partly explains the apparent disconnect between the copper surpluses in 2007 and 2008 as calculated by the International Copper Study Group (ICSG) and rising copper prices. This fast money, as well as plenty of mine, all went away beginning mid last year (refer once more to Fig. 1).
Adding to the investment demand was a number of more tangible one-off production problems around the globe. These included power shortages, inclement weather, labor strikes, lower mined grades and mine productions delays. This year the credit crisis and low copper prices will put downward pressure on copper production.
Global copper consumption rose 4% in 2007—boom times as you may recall—and although China’s copper consumption was up 25%, the US was off 20%: there would appear to be a trade off there. The ICSG notes that apparent (no one knows for sure) refined copper usage in China is significantly lower in 2008. Globally, major copper producers are estimating that demand will be down between 4% and 25% in 2009.
What’s behind the current price increase?
- Both China and South Korea have been adding to strategic reserves and restocking at what they consider to be much better prices.
- Copper producers and marketers all down the supply chain are keeping some supply out of the market due to low prices or a complete lack of buyers.
- The desire by Asian buyers to turn US dollars into hard assets—a phenomenon we are seeing across the entire hard asset class.
- Short covering as the copper price stabilized.
- A favorable arbitrage between the London Metal Exchange (LME) and Shanghai Exchange that made it cheaper to import copper cathode into China.
- Scrap supplies having dwindled due to the lack of credit, low prices and slowing manufacturing activity.
With the exception of Asia’s desire to convert their substantial holdings of US dollars into something of value, I believe all the factors listed above are temporary. Going forward inflation may also play a role.
To come to some sort of understanding of underlying fundamentals of the copper market we need to look at where copper actually goes. The retail and commercial construction markets use about 46% of all copper. Another 12% goes into vehicles. These two industries were trashed, to say the least, in 2008; they are not likely to do too well this year either. Without a global recovery in both industries to past levels I don't see how copper consumption can possibly increase significantly.
Can China save the day?
Most copper imported into China is then reprocessed and extruded as copper wire. When the copper wire is manufactured into tubing, refrigerators and batteries for export it still shows up as internal Chinese copper consumption. There is no way of knowing how much of China’s copper consumption actually stays internal and how much goes back out in other export products. If China is going to save the day for copper we have to approach usage from the perspective of China’s total economy.
China’s GPD in 2007 and 2008 was approximately 6% of global GDP—Europe and USA account for nearly half of global GDP. Based on the most recent World Bank statistics, China’s 2007 total GDP was $3.3 trillion, a full 55% of which was attributable to exports. In 2008 China’s exports were down 28%. This year is not getting off to a roaring start as the Shanghai Daily reports that industrial output is down 12.7% for the first two months of 2009.
China’s building boom is not fairing very well either. Post Beijing Olympics, China’s real estate market has collapsed. According to Jack Rodman, a China real estate expert, in Beijing alone approximately 500 million square feet of commercial real estate was developed over the past few years; this is more than all the office space in Manhattan. Rodman estimates 20% of that now stands vacant. Similar stories are being reported across Asia as documented by the Asia Property Report which estimates that real estate transactions were down 70% in Q-4, 2008. With Asia and the world’s building boom gone bust or at least slowed significantly, and China’s export markets in a severe and prolonged recession, demand for their products and the copper within is unlikely to recover soon. In the near term at least, increased copper consumption would require a global recovery approaching the levels of a few years ago.
Confirming the obvious: true internal Chinese consumption is much less than many analysts believe and is unlikely to take up the slack in global copper consumption.
Both the US and China are proposing major government sponsored infrastructure projects to “kick-start the economy”. Although China building a railroad to Mongolia and Obama greening up some government buildings will add to metal consumption, one has to ask—“Is this going to compensate for the entrepreneurial developers supercharged on cheap and easy credit that drove the last great boom?” Consider: US GDP was about $13 trillion in 2007 of which consumer consumption represents 70%. That 70%, or $9 trillion, is nearly three times China’s total economy. Given the steep decline in global demand for China’s exports, the crash in the world’s construction market, and China’s own building slowdown, how are government sponsored projects going to fill the gap?
An even more fundamental question to ponder might be whether the blind Western devotion to the ideology that both happiness and success are somehow inextricably tied to bigger SUV’s and flatter TV’s is-- over. It is just possible that “we the world” are coming to grasp that the overconsumption and risk-free financial gambling that brought about this mess may not be what Adam Smith and Thomas Jefferson had in mind. If the duped masses come to the realization that they are the ones covering the trillion dollar, flat-out bets orchestrated by AIG and Goldman Sachs in bed with the Fed, Greenspan, Paulson and Geithner, maybe there is hope for change. Maybe, just maybe, as we are all watching our hard-earned savings disappearing down another hole, once again to the benefit of these financial engineers, the s--t will finally stick to the fan.
Even if not, I can pretty well guarantee that we all won’t be watching whatever is happening, brought to you without commercial interruption and televised in color on brand new 52” copper plated LCD TV’s.