Dr. Copper Heading Back to School

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"When combined with the financialization of the market and the increased usage of other materials to replace the red metal, the murky nature of Chinese copper demand means the metal's honorary doctorate should probably be rescinded for the time being."

While long praised for its predictive abilities, changing dynamics within the copper market mean its rise and fall represent a very different world view to what it once did.

Investors had a rather wild ride in 2011. With the ongoing sovereign debt crisis rollercoaster in Europe as a backdrop, investors have sat through nuclear disaster in Japan, floods in Australia, political upheaval in the Middle East, continued financial wrangling in the U.S. and massive amounts of volatility.

Understandably then, those wanting to end 2012 with their heads held high rather than clutching the nearest toilet bowl are looking for any edge they can find. Some swear by the lipstick index—or its latest incarnation, the level of mascara and eye shadow sales—as a predictor of where the economy is headed, while others scour the charts for a clue to the future.

For commodity investors, copper has long been the expert to which one turns when looking for a view on where the global economy is moving—so much so that the red metal is often referred to as Dr. Copper, because it has a doctorate in economics.

But while the metal (used in everything from telephones and electrical wiring to housing and heavy machinery) has been a rather accurate predictor of economic growth historically, its predictive abilities seem to be waning—or, at least changing in focus.

At the height of the financial crisis, at the end of 2008, copper crashed to below $3,000 per tonne—so far so good, from a economic indicator point of view. Economic prospects were as bad as they had been in many years and copper's price reflected this. From there, however, it rose significantly, hitting a fresh high in February 2011 of $10,148/tonne. This rise was predicated, not just on growing optimism that the worst of the crisis was over, but also on the expectation of a substantial deficit in the global copper market—the belief was that while demand was likely to remain strong, many new projects had been delayed as a result of the crisis, and so not enough copper was likely to be available. As a result, prices remained elevated until the summer months, despite a number of macroeconomic clouds on the horizon.

According to the French bank Natixis, while the macroeconomic risks had a dampening effect, prices were undermined largely because much of the anticipated deficit failed to materialize.

It is probably worth noting two things at this point in the story. The first is that, as prices have risen across the commodities spectrum, more and more investors and speculators are entering the market. Add to this the entrance of exchange-traded products backed by physical metal, and it becomes evident that copper prices are less beholden than they once were to the machinations of the 'real' economy.

This is the view of Simon Hunt, founder of Simon Hunt Strategic Services, who told Mineweb.com's "Metals Weekly" podcast earlier this year, that Dr. Copper retired in 2005.

"Without the involvement of the financial community—copper would not be tight. It is actually in a very significant surplus," he said.

The second point to make is that, while historically copper demand has been driven by the West, over the last decade or so it has come to rely increasingly on demand from Asia and, in particular, China, which currently accounts for roughly 40% of the global total.

Given China's increasingly large role in global economics, one might suggest that this shift in demand patterns should serve copper's predictive powers well. And, while this is true to some extent, the big problem is that no one quite knows exactly how much copper China needs. This is because the country's copper buyers often stockpile the metal for use later when prices are low. Then they use up the stockpiles when prices are high.

This stockpiling helped to undermine expectations of a deficit earlier in the year. As Natixis bank wrote in its final note of the year, a period of substantial destocking in China, lasting until July, helped to lower demand.

"As much as 900,000 tonnes of copper were consumed from stockpiles rather than from current production, resulting in wildly differing views of Chinese demand, ranging from -3% to +8.5% depending upon whether measures were based upon apparent demand or estimates of final demand.

"Looking ahead to 2012, even if true Chinese demand growth slows to 5-6%, this will feel more like +12% in terms of its impact upon imports, and if we move to a period of restocking, this could result in an unexpectedly large global deficit of 300,000 tonnes or more."

When combined with the financialization of the market and the increased usage of other materials to replace the red metal, the murky nature of Chinese copper demand means the metal's honorary doctorate should probably be rescinded for the time being.

But, given its new drivers, it could well become a useful indicator for other things—such as the level of risk appetite by speculators and perhaps, in time, the level of infrastructure growth in Asia—which, given the changing nature of the global economy, are becoming increasingly important.

Geoff Candy, Mineweb

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