By Julian Murdoch
What A Difference A Year Makes
A little over a year ago, back when copper was at $4,135/tonne, we took a look at some of the forces working on copper. At that time I concluded, "Real recovery in copper will likely require sustained growth, and much lower stocks."
In retrospect, not so much.
My "much lower stocks" comment was oh-so-wrong. Today global inventories are roughly in line with where they were back then, but copper closed at $7,695/tonne yesterday—an increase of 86.1 percent. (Note to data hounds: Copper prices can be found both on the COMEX in $/lb and the London Metal Exchange in $/metric tonne. The LME provides easy-to-get inventory numbers and pricing information, so that's what I tend to use.)
As the chart above shows, 2008 displayed the classic inverse relationship of supply and price. When supply (as in LME stockpiles, represented with the blue line) was low, prices rose, and vice versa.
Prices nose-dived during the economic meltdown, and stockpiles rose because no one was buying, even at rock-bottom prices. But eventually in 2009, prices began to recover—pushed higher by China's restocking of copper inventories, which helped to decrease stockpiles. But prices then continued to rise, even as stockpiles were replenished.
It wasn't until the beginning of this year that the core supply/demand drivers began to (mostly) make sense again:
But at the same time, it's too simple to expect stockpiles and copper prices to display a direct inverse relationship. Too many forces are at work here.
China And Goldman Sachs: Parsing Copper's Latest Moves
With copper, demand tends to be the dominant driver of price, with demand from the electronics and construction industries requiring the largest percentage of the metal. China, of course, is copper's largest consumer, but it's not always China's import numbers that matter most.
China's economy grew at 11.9 percent in the first quarter of 2010. You'd think that would be great news for copper, and indeed, the strong Chinese economy did play a big role in the copper story in February 2010. But take another look at the tail end of the chart above. Inventory has dropped off, signaling stronger demand, but prices are dropping too. Growth in the Chinese economy is good, but the fear that China may tighten its monetary policy to slow that growth and keep its economy from stroking out may be keeping copper sedated.
Of course, there's another issue dominating the market right now: Goldman Sachs. When the news broke that Goldman Sachs was being charged with fraud, copper prices dropped almost 3 percent by Monday's close.
It is true that Goldman Sachs is a huge player in commodities, and the uncertainty around Goldman's fate has spread ripples across the space, since the market hates upsets in the league tables. But as Ben Westmore, a commodity economist at National Australia Bank, commented to Reuters, "Most of the commodities are just following equity markets."
Westmore doesn't necessarily believe that the demand outlook will be hugely impacted, but instead noted that the news "does breathe uncertainty into these markets."
In other words, the market reaction to the Goldman fraud charges just goes to show that in the absence of real supply and demand forces, news does indeed move the copper market.
Copper Deficit On The Way?
Contrary to what current inventory levels might imply—that is, that there's plenty of copper to go around—industry leaders like Rio Tinto are expecting copper supply to be in deficit next year. Naysayers cite declining ore grades from existing mines and the long lead times for new mines to come online. One of my favorite quotes on the subject of older mines comes from Robert Friedland, chief executive from Ivanhoe Mines, in this article from Reuters: "The world's copper mines are like little old ladies lying in bed waiting to die. They require these very high copper prices to be kept on oxygen."
Add to that a shortage of skilled workers like geologists and engineers to work on mining projects around the world, and you can start to see how copper production could hit a bottleneck.
We can't forget about scrap, another important segment of the copper supply. China announced yesterday a change in the rules around the importation of scrap metal that could discourage sellers from doing business with the country. As of June 1, scrap will need to be separated by type, while the grade of copper must be documented on customs forms. It is part of an effort by the government to catch any misreporting of copper content and collect the appropriate duty payments. It will remain to be seen if scrap sellers find this too much of a hassle and take their wares elsewhere.
Finally, one last news item that could potentially push prices up: In Chile—the world's top copper producer—President Sebastian Pinera recently announced that his government will ask for increases to the mining royalties paid by miners in order to fund post-earthquake rebuilding efforts. Supposedly these increases will be voluntary, but the government is expecting most firms to fall in line and pay the higher royalties.
Of course, the pushback has already begun with the following quote from Chile's mining council: "An increase to a specific tax which affects a single sector would be discriminatory against mining and could affect the competitiveness of miners." There is no telling that if the increased royalties do go into effect what they will do to either the amount of copper coming out of Chile, or the price of that copper.
Wrapped up in a bow, most of the news and supply information suggests support for copper's continued rally (Goldman be damned). The question then, as always, is how much of this has already been priced in to copper's amazing 2009 recovery?