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Copper: What the bellwether metal tells us about a recovery.

|Includes: BHP Billiton Limited (BHP), FCX, RIO

A recent article from Reuters  titled "Economic optimism lifts US copper to 13-month peak" provides an example of the leap of faith many are taking when they observe rising copper prices and conclude that global economic prospects are brighter. The article included a lot of bullet points, but most related to matters unrelated and unconnected to economic activity.

Some of the discussion related to charting. Terms such as "double bottom neckline" and "resistance level" may have meaning among charting traders, but those terms should be confined to discussions relating to where people betting/gambling/speculating on the copper price see the price heading. In other words speculators who are long copper because of a chart pattern shouldn't lead a journalist or sub editor to frame the article around economic matters. The predictions being made based on "double bottom neckline" are unrelated to whether or not economic optimism exists and are unrelated to economic data. For clarity I am not saying a trader can't profit from these things, but merely that they are what they are, and what they are is independent of economic fundamentals.

Another bullet point related to housing sales. The assumption is presumably that, as a so-called bellwether metal, a rise in housing sales means a rise in construction, which means a rise in copper consumption, which means an expectation of a rise in demand. Below is a chart of US copper consumption this decade. For reasons unclear to me consumption has been falling all decade. The International Copper Study Group (ICSG) has forecast consumption in the USA, Europe and Japan to be down approximately 17% this year.

US copper consumption

Two related bullet points mentioned stronger than expected economic growth in China as a basis of copper strength, and a decline in Shanghai stockpiles over the week. The chart below shows Shanghai stockpiles during 2009.

shanghai copper stockpiles

A slight decline over the course of a week against a backdrop of rising stockpiles over the year seems like confirmation bias on steroids. The article wraps up by noting a large increase in LME warehouse stocks. The chart below shows LME prices and warehouse stocks in 2009.

London metal exchange copper prices and stocks

In this chart the disconnect between stockpiles and price is evident, as it is with the disconnect with Shanghai stocks. The drop in warehouse stocks from March through to the end of June occurred as China stockpiled copper (Chinese imports are up 80% but note this coincides with rising Shanghai stocks which seems to indicate stockpiling rather than usage).

Warehouse stockpiles can be used as a proxy for demand -- though not necessarily industrial demand, it could also be, for example, demand to restock inventories, which in itself would be an economic positive. If supply is constant we should expect to see stockpiles decrease during periods of increased demand and vica versa. Another bullet point in the Reuters article referred to industrial problems at larger suppliers in Chile, i.e. the supply side. The expectation here is that supply constraints could arise, but again this is not an expectation of increased growth or a sign of economic optimism, this is an expectation of a supply constraint forcing prices higher (in the future should this eventuate). The current LME copper stockpile represents about one weeks consumption based on peak consumption numbers. When other stocks and inventories are added the total stocks are forecast (ICSG) to be approximately 3 weeks consumption which is not huge, certainly when compared to aluminum and nickel stockpiles. The point of this discussion though is that the rising stockpile is an indicator of weak demand not the bright prospects that are touted in so many articles. The stockpiles also need to be seen in the context of capacity utilization rates among miners being at there lowest since 1989 and supply for 2009 predicted to be down by 0.8%. In other words stockpiles aren't rising because of increasing supply.

So what is driving the rise in the copper price? Well a weakening US dollar has contributed to the rise over the last 7 months. The trade weighted index is down approximately 14% since March, though to be fair it is in much the same position as it was when copper was last trading at these sort of prices in September 08, which was the reference point mentioned in the Reuters article. What else? Well demand for copper everywhere bar China is down significantly on 2008 numbers and we know from import data China withdrew from stockpiling in July -- and even with supply at lower levels than 2008 it is exceeding demand. There are no fundamentals driving this price surge and no indication that the fundamentals will be catching up to the price any time soon.
The speculation that is driving this market could in part be driven by economic optimism mentioned in the Reuters headlines -- who knows what makes people optimistic absent the supporting data. But it seems more likely that when money is free it has to go somewhere and one of those places is commodity markets where people can gamble/speculate, follow trends, read charts and win and lose money without any reference to, or consideration of, the real economy.

Footnote: This GDP plot by John Williams at ShadowStats may explain the decline in US copper consumption.

GDP from shadowstats.com

It shows that when hedonics and other imaginary non-cash items are stripped out of GDP, growth has been negative for almost all of this decade.

Disclosure: long BHP