One of the most reliable indicators of copper demand in recent years may be read on the faces of stressed commuters exiting London Bridge Station on a weekday morning. As the spot price of the bellwether metal topped out in 2011, thefts of copper wiring from UK railways rose 67% year-on-year, causing havoc on railways nationally, but particularly at the busy intersections of London suburban lines.
The past year has seen thefts fall 55%. While the British Transport Police would no doubt attribute that to their efforts to secure vulnerable infrastructure, the degree of volatility suggests metal thieves have simply concluded it is no longer worth giving up a night spent in bed.
Demand for copper – or the lack of it – is a particularly perplexing point right now. Traditionally, copper like equity, is seen as a fair proxy for future growth calculations, but the two have parted ways, with the metal trading sideways-to-down even as the Dow Jones has consistently broken through to fresh highs. Copper inventories recently hit a record global high.
The spread of the Dow Jones Industrial Average Index over the copper spot was similarly breaching fresh record highs day-by-day last week (figure 1). Opinions on what is driving the divergence, and whether copper, alongside other industrial metals, is now oversold, differ widely.
‘Copper used to be regarded as a bellwether of the world economy,’ said Julian Jessop, chief global economist at Capital Economics.
‘However, China now accounts for at least 40% of global copper consumption, so copper prices are disproportionately sensitive to the health of China’s property sector. Perhaps Dr Copper’s field is simply more specialised than before.’
This suggestion is supported by Chinese import figures, with copper down 28% by volume over the course of 2013. Others question whether that is enough to cause the kind of divergence between metals and other forward indicators, though, and the falls pre-date China’s economic slowing.
The Copper Comex spot price is down 22.3% from its 2011 high (figure 2). While recent trading has been choppy and rangebound, there has been growing downward momentum pressure on top of any fundamental considerations.
The number of copper short contracts outstanding is now within a single percentage point of its post-crash record high, reached last summer (figure 3). Goldman Sachs, in a note last week, said it believed those pressures were now overdone, and advocated going long September contracts.
‘Commodity markets declined sharply in February, along with emerging market (EM) equities, owing to renewed concerns over China, which we believe is overdone.
‘Although our price targets – other than gold – remain unchanged, this pullback has pushed our near-term return forecast from 2% to 6%, making commodities the asset class within the ECS [economics, commodities and strategy] coverage universe with the most robust near-term outlook.
‘In the near term, we prefer petroleum and copper. Driving this level of conviction and our six-month target of $9,000/mt [metric tonne] is our view that Chinese metals demand will rise during 2013 both seasonally and on the back of continued growth in construction completions.’
At other end of the pricing equation, a lagging supply response to the Chinese infrastructure boom is a concern. Wealth Manager highlighted this back in September 2012, with figures from the global producers’ Copper Alliance showing that even as mine capacity has risen to record highs in recent years, capacity utilisation has consistently fallen, to below 80% in 2012.
According to Copper Alliance figures, new development is expected to double capacity again this decade, with the biggest expansion of supply in 13 years due to come on stream this year.
Even at the currently reduced spot price, copper by some measures remains well north of ‘fair value’ at around 50% over the marginal cost of production. Jon Ruff, lead manager and research director at Alliance Bernstein’s real asset strategies team, said the market seemed to be taking some of the most aggressive industry estimates too much at face value, however. ‘If history is any guide, this supply glut will never happen,’ he said. ‘The mining industry has a horrendous record for fulfilling its own promises regarding new capacity.
‘Unfortunately, new copper mines are expensive. Expanding existing projects often requires costly adjustments. Building new mine sites is even more costly than expanding old ones, often involving less politically stable countries and massive new infrastructure investments.
‘As we see it, the massive costs and risks involved in finding and opening new mines today hints at why copper prices continue to float above marginal cost: prices need to be high enough to provide miners with an adequate return on their investment in costlier and riskier new mines.’
Given the glut of new projects, Ruff said that the market pricing was possibly still offering too much of a generous response. But equilibrium would be found more quickly than the pace of the recent sell-off and short selling implied, he added.
Regardless of the internal pricing dynamic of copper, at its current valuation a long position could be viewed essentially as an inexpensive put option on global growth and continued industrialisation of the emerging world, said investment analyst the Macro Research Board (MRB). ‘Copper and oil have similar properties to gold,’ said MRB, offering a recommendation of a paired long copper/oil versus short gold trade.
‘But demand for these commodities is also associated with swings in global economic growth and the industrialisation process in the emerging world, and are not safe havens.
‘This is the reason why the copper/gold ratio and the oil/gold ratio tend to track the stock/bond ratio… [and] is consistent with our upbeat economic view and expectation for a further rise in the global stock/bond ratio.’