What’s Going On With Dr. Copper?

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Demand is the issue right now, but the outcome of trade talks and Fed easing will have a big impact going forward.

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Dr. Copper ended 2018 around $5800/tonne and today it is still trading more or less at the same level. With all political turmoil and volatility between the U.S. and China so far this year, one would assume Dr. copper to have been more volatile. After all, the title of Doctor is given to copper as it is the main commodity that serves as a gauge to the health of the overall economy, and most importantly that of China.

After hitting highs of $6500/tonne back in April, it has been on a steady downward trajectory till today. This should not come as a surprise as global economic indicators have been showing lower growth and potentially even recessionary indications as demand has been quite weak.

In the past, copper has always been quoted as a commodity to buy, given its extreme supply tightness and lack of large projects due to how long it takes to bring a copper mine online.

Supply has continued to be a problem. Both mined and refined production fell in the first half of 2019 — by about 1.4% and 1%, respectively, according to International copper Study Group (ICSG), with a host of supply disruptions as well. Weather disruptions in Chile, strikes in Peru and lower output in the African Copperbelt have dented production.

JP Morgan has cut about 840,000 tonnes from their production forecasts because of this. Any increase in copper production has been offset by these shortfalls. The problem is not supply being tight, which it has been perennially, this time the demand has fallen a lot as well. This is one thing most producers and sell-side investment banks fail to capture, as it comes down to macro and global factors.

The ICSG was forecasting an annual demand growth of around 2% per annum, this year, but so far copper demand has actually fallen 1% in the the first half of the year. The weakness is due to a slowdown in the automobile, construction and investment infrastructure sectors. China has been slowing down. But even demand outside of China has been appalling. This can be seen by the horrendously weak Manufacturing PMI’s globally, with the majority of them trading below 50 — signalling a contraction — thanks to Trump’s Trade Wars.

If we enter a recession, there is no doubt that mining equities and base metal commodities that have a balanced demand/supply market will face even lower prices. Nickel is an exception to the rule, as warehouse inventories are significantly depleting due to Indonesia’s ban on ore exports. But generally copper, aluminum, iron-ore, steel and all base metals linked to the global economic cycle will get hit if growth is about to fall off a cliff.

The one silver lining for bulls is that speculative funds are already short copper on the CME (Chicago Mercantile Exchange) by about 53,000 contracts. Given this market has always been held long, this is quite a significant short held by traders. Copper has always been a market that has a deficit of 200,000-300,000 tonnes on an annual basis — a “tight” market. In a global copper demand market of 24 million tonnes, the margin of error is quite small. If demand or supply swings one way, it tends to move the price quite violently.

Right now, demand is the issue. This week’s trade talks are expected to provide some clarity, but the two sides still do not see eye to eye, mostly because President Trump wants to have his way and “wants a big deal or no deal.” China will not acquiesce and has already said changing domestic policy and foreign subsidy laws is off the table. Now if Trump wants to do a deal and show the people, who are clueless in the first place, that he is the best president ever and saved the world from recession, he might be forced to announce one. The devil will be in the detail. Time is running closer and the economic data is getting worse. We have the U.S. Fed that is eager to launch another round of Quantitative Easing but is hesitant to do so given the excess in the system already.

All this will dictate what happens to the economic cycle and the dollar. This will be key to determine where copper price and copper-related equities go next. At $5800/tonne, there is certainly value in copper and the mining equities, but if we carry on the way we have been this past year with no resolution in sight and financial stress in the U.S. asset bubble that has been inflating for years, prices can go lower still.

Only demand can save the day. The jury is still out on that.


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