Copper has been battered from pillar to post in 2014. The red metal has long been considered a growth commodity given its widespread industrial usage.
China’s roaring economy was a key driver of copper demand during the 2000s, but with the nation’s growth slowing in recent years, prices have been hampered by weaker demand.
The following chart shows the price of front month copper futures. The orange line represents the price of New York traded copper (cents per pound) whilst the white line is London-traded copper (dollars per tonne).
As we can see, copper prices have been declining almost non-stop since mid-2011, coinciding with the slowdown in China’s economic growth.
Prices appear to have fallen off a cliff in 2014 as China’s manufacturing sector continues to contract at a worrying pace. On current price action it appears copper prices are bracing for further declines.
However, underlying fundamentals may be indicating quite the opposite.
Market in deficit
Economics 101 says that the price of any asset is dictated by supply and demand. When demand outstrips supply, prices should theoretically appreciate. Conversely, when supply outweighs demand, prices should drop.
The following chart shows the global copper market is actually in deficit (demand outstripping supply). A line below zero indicates the market is in deficit, whilst a number above zero signals a surplus.
The green line shows a deficit of 58,938 tonnes at the start of 2014, which is a far cry from late 2012 when there was a global copper surplus of around 250,000 tonnes.
What this suggests is that the rate of copper’s price slump is being driven more by sentiment, rather than supply/demand dynamics.
What’s also interesting is that the global copper stock-to-use ratio has fallen sharply from about March 2013, as the following chart illustrates.
The stock-to-use ratio reflects the amount of copper inventory available to consumption. The fall in the white line therefore indicates more copper is being consumed relative to global supply.
Collectively, the above two charts are signalling copper prices should be supported by a global deficit of the red metal.
Admittedly, the recent data on China’s economy has been less than impressive. The Final HSBC China manufacturing Purchasing Managers Index (PMI) slid to an eight month low of 48.0 in March.
The data confirmed the third consecutive month of manufacturing contraction in the world’s second largest economy.
Nonetheless, equity markets reacted positively to the weak PMI data, which has boosted speculation Chinese authorities will outline additional stimulus measures to strengthen growth.
Indeed, the China Securities Journal said recently Beijing may expand fiscal spending to spur private sector demand. This would include measures to boost infrastructure and other construction spending.
Even still China is only one side of the story. Both Europe and America are significant consumers of copper.
The eurozone flash manufacturing PMI returned a reading of 53.0 in March, signalling the region’s ninth consecutive month of factory expansion.
The US economy has also begun to regain momentum after the recent winter weather. The ISM PMI showing US manufacturing growth accelerated for a second straight month in March.
With economic growth in these two regions tipped to accelerate in 2014, copper demand is likely to strengthen.
The supply side of the equation should also work in copper’s favour.
Chinese companies have previously used copper as collateral to secure finance agreements, and efforts by authorities to reduce this practice could force these same companies into a fire sale of their unneeded copper stocks.
However that is likely to be more than balanced by supply shortages from key copper exporting hubs like Chile and Indonesia.
Chile is the world’s largest copper producer, but recent strikes at several of the nation’s ports – and the likelihood of more strikes to come – threaten to worsen an export logjam.
Also, Indonesia recently banned exports of unprocessed copper ores from its country.
Because of these bottlenecks, mine supply is not leading to the creation of refined copper products, suggesting global supply will fail to match growth in demand.
So whilst copper prices may be in for some short-term pain, current market dynamics are indicating longer-term gain for the red metal.