Special Report: 2.26.2009

Posted by TED Magazine on Thursday, February 26, 2009

Copper: Do You Like the Sound of $1.50 Per Pound?

By Joe Salimando

First things first. Before we can even think about where copper’s price could go in the near-term or intermediate-term future, we have to nail down prospects for consumption in China.

Such an effort is like using sticky notes on competitors in a mud-wrestling contest.

What’s the macro picture for China? Some say that the country will be fine. Others think China will proceed to build a consumer-driven economy. And not a few believe that China is rolling toward a significant financial/economic collapse.

These days experts are plentiful. Political pundits talk about economics as if they know something about it! For that matter, most economists should have (by now) been totally discredited.

So the idea that your humble columnist actually knows what might happen in China is worth a laugh.

Go ahead, laugh. It’s good for you!

Scenarios and Repercussions

This should be easy to do, right?

China’s economy collapses: BAD. The price of copper falls from here and stays down. I don’t think the U.S. economy is about to embark on a significant and lasting recovery, but even if it did, copper’s price would remain in the toilet if China’s economy halts.

China’s economy rallies before the rest of the world: GOOD. At least, good for electrical folks, because this should mean the price of copper will bounce meaningfully, and before the S&P 500 gets back near 1,250.

China’s economy is so-so, like the rest of the world’s: Mediocrity. More of the same. More rueful remembering of the good old days (early 2008), when copper’s price was well over $3 per pound!

What can be known about China’s consumption of copper? Not too damn much. A Sept. 9, 2008, Wall Street Journal article about China and copper quotes a guy with UBS Commodity Strategy saying that “China is rebuilding stocks as that may herald a copper bottom.”

Look at the chart below. Did copper “bottom” in early September?

Further, that UBS analyst is in good company. Read this July 2008 analysis, which noted that two analysts who had been “spot on” in the recent past (predicting copper’s price would spike) forecast the red metal’s price going to $5/pound in 2008 and $5.50 in 2009.

Go ahead; laugh!

Here’s a Jan. 22, 2009 Reuters news report that you should read. A Singapore-based reporter sat down, put a pencil to it, and came up with “apparent” stats on China’s copper demand:

• It rose 36% in 2007 (from 2006).
• It increased “only” 7% in 2008 (from 2007).
• It’s going to post a 3.5% increase in 2009.

Speculation (of the Verbal Kind)

There’s speculation, like throwing money around to, say, buy 100,000 pounds of copper for delivery in November 2010 (you can do that).

And there’s the other speculation, which boils down to flinging words around.

See this August 2008 piece, China’s squeeze on copper, from an Australian source. The commentator’s conclusion:

“The Chinese appear to be [putting] the squeeze on the hedge funds.”

Brilliant analysis? The guy goes on to say that “underlying demand created by Chinese urbanization and industrialization” is going to support prices.

Verdict enabled by perfect hindsight: This didn’t happen.

Let’s move forward in time. Copper’s price gained in early February (2009). According to various reports, the reason was China’s implementation of a second piece of its stimulus plan. Here’s the lead on a Feb. 4 Bloomberg.com report:

Copper rose in New York to the highest price in a week on speculation that demand will gain in China, the world’s biggest metals consumer.

Is this kind of outlook beginning to sound a bit jejune?

Copper as Part of a Boom-and-Bust Cycle

There supposedly is a “commodity cycle,” and we were (until recently) on the upswing part of that. The downswing part lasted two decades, so some folks were expecting a relatively long “up” part.

For all anyone knows, they might still be correct.

BUT: Here’s what Satyajit Das, a financial commentator, wrote recently:

“Mark Twain once described a mine as ‘a hole in the ground with a liar standing next to it.’ The end of the commodity price cycle has revealed that standing next to the liar is a crowd of hapless bankers, analysts and investors.”

According to Das, the commodity run-up was assisted by a flood of liquidity, and now:

“…declining sales and cash flows, debt refinancing requirements, difficulties in selling assets and limited opportunities to raise equity to deleverage further complicates the commodity bust.”

In this view, the commodity cycle has had it—kaput, done, over, and goodbye!

On the other hand, there is Jimmy Rogers and his adherents; count me as one. He believes the commodity cycle has years to run (especially in oil and food).

Folks on this side of the see-saw point out that copper mines are closing left and right; it takes time (and more importantly, conviction) to re-open these things. Think like a copper producer: After what’s happened in 2006-2008, the next run-up in copper to $2.50/pound almost certainly won’t get dormant mine owners to immediately resume production.

Who is right? The smart bet in commodity markets is that everything goes to extremes. If that’s right, copper may be destined to go lower before, ultimately, swinging much higher in a big hurry.

SO: You’ll want to prepare yourself for more volatility in copper prices, in both directions, than that which you’ve previously experienced. Copper prices might flatten out around $1 later in 2009; but they might also fly over $3 in 2012.

Forecasts (FWIW)

For what it’s worth, some copper forecasts.

1. The guys at Global Insight (including John Mothersole, whose October copper outlook was noted here) made a presentation in December. A graph from the thing is below. They foresee prices in the range of $3,000 to $3,500 per metric ton. That comes out to roughly $1.35-$1.60 per pound.

2. Robert Garino, the director of commodities for the Institute of Scrap Recycling Industries, blogs (on the Purchasing.com site) about commodities. In a Jan. 30 entry, he provided the January 2009 Reuters survey “of some 57 analysts” on 2009 and 2010 average prices for a variety of stuff.

Copper 2009: $1.58

Copper 2010: $1.98

[Incidentally, go here to find the “home page” of Garino’s blog.]

3. Cochilco, which is the state copper commission of Chile, predicted earlier this year that copper’s price would average $1.60 in 2009 and $1.50 in 2010. [of course, back August 2008, Cochilco’s forecast for 2009 was $3.40. Info here.]

4. From a Jan. 4 Purchasing.com story: “Consensus forecast puts copper at $1.56 this year.”

5. Macquarie Research (a name you would know were you in the metals biz, I think) lowered its forecast for copper by 9% (in mid-January). The call now is for $1.55 per pound.

6. Credit Suisse says $1.75 this year and $2.25 in 2010. Those average annual prices forecasts are lowered 30% and 25%, respectively.

Lower Prices = Lower Supply

And then there’s Fortis. The company publishes a Fortis Metals Monthly, which I download (more or less every month), free, at www.kitco.com.

Apparently, the copper analyst there believes (still) in “the law of supply and demand.” Here’s the copper verdict delivered in the December issue:

“Now that copper has finally succumbed to the global recession we shall start to see more production cuts, such as Freeport’s effort in early December.

“We expect global copper consumption to end 2008 at 17.9 metric tonnes, and possibly [less than] 17.9 metric tonnes in 2009, as any appreciable growth in China will be offset by contractions in the West.

“Sub-$3,000/tonne prices should threaten some 1.8 metric tonnes/year of production capacity on a cost basis, which, we believe, will need to be shed in order to stabilize the price.

“We may well see a rash of announcements by the major producers…BHP, Rio Tinto, Codelco, Grupo Mexico and Xstrata…on further cuts.”

Note that $3,000 per metric tonne = $1.36 per pound. “Freeport” = FreeportMcMoRan Copper & Gold (stock symbol FCX).

Take-Aways

With this column and last week’s you’ve read 2,800-plus words (plus graphics) devoted to copper. If I’ve done my job, you might have devoted hundreds or even thousands of neurons (basic brain stuff) to the past, present, and future of copper prices.

Where does all this leave you?

• It seems rational to believe that copper’s per-pound price will hang around $1.50 per pound in 2009, with risks to the downside.
• Of course, recent experience tells all of us NOT to associate rationality and the price of the red metal.
• Should we get more downside, what we’re likely to get—perhaps in 2010 or 2011—is a HUGE bounce UP. More mines will be shuttered. Production will ratchet down to (profitably) match demand. When demand bounces, production won’t even try to quickly catch up.
• And, of course, the only real truth we can know about this particular base metal and its future: Bad news on China’s economy = bad news for copper’s price.

	Joe Salimando of EFJ Enterprises is a consultant, web content provider, and wordsmith based in Oakton, Va. To contact him, call 703-255-1428. See also The EleBlog.
Personal Disclaimer: The appearance of the ambling pachyderm is indicative of the writer’s obsession with elephants, not his political leanings.
IMPORTANT NOTE: THIS COLUMN REFLECTS ONLY THE OPINIONS OF ITS AUTHOR AND DOES NOT REFLECT THE OPINIONS OR POLICIES OF NAED, TED MAGAZINE, OR THE ADVERTISERS ON THE TEDMAG WEB SITE.