Special Report: 7.16.2009

Posted by TED Magazine on Thursday, July 16, 2009

Copper’s Cross Currents

By Joe Salimando

Copper ended 2008 at $1.37/pound. More recently, our favorite red metal has levitated in a range around $2.25 to $2.35. That’s a 60%-plus move up!

Of course, it’s not (at least, not yet) reminding us of the past few years. Copper ended 2007 near $3.04, and closed 2006’s trading at $2.84. Prices twice threatened the $4/pound barrier.

But let’s not look at the teeth on this gift horse!

Is this a sign of things to come (more “green shoots,” perhaps)—? Does copper at $2.30/pound mean something? What will the rest of 2009 look like for the red metal?

Print More or Print Fewer?

Predicting the future price of any given thing is ridiculously hard. Were it easy to see a bright future for the metal palladium, for example, we could buy the ETF (exchange-traded fund) with the symbol PAL. Have you done that?

Of course you haven’t, as the future of palladium isn’t crystal clear. [Plus: ETFs seem a crapshoot in the truest meaning of that word.]

But copper’s situation today is even more confusing than usual. Factors you must project include the relative valuation of the U.S. dollar (vs. the world’s other currencies); some questions:

• Will Ben Bernanke and his Fedsters buy additional big heaps of U.S. Treasury bonds? They’ve said they will buy $300 billion worth; they’ve put at least half that to work, with an unanticipated result (long interest rates, and 30-year mortgage rates, moving UP instead of down!). 

• If Bennie is printing money to buy the Treasurys, will that lower the dollar’s relative valuation?

• Lately, Bennie has said he won’t print even more money after the $300 billion. Is he “jawboning” or speaking truth? If he suppresses money creation, and no one else materializes with new cash to buy newly created T-bonds, what will that dramatic (and public) fall in confidence do to the U.S. dollar?

Chinese Puzzle

You might not share this conclusion, but my understanding of what’s happened to copper—and other goods—in 2009 is “the Chinese.” You can “see” this in the value of the Baltic Dry Index, which has about tripled off its late-2008 bottom.

Apparently, decision-makers in China won’t purposefully harpoon the value of the U.S. dollar. They’ve either come to the conclusion they can’t hurt us and themselves, or they have decided to put this weapon on a shelf until they need it.

It’s become clear that China is doing the following:

1. NOT buying the bonds of “agencies” (Freddie Mac and Fannie Mae). That’s one reason Bennie has revealed plans to print nearly $1 trillion dollars to buy “agency” bonds.

2. NOT buying longer-duration Treasury issues. China has shifted to shorter stuff. That’s one reason longer-duration bonds have increased in yield (driving those mortgage rates higher)—while the short stuff carries ridiculously low rates.

3. USING some of the Chinese national dollar hoard (the country also has reserves denominated in other currencies) to buy real goods. The country is widely reported to be buying and warehousing copper (and other items).

4. Picture yourself as a Chinese decision-maker and take a long-term view. You might basically already see U.S. dollar holdings as worthless. Investing in Treasury bills and notes just brings back (ultimately) more dollars. BUT: Using dollars to buy material things (including copper, zinc, aluminum, and crude oil) makes more sense.

Thinking this way makes copper’s price (whether it’s $1.96 or $2.59) totally irrelevant!

Chinese buying in 2009 may well have buoyed copper’s price; lots of people so believe. That leads to the next question, which is roughly as answerable as the Fed’s next printing-press moves: Is there a point at which the Chinese will stop buying all of this “stuff’ (including copper) for future use?

Then There’s Supply & Demand

Outside of the dollar and the Chinese, there really are supply-demand factors.

Copper harvesting (wrestling the earth for new supplies) was more profitable in 2006-2007-2008, at prices higher than $2.25/pound. Some mines aren’t profitable when copper dips below $1.80, according to reports ($1.80/pound = $4,000 per tonne, by the way, and a tonne = 2,205 pounds). There might well be a “floor” to prices that’s neither artificial, nor set by China, nor subject to Bernanke’s manipulations.

Copper use isn’t a big secret. Construction is a major source. Yes, residential building in the United States is pretty close to frozen. But nonresidential construction hasn’t (yet) taken it in the shorts. Globally, construction is in a depression (outside of Asia’s big countries). This affects demand.

There are other factors. Unrest in key mining countries, including potential strikes at big mines, could be important (think: Peru). Nations that are building reserves of U.S. dollars and other currencies (think: Brazil, India, and Russia if oil’s price keeps going up) might choose to emulate China and buy copper and other materials.

Scrap availability is yet another factor. According to one report, “scrap accounts for some 40% of the raw material used by smelters to make refined copper”—and, this Bloomberg.com story claimed, “the scrap market remains tight.”

Nightmare Scenario—Coming Soon?

Best case: The recovery actually appears; copper demand (outside of China) rises. The Chinese build massive new warehouses and continue to buy “stuff” with their reserves. Plus, the U.S. government continues to act stupidly, with Bernanke printing big new gobs of money—decreasing the dollar’s relative value and causing a copper price jump.

One can envision all the above happening; call this the case for $2.50/pound copper. So the upside might be: More of the same, but no big further run-up in copper’s price.

Worst case: What if the following happen at roughly the same time?

1. The Chinese hit capacity. At some point, they think they have “enough” copper for the foreseeable future. Or perhaps they stop buying just to see what that does to the prices of all this “stuff.”

2. Another possibility on China: Prolonged weakness in the U.S. economy leads to increased saving by U.S. consumers, reducing demand. This not only gives China fewer new dollars to “recycle,” but it seriously hurts the Chinese economy. That might dictate to the dictators (the Communists) a stop to material buying.

3. I believe No. 1 and No. 2 could happen simultaneously.

4. Copper demand falls further outside of China. Conversations with electrical construction people have convinced me that nonresidential is going to fall off a cliff sometime this summer. I have no idea whether that’s the case in Europe, but if there’s a serious drop in the construction of new commercial and institutional buildings, we will have a smaller market for copper. 

5. Add the possibility that “the market” dictates to Bernanke that he just can’t print more money. My personal hunch is that Bernanke doesn’t listen to the market (or anyone else), and that he needs to go back to Princeton. But let’s say, for the sake of argument, that he “wises up” and stops the heavy meddling.

Put all that together now and/or on into 2010, and you have a scenario for a steep drop in the price of copper (and other stuff, including crude oil).

OF COURSE, there are numerous “middle cases” between the best and worst. For the time being, though, you might want to “weight” the best and worst cases. My personal feeling is there’s a 10% chance of the “best” taking place—and a 30% possibility that we’ll see the worst.

A Look Around

OK—I’ve imposed my guess on you. What are other people seeing for copper’s near-term future? Note that Purchasing.com reported copper’s price in the year’s first five months as averaging $1.75/pound.

• Consensus forecast of eight nonferrous metals analysts—price to average $1.53 for 2009 (Purchasing.com, April 9)

• Barclay’s—$1.82 in 2009, $2.48 in 2010, $3.18 in 2011 (Purchasing.com, April 1)

• CRU Group (London)—price to average $1.83 for 2009 (Purchasing.com, June 3)

• J.P. Morgan—copper to average $1.67 in 2010 (Purchasing.com,
  April 9)

• optionsXpress—copper could correct below $2, no return to December 2008 lows of about $1.26 (Wall Street Journal, April 18)

• TD Newcrest (Toronto)—price to average $1.70 for 2009 (Purchasing.com, June 3)

• UBS bank = $1.65 average price for year (Bloomberg.com, April 17)

• Unnamed executive with Rio Tinto Group—“metal’s price may reserve recent gains in the next nine months because of an ‘uncertain’ outlook” (Purchasing.com, June 3)

Also of note:

Fortis Metals Monthly (May)—this company each month provides predictions about metals. Projected copper prices (translated from $ per tonne):

2009—$1.72 for the rest of the year.
2010—average for the year: $1.64
2011—$1.98
2012—$2.59
2013—$2.72
2014—average for the year: $3.40

International Copper Study Group—this isn’t about a price, but the ICSG predicts this year’s global copper production surplus at 345,000 tonnes (it was 250,000t in 2008) and a 400,000t surplus in 2010 (reported on April 21 on MiningWeekly.com).

	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.
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