By Stephen Pope, Managing Partner Spotlight Ideas
- C21 saw significant mine capacity increases.
- Copper in excess supply.
- Price will decline; target USD2.88 / lb.
There is a surfeit in the copper market.
As at midday on September 3rd 2013 copper traded at USD3.278 / lb a rise of 8.01% off the local low of USD3.035 / lb on June 24th 2013. The price is just a shade off the recent closing day high that was printed on August 18th at USD 3.367 / lb, or +10.94% from the June 24th close.
Copper usually trades off the back of the outlook for the global economy given that it is a primaryindustrial metal. One might assume that prices would be on the up given a slowly improving outlook for the global economic recovery after data on Monday, September 2nd implied:
• Chinese manufacturing activity expanded for the first time in a year in August.
• China is the world’s #1 largest copper consumer; 40% of world consumption in 2012.
• Eurozone PMI reports showed manufacturing expanding as the index was 51.4 up from 50.3.
• Europe as a region is #3 in global demand for copper. *
* Spotlight has mixed views about this, see “ Manu’fractured’ ” September 2nd 2013
However, “Economics 101” teaches that price is not just determined by demand, real or potential. One has to factor in the level of supply and it may come to pass that this recent rally in the price of copper is in danger of suffering a reversal as there is a glut; the largest in 13 years in fact that may simply swamp any acceleration in demand that is building across the developed and emerging world.
Flashback to April 4th 2013:
The world’s largest mining company, BHP Billiton Ltd said copper supplies are likely to exceed demand during 2013 and 2014 on growing stockpiles. The miner had pressed ahead with increasing output at its Escondida mine in Chile by 10% pa through 2015 when output was targeted to reach 1.3m tonnes.
Chile is the leading copper producer (36%) and the Mining Minister Hernan de Solminihac said global copper supply will exceed demand by between 97,000 and 167,000 tonnes. However, that is a relatively minor imbalance as the market estimates that production will exceed demand in 2014 by a colossal 408,000 tonnes. That would be the largest imbalance since 2001.
Why the excess?
During the 1980’s, 1990’s and into the early years of C21 commodities had been in a bear market and little investment in new mines had taken place leading to a major supply bottleneck in the mid 2000’s. Within every industrial commodity supply chain prices started to accelerate and as such the incentive to step up production was undeniable. Once uneconomic resources became attractive; therefore the industry supply curve shifted out to the right at every price point. At first there was no excess supply impact as demand was also expanding ahead of supply…ergo higher prices were sustained. In the Australian mining industry export revenue soared 585% in USD terms from 2001 through 2011 cf. the volume of mining exports that rose by only 42% over the same period.
However, the Australian mining case can be number crunched to illustrate the magnitude of price appreciation which will underline why production has been stepped up so aggressively.
Therefore:
So prices rose by 24.1 times or + 2410 time and the price elasticity of demand (η),
= %δQ/%δP 42/2410 = 0.0174
i.e. industrial commodity demand was extremely inelastic.
Given that economic factor it is no wonder that at various price points for copper in USD / lb we see the percentage amount of supply in successive years rise with price (please note that the base year was 2001).
Figure 1: Supply increase (%) in 2006, 2011 and 2016 forecast at varying price points USD / lb
Source: www.copper.org, Spotlight Ideas
Looking ahead to near term price direction:
Currently the price of copper is 29% below the record level that was established on February 14th 2011 at USD4.641 / lb. However, one reason why supply is still offered in abundance is that prevailing prices are running at 50% above the level the costliest mines need to break even.
Recent economic data; be it from China, the USA or even the Eurozone is encouraging, however, there is nothing that leads one to foresee surging demand. Spot and futures prices recovered for the 2013 low prices as new bottlenecks stemming from mining accidents and strikes plus refinery outage and falling declining supplies of scrap metal in China prevailed in H1 2013. However, most of these pressure points on the supply chain have eased. Indeed Freeport-McMoRan Copper & Gold Inc. announced this week that it had brought an end to the application of the force majeure clauses in its delivery contracts bought into effect when a tunnel collapsed at Grasberg, Indonesia.
In Figure 2 we illustrate that at the moment, the 50 day moving average (50dma) is running below the 200dma and unless that were to be quickly corrected the most prudent strategy is to look for a general decline in the copper price. This is not just a technical argument as the industry opinion is that supply from refineries will advance 5.2% to 21.84m tonnes next year as consumption expands just 2.8% to 21.42m tonnes. This does clearly look to be an opportunity for commodity investors to sell into recent strength as we judge that copper surfeit will widen over the next year.
Figure 2: Copper Spot Price
Copper spot —, 50 day — , and 200 day — moving averages
Circled areas 50 day crosses 200 day MAVs
Source: www.copper.org, LME, Bloomberg and Spotlight Ideas
Figure 2 illustrates the well-known phenomena that when the shorter duration moving average crosses a longer duration moving average from above to trade at a lower price, then of course the spot will decline as well. This is seen to be the case in the price history from January 2nd 2011. However, this alone does not indicate where we might analytically anticipate prices will evolve to.
Naturally we would like to be able to separate any emotional or qualitative input from our analysis, however, we cannot escape the fact that the street seems to be heavy with the expectation that Chinese demand in 2014 will only rise 4.0% YoY cf. 9.5% YoY in 2013. Coupled to that we have to look into the detail that is accessible from the LME. Their data reveals that warehoused stockpiles declined by 11% to 589,750 tonnes during July and August. In the broader context that is 84% larger than in January and inventory totals are on track to exceed 1m tonnes during 2014. Client demand to draw down LME warehouse supplies declined by 23% in July and August and the level of copper held in inventory gained by over 30% since this year began.
New sources of supply:
As we illustrated in Figure 1 above, we expect supply offered at varying price points to expand out to 2016 as new mines and deeper exploitations of existing facilities will keep adding supply onto the market. Production coming to market grew at 6.2% QoQ in Q2 2013 and the ore content is proving to be richer at 6.55 Kg / tonne cf. the 2012 average of 6.47 Kg / tonne.
Copper ~ Technical Analysis
Figure 3: Copper Spot USD / lb and Technical channels.
Source: Bloomberg and Spotlight Ideas
The price channel that copper has occupied since January 2011 is a corrective marked as [1]. Within that corrective one will note a, complex…indeed messy combination of minor correctives marked as [A, C, E and G] plus four impulsive waves [B, D, F and H].
The trend is lower and as we have detailed in this paper the supply and demand relationship has reversed the scenario of early C21 when demand exceeded supply by a mighty magnitude. Now we have the reverse and as such the path of least resistance for spot is lower. Based on Fibonacci analysis from the start of the corrective [G] we plot the extension of the range low of USD3.035 / lb we list in Table 1 the levels we project for copper.
Table 1: Estimates of where copper, USD / lb can decline to.
Source: Spotlight Ideas
Reflected in sector decline:
To conclude, we have looked at the data from Spotlight Indices © Spotlight Ideas. This reveals that on a weekly basis the recent revival in the “Basic Resources” sector has started to unwind. If the expectation is that industrials commodities are broadly in a state of surfeit then that sector is going to bear the brunt of downward price pressure.
Figure 4: Indices since January 2013
Basic Resources edging lower