In 1968, Canada supplied half the nickel for the non-communist world and 90% of US nickel imports. Why am I talking about nickel in a copper story? Bear with me.
"World demand for nickel had grown steadily from 1966 through 1969, while supplies lagged behind. The industrialised countries, increasingly prosperous, were demanding more nickel for stainless steel, alloys for jet engines and space hardware, long-life batteries, and dozens of uses requiring hard, strong corrosion and heat resistant materials. Furthermore, the United States increased its nickel demands to satisfy military needs."*
In 1969 the US was fighting the Vietnam War, and growing disillusionment across the globe began to sour what had been a golden age of prosperity in the West. In 1969 man landed on the moon and the Concorde took flight. Richard Nixon was elected to the White House and John Lennon went to bed for peace. In Australia, a company by the name of Poseidon announced it had found nickel. Bob Hawke, future prime minister, was elected as president of the Australian Council of Trade Unions.
Early in 1969, the price of nickel was 1500 pounds per tonne on the London exchange. By March it had risen to 2000 pounds. Then the mine workers at one Canadian nickel mine went on strike, demanding higher pay. They were shortly followed by others, and by the time the strike ended, four months later, the price of nickel was 6000 pounds - a 400% increase.
Four years later, in 1973, the Arab oil embargo was put in place. The price of oil doubled. Six years later, oil had risen from its steady, post-war price of US$20/bbl (in today's dollars) to US$104/bbl at the time of the Iranian revolution. The seventies was a period of stagflation, recession, hardship, and seemingly unending strikes in the industrialised world.
It has taken three decades, but oil has now exceeded that price. Two weeks ago Haiti, the Philippines, Indonesia and Cameroon experienced riots in the streets over the soaring price of food.
Today Chile produces 40% of global copper supply. The state-owned copper producer Codelco alone accounts for 12% of global supply. There are 18,500 workers on fixed contract at Codelco, but more than twice that number are subcontracted. Last week those subcontractors went on strike. Margins for copper producers in Chile are currently running at an astounding 75%. Mine workers, however, are finding it increasingly difficult to afford basic food and power.
It was hoped that a quick resolution would be found for the strike, however this week subcontractors at Codelco's El Teniente mine - the largest underground copper mine in the world - began to throw stones at contracted workers as they tried to enter the mine. The contracted workers are now refusing to work until their safety is assured. The Andina and Salvador mines have already been closed for the last ten days, and on Friday workers at Salvador attempted to set fire to water and power stations. Trouble has not yet spread to Codelco's largest production division, which includes the Chuquicamata mine. Credit Suisse analysts suggest that if Chuquicamata is forced to shut down, copper prices could easily rally US$500-1000 per tonne on the news (current price US$8650/t). Says Credit Suisse:
"Perhaps the latest unrest at Codelco is just another passing ship in the night that will be quickly forgotten in the markets. However, if unrest does accelerate it could not happen at a worse time for consumers who appear to have run down their own inventories in Europe, the US and China."
It was Credit Suisse who brought up 1969.
***
Since the US Federal Reserve "bailed out" Bear Sterns in March there has been a growing optimism that a trough in global financial sector weakness has now been seen. This, the market believed, would allow the Fed to redirect its focus on the two side- effects arising from massive monetary easing and liquidity injections - the tumbling US dollar and subsequent soaring commodity price inflation. Leading up to the April rate decision the US dollar had stabilised and grown stronger. The market had decided it was time to reverse speculative positions in commodities and return to stock investment. With only a 25 point cut and a majority belief the Fed was now on hold, the US dollar has risen further.
As a result, the Dow Jones index has rallied about 5% in the month of April - it's first positive month since October last. Gold has fallen from over US$1000/oz to US$850/oz. Wheat has fallen from around US$12.50/bushel to around US$7.75/bushel. And copper...well...copper's about the same price it was in March.
Gold's movement is a close correlation of the US dollar movement in the period in the converse, or if you look at at chart of the euro against the dollar the pattern is as good as identical:
Once again - the same pattern. Which begs the question - is wheat trading as a function of global demand and supply balances, of seasonal factors, droughts and floods, stockpile builds and rundowns? It would appear not. It would appear wheat has traded as a close negative correlation to the movement in the US dollar, and thus a close correlation to the inflation hedge that is gold. Indeed, this chart indicates just how much commodities have become a financial market security in their own right, and a direct inflation hedge that bypasses "money".
There are riots in Haiti because grains are the new gold. There is no doubting a secular shift in the global demand for food ("soft" commodities) has occurred in recent years just as there has been a secular shift in the global demand for hard commodities such as base metals since 2004. But the price movements of the last months indicate soft commodities have taken on a new persona as financial securities. And the common belief is that base metals are simply another commodity class which is equally under the spell of speculators playing inflation and the weak US dollar. It is taken as a given that base metals are also being played as a straight inflation hedge at present, and thus there should be a similar vacuum opening up below today's prices, particularly if a US dollar rally gains traction.
There is definitely speculative "hot money" in base metals, particularly copper. That's why the Fed-based US dollar rally this week has resulted in copper breaking down from its consolidation highs. It is likely metals will see further weakness if the trend in the US dollar remains positive, and if the preferred trade of sell commodities/buy stocks remains preferred. However, just how far can copper fall? After a bit of a shake out, it must eventually come back to issues of ongoing demand and weak supply.
The strike in Chile is a clear supply case in point. Mexican copper producer Grupo Mexico has been planning to ramp up its production at its Cananea mine, but rolling strikes in that country have now entered their ninth month. Grupo has suggested the situation may eventually lead to the closing of the mine.
As yet there appears to be no strike problems at BHP Billiton's Escondida copper mine in Chile. Escondida is the world's largest copper mine, but production has fallen 13.4% year on year, Barclays Capital reports, because of lower grades. BHP is also having problems with consistent power supply, as are all of Chile's copper mines.
Over in Africa, the two large copper producing nations of Zambia and the Congo are also facing up to the simple reality their dodgy power supplies cannot provide for planned mine expansions.
While supply problems have been mounting, higher prices have encouraged consumers to work off inventories, thus running down their stockpiles in Europe, in the US and in China. Copper supply held in London Metals Exchange inventories have fallen to the equivalent of only 3.5 days consumption. Consumers have opted for "just in time" purchasing, matching raw material orders against end-product orders. There may yet be some unofficial Chinese inventories being held by consumers, and this is hard to determine. The existence of such stocks is suggested due to lack of recent Chinese buying in London. However, are the Chinese simply hoping the price comes down? If so they might catch themselves short.
Nevertheless, demand for copper has not fallen in China as many are expecting given the US slowdown. There was a narrowing of copper imports in March compared to February, the analysts at Deutsche Bank note, but this is most likely due to the inclement weather halting production. On an annual basis, says Deutsche, China is set to post its largest trade deficit on record in 2008.
Deutsche is expecting the copper market to move into a small surplus in 2009, but is no longer so confident. With various supply problems around the globe, it may well be that consensus supply estimates have been overstated. On the demand side, the world's two largest consumers are China and the US. Most of China's copper goes into electricity supply, and China itself is suffering from power shortages and is racing to build more power plants and connect more businesses and homes. Most US copper goes into building and construction, which is clearly impacted on the residential side.
However, analysts have been surprised just how well US demand has held up. Consumption levels are relatively flat which, under the circumstances, is a strong result. Deutsche also believes demand estimates may have been understated.
BCA Research notes Chinese growth in production of consumer goods such as motor vehicles and refrigerators has eased from its lofty heights recently. Nevertheless, actual production remains well above levels of one year ago. BCA also notes on the flipside that China's production of its own metals has maintained a steady pace of growth from 2004 and 2007 - right up to the snowstorm disruptions. But since the snow has melted, "the bounce back in production has been muted". It looks like power is the underlying problem.
Barclays Capital suggests one should be wary of figures which show a recent slowdown in Chinese consumption of all metals. The bad weather and the first quarter period of destocking may well have warped the numbers, and price upside would thus result.
BCA Research suggests investors stay overweight copper.
Deutsche Bank believes demand side forecasts for global copper have "some strong underpinnings from the key consumers". As such, the analysts suggest, "there is potentially upside risk to the copper price should supply growth falter".
Credit Suisse has put its money where its mouth is. The analysts suggest "it will take a major global recession to push copper prices down in the coming months". They reiterate that they see US$12,000 per tonne (US$5.50/lb) as a realistic price for copper in 2008, but if the strikes in Chile drag on that price could be significantly higher. Current prices are around US$8500/t (US$3.80/lb).
CS has raised each of its copper price forecasts (for use in stock valuation, therefore always conservative) for the years 2008-10 to US$4.00/lb. The 2008 estimate was previously US$3.60, 2009 was US$3.50 and 2010 was US$3.00.
It would not be hard to foresee a more accelerated correction in global commodity prices ahead, beyond that which has already occurred. But in the case of copper, the question remains as to how much the price is really influenced by "hot money", and how much is simple demand/supply. To abandon copper at this point would be to do so at risk. On the other hand, weakness in copper and copper stocks could pose a valuable buying opportunity for the future.
AAR Price at posting:
0.0¢ Sentiment: ST Buy Disclosure: Held
(20min delay)
