Copper: what does the price fall portend?A decidedly bearish...

Copper: what does the price fall portend?

A decidedly bearish view on what happens next with respect to the copper price from a specialist analyst who predicted a major decline in the copper price here almost exactly one year ago.
Author: Simon Hunt
Posted: Tuesday , 02 Dec 2008

WEYBRIDGE, UK -

To serious students of the copper market, the 60% fall in the copper price since early July was no surprise. What was surprising was how long the price had defied gravity and the real situation. The reasoning was mainly twofold. The first was a proper reading of the macroeconomic situation with its impact on global consumption; and the second was the knowledge that copper prices were being manipulated by groups who were both holding material off the market and others who were encouraging financial institutions to engage in holding leveraged positions and other instruments in the market.

Ever since the BIS and others had been warning that financial markets were heading for meltdown in the early months of 2007, it was clear that the global economy would slowdown sharply, yet there were persistent forecasts that the global copper market was tight and that prices could only advance higher. China and India would save the world's economy and copper consumption were the reasons given (see Monday's China PMIs to show just how wrong was this assumption).

Reality did not meet these expectations because there was a big difference between the tonnage of copper actually going into furnaces and that being reported as global consumption. This is because material was being sold directly to financial institutions and others - thus being counted as consumption - with that material frequently being held off the market, so constituting a hidden stock. These hidden stocks probably total around 1.5-2.0 million tonnes held in China and elsewhere in the world.

This development is nothing new in the annals of copper: it happened massively in the 1978-1980 bull market, resulting in hidden stocks (estimated at the time to have been about 1million tonnes) being dribbled onto the market throughout the following decade; it was a decisive factor in the Sumitomo affair; and it occurred with the demise of Enron. Bull markets in copper invariably are associated with manipulation. What is so different this time was the sheer scale of the operation.

The speech given by the US Attorney General on 23rd April 2008 and the testimonies of Michael Masters and others to Congress in the early summer indicated how the markets is manipulated. It was these hearings that led to pension funds and other institutions starting to liquidate their positions.

In fact, once adjustments for the accumulation of these unreported stocks (held both in China and elsewhere) are made, the global market has been in surplus since mid-2005. The truth is that in the three-year period 2005 to 2007, world refined consumption rose by only 1.5% a year compared with its longer term trend growth of 2.7% a year.

This fact fits with market reality. Fabricators were always able to buy metal promptly at premiums well below those of producers. Had the market really been tight, as analysts kept on stating, spot premiums would have been consistently higher than those of producers.

The question is what happens now? The best that one can say for the world economy is that growth will be below trend for the next five years with the risk of something far more painful developing. This would imply that global copper consumption will grow at rates well below its long term average rate, especially when account is taken of substitution, which should continue despite the fall in price: for end users will be under constant margin pressure so will continue to design copper out of their systems if such action leads to cost savings.

Under the best case scenario, world consumption should grow by an average of only 1.7% a year to 2015, with very low growth rates in the nearby years, and under a worse case environment it might actually fall by 0.2% a year.

Pressure will then be on the supply side of the equation, not how much new capacity will be required to meet the world's furnace needs, but how much will have to be cut from existing capacity and that which is committed for commissioning, or, where capital has already been sunk.

The cutbacks needed to bring some semblance of balance back to the market are huge and will include cathode produced from secondary materials, SX/EW, though these operations will probably be the last to be cutback, and concentrate producers.

The conclusions are simple but dire. High copper prices and low treatment charges always result in low prices and high treatment charges, no matter what producers try to do. The secular bull market in copper prices ended in early July this year when copper prices hit $8950. Prices will be volatile around a falling trend which will probably last until around 2018. Post 2010, we will surely see prices below $2000.



Simon Hunt was one of the founders, in 1975, of top metals analysis consultancy Brook Hunt, which still bears his name. He left at end-2005 to start up Simon Hunt Strategic Services which specialises in copper, global economics and China. For further information please contact Simon Hunt at Simon Hunt Strategic Services on 0207 859111 or [email protected]