HEARD ON THE STREET
Updated June 25, 2013, 3:28 p.m. ET
Bottom Is Falling Out of Copper Prices
By LIAM DENNING
Copper's world is coming apart. The price has fallen 16% so far this year and is 34% below February 2011's all-time closing high.
This isn't just a case of slowing economic growth. The global forces propelling the metal's stunning rise over the past decade are shifting. Copper's supercycle is entering its downhill run.
Copper's surge reflected flat supply running into surging demand, mainly from China. When that happens, prices spike to a level at which demand is destroyed, to balance the market. This is in contrast to a more stable market where prices are usually closer to the marginal cost of supply.
Copper spent much of the period from 2005 to 2012 at levels at least double the marginal cost of production, according to Deutsche Bank, reflecting persistent supply deficits. The number of days of consumption covered by copper stocks fell from more than 60 in 2003 to less than 20 by 2008.
The market has now loosened. Already, the stock-to-consumption ratio is back up to almost 50. On the demand side, China's attempted shift away from economic growth predicated on breakneck construction—with good reason, as the country's recent credit crunch demonstrates—will cause copper-consumption growth to level off.
And more copper is becoming available. Between 2005 and 2012, disruptions such as strikes took the equivalent of between 5% and 8% of global mine supply off the market, according to Macquarie. So far this year, though, disruptions equate to about 2%. Moreover, an earlier surge in investment brought on by higher copper prices is starting to bear fruit.
Deutsche Bank and Macquarie expect copper supply between 2013 and 2015 to exceed demand by an average of roughly 500,000 metric tons a year—higher than the surplus in 2009, when the average price fell 26%.
Already, copper's premium to the marginal cost of supply has fallen to 35%, Macquarie estimates. Even so, that is still much higher than zinc's premium of 5%. Nickel and aluminum, meanwhile, trade at discounts, reflecting excess supply.
A bullish counterpoint is that inflation in the price of labor and equipment will continue to raise the marginal cost of supply, offsetting any fall in copper's premium.
But Deutsche Bank points out that a "significant" contribution to this has been the decline of the dollar—in which copper is quoted—against the currencies of major producing countries such as Chile and Australia, where costs are priced in local terms. Indeed, on a one-year, three-year and five-year view, copper-price moves have shown a greater correlation with the dollar than other industrial metals, and even gold.
Over the medium term, better economic prospects in the U.S. and signs that extraordinarily loose monetary policy is ending should support a stronger dollar. That will tend to cap copper's marginal costs in dollar terms, and therefore prices, especially as weaker commodity prices will tend to weaken producing countries' currencies anyway.
Further pressure could be applied if copper producers start hedging more aggressively by selling future output. If they see the world is changing, they will almost certainly do that.
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