Could copper fall to $1,500 a tonne by mid-decade?

A copper price scenario that suggests a sharp fall, followed by a boom, followed by an even more precipitous collapse as the world dips into a second phase of this current recession.

LONDON - 

One can hardly call copper and China specialist, Simon Hunt, a copper bull, but his latest assessment of the global copper market is gloomy to say the least.

In a recent speech to a small group of financial institutions Hunt, who runs Simon Hunt Strategic Services, put forward his analysis that the global copper market has actually been in surplus in true consumption terms - and casts considerable doubts on any ongoing positive Chinese impact on the copper price, as well as on the strength of any global economic recovery.  Indeed he feels we are still in a recession/depression scenario with a second major decline which will really kick in about 2012 and while the copper price may rise to around $7,000 a tonne by mid-2012 what will follow is a price collapse  reminiscent of the 1930s or the 1980s.

"Thereafter [mid-2012], the real bear market will occur as the effects of the second global recession in this cycle impacts prices and as the renewed credit crisis forces unreported stocks into the market, just as what happened in the 1980s. We should then see copper prices around $1500." says Hunt. 

How does Hunt arrive at this potentially horrendous scenario for copper producers?  With a mixture of supply/consumption analysis coupled with gloomy assessments of the state of, and outlook for, U.S. and global economies, a breakdown of the true state of Chinese stocks and likely demand over the next five years and a significant warning on substitution for copper in some of its key usage elements.

Hunt reckons that private sector debt is collapsing almost at the same pace that public sector debt is

soaring and that it will continue to do so.  Because the Baby Boomer generation is now feeling unable to bank on asset values continuing to rise to meet their retirement needs they are turning to savings, replacing debt.  This implies slower consumer spending which in turn suggests a major slowdown in demand and all that means in terms of reduced demand for basic metals like copper.  "We have only just begun the long journey of deleveraging" says Hunt "which will have its volatile years, but, with a clear central direction of replacing debt with savings."

While this cannot be a bad thing for those who are switching per se, for the economy as a whole, used to consumers spending more than they earn in confidence that property and stock values will continue to rise to bail out their debt, this is potentially very alarming.  If the consumer stops spending at recent levels then the economy will not suffer inflation, but deflation.

Furthermore, adding to the consumer worries is the continuing spectre of unemployment.     "The psychology of seeing one's neighbour without a job carries with it an instant cautionary tale." Reckons Hunt.   "The issue is not the generally reported unemployed of 9.7%, or 14.9 million people in the USA, but those who cannot get a full time job or have opted out of the system for one reason or another. This sector, which the BLS defines as the U6 category, numbered 26.3 million or 17% of the civilian labour force at the end of August this year.  It is this category which impacts consumer spending and which should receive greater focus, but the number is too horrible for the political spin doctors to allow

widespread publication. In fact, it is getting close to the 25% experienced during the years of the Great Depression."

"It is not just the rising numbers of unemployed which are and will continue to impact consumer spending, but the number of hours worked per week, which is at an all-time low. Moreover, in real terms, average weekly earnings are at levels last seen in 1980.  None of the above suggests that consumer spending is about to take-off and that is some 70% of the US economy and 20% of global GDP." Hunt goes on.

So how about China, where many see continuing growth relieving much of the downturn seen in the West .  Hunt is not optimistic about this continuing - and also doubts recent Chinese official statistics on the strength of demand there.  What he sees as a developing problem for China is that it still relies for around 35% of its GDP on exports, 50% of which have been going to the U.S. and Europe.  These exports have been falling month on month - and although there may be a pick-up as the Thanksgiving and Christmas holiday season approaches, he expects the downward trend to continue.

And then to compound Chinese worries there is the beginning of ‘reverse globalisation' where currency parity changes are making it less profitable to move manufacture and services to the developing world and a trend is starting to bring this back to the ‘Old World.'  Politically this is also attractive at a time of ultra high unemployment.

On ‘substitution' Hunt points out that in an era where it is going to be virtually impossible to raise prices, the rationale for using cheaper, or more efficient, substitutes is strong.  Or perhaps most of all reduce the amounts being used.  While copper prices may have fallen, they are still relatively high and new technology is enabling manufacturers to reduce quite substantially the amounts of copper used in many key markets.

On the prospects for the Chinese market and the perception that the nation has been considered by nearly everyone to be the savior of the world's economy in general, and copper in particular, Hunt feels the country's announced statistics are at best inconsistent and at worst misleading - particularly in relation to the past year and a half.

Here he notes that a considerable proportion of Chinese consumption is by small enterprises and points to the wire rod sector as a prime example.  Wire rod accounts for around 70% of Chinese copper consumption, of which 40% has been accounted for by small plants.  By early this year around 25% of these, he reckons, had shut down.  This led to increases in output from larger plants - which has been taken as a sign that consumption is increasing when this probably has not been the case at all.

Hunt feels that to estimate Chinese usage this year is particularly difficult as there appears to be so much speculator-driven buying in evidence.  But meanwhile industry itself was being cautious in its inventory controls and that it was financial institutions, individuals and sectors outside the copper industry itself which had been buying physical copper.  He reckons that about 40% of all cathode imports in that period are owned by foreigners with the material being stored in warehouses outside the reporting system and that by the end of August that the surplus copper so held was as much as around 1.4-1.5 million tonnes!

Hunt goes on to conclude that China's increase in refined consumption will be modest this year. Copper used in power cables has not been the booming market that analysts had hoped for. It should increase by around 7% this year and 13% in 2010. Copper used in the export of consumer goods accounts for about 14% of total consumption in China and should fall by some 20% this year. The total increase should be around 3% this year and 6.7% in 2010. 

Thus overall world refined consumption is likely to grow only modestly in the years to 2015 because of low global economic activity and the lingering impact of high copper prices on manufacturing. With technological innovation and development having a significant negative impact on global consumption over the coming decade. 

The other side of the equation though is production.  To an extent Hunt feels this is less of an issue than consumption but that there will be plenty of copper to meet global requirements, but there is flexibility here as producers can cut production to bring supply and demand into balance so perhaps not all projected expansions and new developments will proceed on time, or in some cases at all.

However Hunt notes that if copper production follows the 1975-1985 pattern with a speculative boom followed by an even sharper downturn.  At this time cash operating costs rose sharply, but then fell back to the start levels as the economy turned down into recession.  This time, Hunt feels, 2010 costs may fall further and that by 2015 they will be even lower because by then the price outlook may be dire.

Hunt says that now "Prices are being driven by speculators  and others, which is a common occurrence

throughout copper's history, only on this occasion the size dwarfs anything seen before. If, as we were told reliably that there was at least 1 million tonnes so held in the early 1980s, the fact that there is probably 2.5 million tonnes now being held outside the reporting system would appear very possible. 

It is to financial markets that we have to look to in order to divine the direction of prices. And this, in turn, depends on flow of funds, equity and currency markets.  We should soon see the US dollar  bottom and start a period of about 18 months of rising sharply. That will take some of the bloom away from commodity prices. Thereafter, the US dollar should fall sharply but coincidentally with our forecast of a second credit crisis and global recession. Copper prices should then be falling."

So what does this all mean for copper prices?

"The important factor is that it is not real fundamentals which are driving prices but developments in money markets." Says Hunt.  "Between now and around mid-2012 copper prices should trade within a $3500 to $7000 range with prices approaching that  lower level in the early months of next year, followed by a renewed attempt at US$7000 in mid-2012."

With his assumption that second phase of a very painful global recession would be truly kicking in at this time Hunt sees the copper price collapsing to the $1500/tonne level  with the bottoming out of the markets carrying on until 2017.

As noted above, this is a gloomy assessment and is at odds with much of the talk of the current recession drawing to a close by early next year.  The analysis also suggests that the current highs, and some of those to come are speculator-driven and thus depend on market perceptions rather than on a true supply/demand scenario.  This makes it extremely difficult to forecast real price trends, as Hunt admits.  There is certainly evidence in his analysis that there could be a double dip and a ‘W' shaped recessionary pattern as we have pointed out here beforehand.  It also suggests a defensive investment strategy may be in order, not only for those invested in copper, but in the markets as a whole - but then it depends whose analysis one relies upon.

Simon Hunt Strategic Services may be contacted via www.shss.com

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