The Impact of QE2 on copper and the possibility of bubbles - Simon Hunt

A look at the impact of further quantitative easing on commodity markets in general and copper specifically and why a supply squeeze is unlikely

GEOFF CANDY:  Welcome to this edition of Mineweb.com's Metals Weekly podcast.  Joining me on the line is Simon Hunt - he is with Simon Hunt Strategic Services.  Simon you wrote an interesting article last week on the likely impact of the latest bouts of quantitative easing and you specifically mentioned copper and before we get into the specifics of that metal, if we can perhaps take a step back and get a sense on why you look on this latest bout of quantitative easing so unfavourably.

SIMON HUNT:  Because all that the Federal Reserve is attempting to do and most other policy makers is to delay something which is inevitable which is the writing off of debts and toxic assets.  You only have to read what the OECD is saying and what the Bank of International Settlements is saying and why Reinhart and Carmen say in their workings, debt has to be written off before you can approach a period of sustainable growth.  So all they're doing is buying time - kicking the can down the road for the next set of policymakers.

GEOFF CANDY:  And is there a sense that they longer you wait before you take your medicine the worse the infection gets?

SIMON HUNT:  Well yes, but what the impact which we've started to see that is going to go through a number of volatile movements is that people are saying that there is too much liquidity -where can we park our money and it's going to go into equity markets and commodities.  The problem is that with rising commodity prices, particularly for America - rising energy prices, gasoline prices and food prices - what the Federal Reserve is doing is hurt the very households they're trying to help.  But in so doing what our cycle and technical work is showing is that we will see next year, and certainly in the first half of 2012 very sharp increases in bond yields.  Taking for example the 10-year US Treasury to well over 6% by the middle of 2012.  Now that's probably going to lay the foundations for the next global credit crisis and exactly where it's going to arise whether in the public sector or the private sector nobody knows because it's going to be a classic black swan event.  That will give us five to seven years of real deflation - that has to be written off.

GEOFF CANDY:  In the scenario where you talk about this and potentially the creation of bubbles in some of these equity and commodity markets, do you see this happening across the sector or across the complex - or are there specific sub-sectors where bubbles are perhaps more likely than others?

SIMON HUNT:  It's going to be across the complex - to varying degrees - but where copper goes inevitably the rest of the base metals follow.  Some will rise more than copper and others less than copper, but that will be the direction.

GEOFF CANDY:  I want to get into the specifics of the copper market shortly, but one final question on the macro side of things - if we look at what the US is doing and then at what Europe is doing where you're seeing a lot of significant cuts happening in budgets across the board.  How do you think those two seemingly opposite factors interact?

SIMON HUNT:  Good question - governments like our own government here (in the UK) are probably fully aware of the risks of the second global credit crisis - unless they start to put their own houses in order now, they're going to be ‘killed' is too strong a word but they're going to be under very significant pressure when that crisis arises.

GEOFF CANDY:  Looking at copper specifically now, clearly there is some concern at a fundamental level in terms of supply and demand for copper given that some projects have been delayed as a result of the first financial crisis if you will - where do we stand at a fundamental point of view and how does this bubble creation overlay on that?

SIMON HUNT:  The fundamental question that one has to ask is what is demand, and what is real consumption.  Since 2005, the financial sector has got highly involved in copper by often buying directly or indirectly, cathode copper from the producers and warehousing it outside the reporting system.  That is demand and demand has been strong but real consumption - that is material that goes into furnaces has been a completely different dynamic since 2005.  You have major cable makers saying to the industry that between 2006 and the end of 2010 one million tonnes of copper will be lost to aluminium and fibre optics.  How does that square with the tight market?  Also across many products, manufacturers through improved design and tighter specifications arte allowing something like 20% to 40% to be used per product.  Air conditioning and refrigeration tubes are a fine example, but there are many across the board.  The second development, which manufacturers have been pursuing with increasing intensity, has been to find new technologies that actually replace copper and the one that is the most prominent is high temperature super conductors, which are either in 2011 or 2012 will start to be put into commercial use.  That's not just for high voltage power cables, it's for windings of transformers, generators, electric motors and so on - that is a major development.  That's a very large chunk of copper consumption and it's here.  LG Cable made an announcement last month that they were buying a significant amount of high temperature super conductors from American Superconductor Company.  First it will go into the Korean national grid (KepKo) and they will also be installing it in other grids around Asia.  In November 2009 the general manager of the Shanghai Electrical Research Institute, which is the governments primary research institute for the cable market, actually said that we will deploy the first line of high temperature super conductors early in the next decade, i.e. round about now, and that will be followed by a very rapid deployment across China.  As everybody knows that power cable is one of the great growing dynamics of the country.  These are just two examples.  Further down the line low voltage power cables - copper will be replaced by nano-tubes.  This is what the cable industry is saying, it's not what I'm saying.

GEOFF CANDY:  If I understand what you're saying then, almost too much has been made of this potential supply squeeze.

SIMON HUNT:  If we're talking real fundamentals there has not been and there wont be any real tightness in the market.  Tightness is created by the financial sector, believing that copper is going to be a safer asset than holding dollar assets.

GEOFF CANDY:  So clearly not a good outlook for copper going forward in the long run.

SIMON HUNT:  No - you're going to have a best global weak economic activity, on top of that, falling intensity of use.  No shortage of copper, the constraint is not on supplies, the constraint will be on real consumption and it's only going to be made worse by all of the hidden stocks, i.e. stocks owned by the financial sector which are mostly warehoused outside the market or outside the reporting system - then having to come onto the market.  We had the same phenomenon, but in a smaller degree, in the early 1980s.

GEOFF CANDY:  What does this mean for the notion that copper is a good proxy for global economic growth

SIMON HUNT:  Dr Copper retired in 2005...

GEOFF CANDY:  Just to close off with then, how does China fit into all of this?

SIMON HUNT:  What comes out of the 12 five year plan is that it's not going to  - it's quality of growth that is going to be the emphasis, not quantity therefore we should be looking at growth rates of GDP of between 6% to 8% - not the 10% to 12% - therefore that alone at the margin, is a very significant change, but like in the rest of the world, China is going to adopt new technology - probably more rapidly than anywhere else.

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