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Why You Should Pay Attention to Copper

Why You Should Pay Attention to Copper

The world price of copper both reflects and drives the hopes and fears of economic recovery and disaster.

Roughly 50 pounds (22.7 kg) of copper is used in producing an automobile and 400 (181.4 kg) in constructing a house. The metal is also used in many electrical applications, shipbuilding, piping, roofing and household consumer products, especially in numerous alloys including brass and bronze. So it is not without reason that copper is considered the leading indicator of industrial activity not just in the US (where nearly half of all copper consumption is in building construction) but worldwide as well. It is, in fact, the most important of the nonferrous base metals, which also include aluminum, lead, nickel, tin and zinc.

Historically, copper prices range widely. Eleven years ago the price was well under $1 per pound. However, it rose to nearly $4 per pound in mid-2006 before losing over a third of its value in the next eight months, only to rise back over $4 per pound by mid-2008.

The price of copper in China

Chinese buying was the main propulsion behind the price rises in copper and other base metals up until late 2008, when copper fell to $1.25 near the end of the year. Chinese industry then decreased production and consumed existing supplies. After that process, in early 2009, base metals prices jumped back on renewed Chinese buying. China was in fact expected to provide close to half of growth in global demand for industrial metals in 2009. However, poor demand in economic sectors ranging from construction to the automotive industry led to declines largely across the board.

Global stockpiles of copper declined throughout 2009 as Chinese demand increased, but (since copper like many other commodities is priced in US dollars) part of the increase in the metal's price also reflected the US dollar's weakness at the time. All commodities felt the effects of the dollar's problems but copper saw particular gains.

China is motivated also to acquire warehouse stocks of metal supplies beyond its immediate needs in the current demand cycle. Anthony Harrington, a Contributing Editor to Bloomsbury's QFinance and twice honored as UK Financial Journalist of the Year, told ISN Security Watch that "inventories in the London Metals Exchange (LME) monitored warehouses were still falling,” presumably due to Chinese purchases for their own warehouses. “By way of contrast, [the price of] aluminum has dropped ... after BNP Paribas warned of a significant global aluminum surplus in 2010.”

According to Harrington, Chinese demand for copper has "at least two major sources: one is its desire to secure sufficient commodity stocks to continue its astonishing rate of growth, while the other is its desire to invest its mounting dollar surpluses in something other than US Treasuries."

Omens of the future

Since copper prices have strengthened in recent months, it is important to determine whether this is due to increased ‘real’ demand or to stockpiling. Last month, Chinese officials were forecasting annualized growth of 10 percent in the second half of 2010 and 11 percent for the full year. Harrington points out that this was taken as an optimistic sign for the markets even though US economic performance has been sluggish at best. However, despite the improvement in Chinese economic figures, expert consensus is recently coming down on the side of stockpiling.

That would mean slackening demand in months to come, with a fall-off in prices that could reverberate into weakness on the equity exchanges for the stock prices of producing companies. Indeed, Harrington notes, "Chinese officials ... will not want to bid the price up against themselves, so [they will] sit on their hands and wait for the price to quiet down" since although "bulk buying on the scale that China has gone in for might start at advantageous prices for the buyer, [nevertheless] subsequent purchases will see the price moving upwards."

So significant is the metal that when state-owned Chinalco (Aluminum Corporation of China) offered $19.5 billion in early 2009 to double its stake in the world-class Australian mining company Rio Tinto from 9 percent to 18 percent, the move was seen in Australia as a threat to the country's economic autonomy. The government did not object when Rio Tinto instead found an arrangement with BHP Billiton.

Copper prices, stock markets and the financial crisis

Because of copper's significance for industrial activity, stock markets watch the world price. Higher prices are taken to mean higher demand, which is in turn taken to mean increased economic activity in the future. Especially today, in the new financial environment of increased share-price volatility around the world, stock markets also sometimes overreact to the swings in world copper prices.

Likewise because of China's importance as an importer and consumer, world stock markets are also sensitive to indicators of Chinese economic activity. "There is absolutely no doubt," Harrington says, "that if China were to announce that its economy was expected to miss, say, an 8 percent growth rate for 2010, that would have huge implications for a crash in global equity prices, and not just on mining stocks. However, the chances of this look remote" at the present time.

Macroeconomic fundamentals offer little support for copper or other base metals. Steel companies helped lead the recent Chinese stock market advance but copper imports and therefore prices are at potential risk if demand from other countries does not increase to pick up the slack.

India's consumption will be an important driver of global prices over the longer term, and Indian companies such as Hindalco and Sterlite are significant producers in their own right. The degree to which that is so, however, depends in part upon further electrification of the Indian countryside, to which there remain numerous bureaucratic obstacles.

By. Robert M Cutler

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