Copper Bubble or Bull? – Part One

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Everywhere you look in the business pages and on the news, the sense is that copper is in supply deficit and demand is coming back not just from the emerging markets but gradually from developed markets as well. The consensus is that demand is outstripping supply due in part to miners having been slow to bring capacity back on stream following the crisis of 2008-9.

To what extent is this correct? And even if it is correct, are we right to think this means copper is on a sustainable bull run? A report this week in Reuters quoted Catherine Virga, senior base metals analyst with CPM Group in New York as saying, “Mines are going to continue to strive to bring improvements on the supply side, but it’s just now a question of whether or not that’s going to be able to outpace demand.”  Pointing to operational problems faced by mines, falling ore grades, labor unrest and the cutbacks initiated in 2009, the International Copper Study Group (ICSG) said production is likely to be limited to 16.2 million tons in 2010.  Looking to 2011, increased economic activity is expected to boost end-user demand for the metal much faster than production, pushing the global market deeper into deficit of about 400,000 tons.  New mine projects in 2011 are few and far between; most additional capacity will come from enhancements to existing operations, as Freeport and Xstrata have managed to do this year. But with potential shortfalls looming elsewhere it is feared such additional production may not achieve much more than plugging the gaps left elsewhere.

Chile’s Collahuasi, the world’s No. 3 mine, owned by Xstrata and Anglo-American, is an example of how attuned miners are to global copper prices and how willing they are to down tools if they feel a larger slice of the pie (rising copper prices) is due to them. Collahuasi went on strike this week and although production has been sustained with temporary workers so far, it may not be a viable long-term solution. Sustained high prices will exacerbate this trend, increasing volatility in copper prices as labor becomes more assertive and investors see shortages getting worse.

While no timetable for ETF Securities’ copper-backed and base metal-backed basket ETFs has been set, it is widely acknowledged that, at least for copper, a physically backed fund would suck metal out of the physical market increasing shortages. For that very reason it is likely to be popular as a self-fulfilling investment. The resulting shortages would push prices higher, creating a gain for the investor.

Chinese buying of primary cathode has been more muted of late. The recent high prices are possibly putting buyers off in the short term, but the gradually appreciating RMB is closing the SHFE-LME arbitrage window, a fine calculation at the best of times, making primary metal imports more likely if Chinese buyers get panicked by a continually strengthening LME.

We will continue this series in a follow-up post tomorrow.

–Stuart Burns

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