Should copper prices be soaring?

The recent bull-run in copper prices is not something you would expect to find in the script, given the turmoil in the financial markets.

After skyrocketing to the $4.65-per-pound level in mid-February, copper prices had a sharp correction, falling by more than 15%, before finding support at $3.85 per pound. The stock market continued its ascent through the end of April. The stark divergence was a bit of an enigma because the two markets normally move in unison – give or take. Perhaps the copper market was more prescient than the stock market in foreseeing the potential harmful effects on the global economy that would result from the fallout from the European sovereign debt crisis and the inability of the US Congress to reach an agreement on raising the Federal Government’s debt ceiling. But then, copper prices rallied by 40¢ per pound even while the stock market was in the midst of a scary decline. The usefulness of copper prices as a harbinger for future economic conditions looked questionable.

The copper rally gathered steam when rare winter storms hit the copper belt in Chile in late June and early July, causing a complete shutdown for several days at huge mines, including Escondida, the world’s largest copper mine. Coupled with ongoing labor disruptions, the slowdown in Chilean output provided the foundation for the current leg of the rally that has brought prices all the way back to the $4.50 level. Is this strength sustainable?

During the recession in 2008, prices fell dramatically because demand was so weak. As soon as the global economy began to recover in 2009, however, the mining industry could not keep up. Current supply-side trends remain sluggish. Monthly Chilean output data have been directionless, alternating between strong and weak results. Overall, average monthly production since the beginning of 2011 is down 0.05%. Mine output in key producer Indonesia is seen falling by more than 25% this year because ore grade is declining.

While it’s quite true that the output problems in Chile – weather and labor – are of a temporary nature, it does highlight the vulnerability of a single region that provides 30% of world supply.

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