Copper prices finished 2012 on a strong note and sprinted to multi-month highs to ring in the New Year (Chart 1). Aside from piggybacking on the stock market rally, the strength in copper prices has been underpinned by what seem to be some bullish supply and demand fundamentals.
Expectations for growth of 2012 Chilean production ran high, even as recently as several months ago. Early estimates put output up by as much as 10% over 2011. Between June and August, monthly production figures averaged 7.7% growth. It seemed as though some of the chronic problems such as labor strife and weather were not hampering operations and that the optimistic estimates were achievable. With data current through the end of November, year-over-year production is up only 2.85%, however, which leaves the promise of explosive growth in Chilean output in doubt.
While no region has experienced runaway growth, economic data is showing moderate recovery, at least enough to keep demand in industrial commodities steady. According to the International Copper Study Group’s (ICSG) most recent report, which covers the period between January and September 2012, global usage for refined copper grew 5.5% over the same period in 2011. Production of refined copper grew during this period as well, but by only 1.7%, ostensibly creating a drawdown in global supplies.
ICSG estimates that up to the end of the third quarter of 2012, the global market is running a huge production/consumption deficit of refined copper to the tune of 594,000 tonnes, compared with a deficit of only 74,000 tonnes at the same time in 2011.
Global warehouse stock levels tell a bit of a different story, though. Although not necessarily a completely reliable indicator – because it’s hard to know how much of warehouse inventory has already been sold forward – it should be somewhat disconcerting to bulls to see stocks rising at all three major exchange warehouse systems. Chart 2 shows combined LME, Shanghai, and COMEX stocks have increased since this past summer by over 40% to the highest level in almost a year. Regardless of the broader recovery in copper demand indicated by the ICSG data, this market’s consumption fortunes are tied to China. The most recent import data show that Chinese imports of refined copper rose 13.5% from October, but were down 27.7% year-over-year (Chart 3).
It is hard to justify copper at $3.50 to $4.00 per pound – or even at lower prices – without the influence of Chinese imports. The average cost of production – even after including copper from mines with lower ore grades in Chile, which is more expensive to extract – is still far below current prices. If this commodity lived by the rules of many other commodities, prices would have to plummet to catch up.
Peru is the world’s third-largest copper miner and currently produces 1.3 million tonnes, or 8% of the world total. Newmont Mining is pouring a massive amount of capital into the Peruvian mining sector. There are hurdles to overcome, primarily in addressing environmental concerns. However, if plans proceed as expected, output could double over the next two years. Even if the deficit number were accurate, an influx of such magnitude would handily erase any shortfall.
Chart 4 shows that funds are net long, but not overwhelmingly. A continuation of the rally in the stock market can easily carry copper prices above the $3.85-per-pound highs seen this past fall – and beyond.
Remain short. Maintain stops recommended on October 17 at $3.85, basis the nearest contract, close only.