Copper – The Recovery is Underway

Very rarely does a bull market announce its impending arrival. And given continued weakness in many key sectors of the economy, coupled with structural changes underway domestically and indeed within the global copper community, one is hard pressed to even imagine that the market will improve anytime soon. For sure, today’s environment is characterized more by continued downsizing, rather than plans for expansion for future growth. But important changes are underway and if history is our guide, now is the time to prepare for these developments to unfold.

Last year, we saw global production exceed consumption by nearly 320,000 short tons, following a surplus of 825,000 ST in 2001. As a result, inventories held in Comex and London Metal Exchange warehouses soared to a record high 1.4 million tons and prices of course reflected the severe weakness. During 2002, the Spot Comex price for copper traded well below 70¢ and for the full year, came in at slightly less than 72¢, representing the lowest annual average since 1986. Further, this was also well below the average price of copper over the past thirty years of 85¢ per pound.

That said, the market has been in transition as evidenced by several factors, suggesting the worst may be behind us, with better days ahead. First and foremost, during the first quarter, global production fell 1.8% from the year ago period, while consumption rose 6%, resulting in a deficit of 80,000 ST, as compared to a 235,000 ST surplus during 1Q 2002. Also, inventories held in Exchange warehouses are down some 365,000 ST from the year ago period; scrap remains very tight and spreads have been narrowing. Technically too, chart patterns have become more encouraging with what appears to be a long-term double bottom at 60¢ that took two years to develop between 1999 and 2001.

As is typically the case, there are any number of factors that could muddy the waters to include how and when Codelco will decide to move inventory that is being withheld from the market, or how the Chinese will manage their government stockpile, or for that matter, when unutilized capacity will come back on line.

Interestingly, although the record high level of exchange stocks we saw last year seems incomprehensible, relatively speaking, in broad terms, it was no worse than prior bear markets that also ran their course. That is to say, in 1977, when exchange inventories reached a record high 900,000 ST, global consumption was approximately 9.4 million short tons representing a 9.6% ratio of stocks to consumption on an annual basis. In 1984, inventories rose to the 900,000 ST level again; global consumption stood at 10 million ST putting the same ratio at 9%. Last year, consumption stood at about 16.6 million ST, giving us an 8.4% ratio of stocks to consumption. This is not to diminish the gravity of the situation, and the severe toll it has taken on the industry, but it does lend an element of perspective to an otherwise grim picture. Granted, none of these figures take into account stocks held by producers, merchants, consumers or governments, but it does nevertheless give us a consistent point of reference, not only about the past, but it also provides a potential view of the future.

Historically, once global inventories begin to decline in earnest from their record high levels, it is not very long thereafter that prices not only recover, albeit very arduously, but set the stage for new highs being reached.

Looking ahead, one can cite any number of reasons why ‘this time it is different’ and therefore prices won’t approach their previous high levels . . . just as they said in prior bull markets. And it is exactly this rational that in fact becomes the catalyst to send prices soaring when the reality of the market finally sets in. Of course there is no blueprint, or time table to determine how, or when this will occur, and the difficulty is exacerbated by virtue of vast changes in consumption patterns that have emerged. But make no mistake, the seeds have been planted and the next phase of the cycle is already underway.

John E. Gross
July 5, 2003