In this author's opinion, China, and to a lesser extent India and other developing nations, are responsible for the largest and longest base metals bull market the world has ever experienced. Many fear the bull market for natural resources is over when in fact nothing could be further from the truth. This seems especially true, because of the supply/demand picture, regarding copper.
Copper's chemical and physical properties include high ductility, corrosion resistance, malleability, excellence as a conductor of heat and electricity and alloying capability with other metals - zinc to form brass, aluminum or tin to form bronzes or alloying with nickel - to acquire new characteristics for use in highly specialized applications.
Copper is used for conducting electricity and heat, telecommunications, transporting water and gas, industrial machinery and equipment, coins for currency, roofing, gutters, downspouts, protecting plants and crops, and as a feed supplement.
Copper's price hit US$3.75 per pound in May 2006 after rising from a 60 year low of US$0.60/lb in June 1999. By February of 2007 it dropped to US$2.40lb but rebounded to US$3.50/lb by April 2007. By February 2009 copper prices were - because of weakening global demand and a steep fall in commodity prices - at US$1.51 per pound.
Copper prices started a comeback and during the summer of 2009 and again during this summer the price of copper defied conventional market wisdom - sell in May and go away - by rallying strongly and managed to hold close to its recent highs coming into the end of August.
Copper inventories at the London Metal Exchange (LME) and Shanghai Futures Exchange have both seen dramatic reductions.
Copper exploration/development companies looking for or trying to develop deposits already found and copper miners looking to expand their production capacity are all facing some serious challenges, including falling ore grades, country risk, water supply, labor problems and strikes, shortages of skilled labor, cost of capital for project finance, capital cost overruns, tax and sharing initiatives and energy costs.
Other challenges include inadequate exploration funding which the Metals Economics Group estimates plummeted 42% to $7.7 billion in 2009, a lack of new discoveries and currency fluctuations. "The reason why the prices are holding up so very high is that there has been only marginal increases in new copper mine development over the past five years," Patricia Mohr, vice president for Economics at Scotiabank Group in Toronto has said.
On August 24 the International Copper Study Group (ICSG) released preliminary data which showed world copper production fell short of refined usage by 190,000 tons in the first five months of 2010.
This author believes the full ICSG report showcases an underperforming industry and tells us there is the potential for a large copper demand/supply imbalance coming in the near future. Also consider:
- The declining rate of production at the world's largest copper mine, Escondida. BHP Billiton forecasts a 5% to 10% production cut at the mine this year due to lower ore grades. Bart Melek, global commodity strategist with BMO Nesbitt Burns in Toronto, said this could take as much as 80,000 to 100,000 tonnes of copper out of the market.
- U.S. copper mine production had been expected to increase by more than 200,000 tons last year, but instead production declined by 120,000 tons.
- Rio Tinto and Freeport McMoRan both saw their output drop in the first six months of this year.
- Lagging investment in new mining capability because of recent low prices.
- The growth in demand from China, India and other emerging markets.
- Consistent declines in warehouse inventories that are underpinning the price of copper.
- A low interest rate environment that bodes well for the whole resource sector.
- The overall weakness in the U.S. dollar translates into support for dollar denominated metal prices.
- The potential for a drop in production from Australia, the world's fifth largest copper producer, as a result of a resource tax the government might implement.
- India's power production needs will rise by 15% to 20% annually, which means, according to the International Energy Agency (IEA), that India needs to invest $1.25 trillion by 2030 into its energy infrastructure. Because of this investment into new infrastructure, India's annual copper demand is expected to more than double to nearly 1.5 million tonnes by 2012, up from a current 600,000 tonnes. India usually exports between 100 and 150,000 tonnes a year. Indian copper exports are likely to cease and indeed Indians might become large copper buyers.
"There is no question that the current production numbers are to some degree validating that there is an issue starting to manifest itself on the supply side." Mark Liinamaa, vice president market research, Morgan Stanley.
"Prices are underscoring the relatively robust nature of physical conditions and from a business cycle perspective inventories remain fairly low. If economic conditions deteriorate there isn't going to be that much destocking as manufacturers have been quite disciplined ... The market is factoring in the fact that supply tightness is not going away." Dan Brebner, analyst Deutsche Bank
According to Barclays Commodities Research analysts copper is forecast to average $6,989/t this year and $7,763/t in 2011. For 2011, BMO anticipates a global supply deficit of some 280,000 metric tons, with a price forecast of $3.70 a pound. Investors still have concerns that include the extent of the recovery currently underway in the US and Europe and a slowdown in Chinese growth
People have been using copper for over 10,000 years and recycling (it can be recycled without any loss of chemical or physical properties) almost as long - it has been estimated that at least 80% of all copper ever mined is still in existence.
Unfortunately, according to Barclays Commodities Research analysts, Indications are that demand in Europe, the US and Japan is holding up well and scrap has become very tight. "Scrap (supply) is tight," says Edward Meir, an analyst with MF Global.
"There is little information regarding this market (talking about the scrap market); however, it has not been a decisive factor either for the demand or supply side of the copper market," says Juan Villarzu, former head of world's largest copper company, Codelco.
China
Copper consumption estimates for China are being revised up, says Scotiabank economist Mohr. "Huge spending on copper-intensive power infrastructure on the state grid in 'rural areas' will continue through 2012" at a rate of 12 billionn RMB, she says. "Beijing has also renewed the 'home appliance subsidy scheme' and is promoting electric cars, which are twice as copper-intensive as conventional vehicles." Mohr also said that China's demand for copper will grow 13% this year and by another 8-10% in 2011.
"I think the global growth story is back on. China, India, and Brazil, especially, are just growing by leaps and bounds ... and they need the copper for housing and infrastructure." Michael K. Smith, president of T & K Futures and Options Inc.
The Chinese are increasing the level of housing construction, seeing strong increases in car sales - up more than 50% year-over-year, targeting urban population growth of 60% by 2020 - up from 49% this year, currently consuming 40% of total global base metal production and raising domestic metal prices, by stockpiling, to stave off unemployment.
They are creating and transmitting more electricity, providing massive direct subsidization of export production in many key industries, maintaining strict non-tariff barriers to imports and keeping their currency, the yuan, at an artificially low exchange rate which keeps China's exports cheap.
At the end of 2009 mainland China's total population was 1.334 billion with 712 million people or 53.4% of the populatio residing in rural areas while 622 million or 46.6% were residing in urban areas. Chinese urban dwellers are the largest such population in the world.
City's Blue Book: China's Urban Development Report No. 3 noted that China's urban population is twice that of the population of the United States, one quarter more than the total population of 27 countries of the European Union and that the urban economy would continue to drive domestic demand.
The UN has forecast that China's population will have about an equal number of people, the 50%-point phenomenon, living in the rural and urban areas by 2015. China has set a goal of 65% of urbanization rate in 2050. Over the coming 40 years that means 20 percentage points of urban growth per year, that translates into 300 million rural residents becoming urban residents over this time period.
By 2025 China's urban population is expected to rise to 926 million and by 2030 that number will increase to a billion. China's current urbanization rate of 46% is much lower than the average level of 85% in developed countries and is lower than the world average of 55%. In 2010 the disposable income of the urban population stood at 17,175 yuan per capita while the net income of the rural population was 5,153 yuan per person.
Over the next two decades China will build 20,000 to 50,000 new skyscrapers by 2025 and 40 billion square meters of floor space will have been built. By 2025 221 Chinese cities will have one million people and more than 170 cities will need mass transit systems.
"The growth potential of the vast middle and western regions, together with the rapid development of small cities and towns, could keep the economy on the fast track for at least 15 to 20 years." Wei Houkai, director of the center for China's regional development at the Chinese Academy of Social Sciences (CASS)
India
Every major industrialized country in the world has experienced a shift over time from a largely rural agrarian-dwelling population to one that lives in urban, nonagricultural centers, according to McKinsey Global Institute's report India's Urban Awakening. India will be no different and urbanization India will be on a scale, that outside of China, is unprecedented, the report added.
India has 1.2 billion people and the second largest urban system in the world - currently 340 million people. Less than 60 percent of the households in India's cities have sanitation facilities, and less than half have tap water on their premises. The share of the urban population in India is expected to reach 40% by 2021, and by 2011, urban areas could contribute around 65% of GDP.
By 2030, Asia's third largest economy would have 68 cities with populations over 1 million, up from 42 today. With less than 1/3 of the population India's urban areas generate account for 90% of government revenues.
Conclusion
This author believes that the US and Europe are, or are in the process of becoming, mostly irrelevant when it comes to the demand side of the copper supply equation. Increased demand for the red metal in developing nations will more than make up for decreased demand in the western world. And when western economies recover, as they eventually must, then the supply squeeze will become even tighter.
The citizens of the world's developing nations aspire to have what we have, the ease of travel, home phones, electricity, central plumbing, heating and air conditioning, cars, toys, consumer electronics and home appliances.
When you consider the recent lack of exploration spending, increasing demand from developing countries, country risk (the Democratic Republic of the Congo comes to mind) declining resources and grades at the world's largest copper mines and that a sufficient number of new deposits that have been found are not being brought on stream in a timely enough fashion - and those that are, carry, for the most part, much lower grades than those presently being mined - then you might be forgiven for coming to the same conclusion that I have: growth in global copper demand seems likely at the same time supply is declining.
Could copper come into a major demand squeeze? Is the red metal on your radar screen? If not, maybe it should be.
Richard (Rick) Mills is president of Northern Venture Gorup and host of aheadoftheherd.com. He can be e-mailed at rick@aheadoftheherd.com.
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