Copper is normally seen as a bellwether for the global economy. Yet, even as the global economy seems to be accelerating, copper prices are actually down 6.52% year-to-date (YTD). The decoupling of copper’s historic relationship with accelerating global growth is a troubling sign that something might be afoot.
An analysis of copper’s long-term fundamentals, together with short-term sentiment and technical indicators, gives us reason to believe that the red metal might remain under pressure in the coming months. In the following paragraphs I will explain these factors in detail.
Copper fundamentals to remain challenging for the coming years.
Copper’s biggest headwind going forward is the large supply that is expected to come into production in the next few years. (Figure 1).
Figure 1: Major mine expansions underway in 2014-2017 (Source: Credit Suisse)
Back in the heydays of the 2011, Commodity boom, copper prices where trading north of $4.5/pound. At that time, mining executives largely expected copper prices to remain elevated over the long-term and resulted in committing billions of dollars in the construction of new mines and major expansions of existing copper projects. Now that most of the money has been invested in these projects, mining executives have little other choice but to go forward with these planned production expansions or face a complete write-down for the billions they invested. As a result, global copper mine supply is expected to grow enormously in the coming years (Figure 2). Market consensus expects copper mine supply to increase more by more than 6% in 2015, and by nearly 5% in 2016, before leveling off in 2017.
Figure 2: Global copper mine supply growth (Source: Deutsche Bank).
The end result of increased global copper production is obvious. Even with an expected increase in global copper demand, accompanied by an expected decrease in global scrap supply, the above-mentioned increase in global mined supply will ensure that the red metal is in ample supply. A forward projection of the World copper supply/demand balance shows that copper is expected to be remain in surplus at least till 2016 (Figure 3).
Figure 3: Projected global copper demand/supply balance till 2018 (Source: Citigroup Research).
More troubling fundamentally is the fact that, currently, copper remains one of the most profitable base metals to mine (Figure 4). Assuming price data from July 2014, copper is the most profitable metal to mine after Zinc. Compared to other base metals, such as Aluminum, Lead and Nickel, copper mining commands healthy margins.
Figure 4: Industrial metal prices vs marginal cost to produce (Source: Deutsche Bank).
An analysis of the copper-cost curve suggests that prices have to fall under $2.80/pound before mining companies start facing any real pain (Figure 5). Over 90% of copper mines will break-even on an all-in cost basis if the copper price stays above $2.80/pound. Only if copper prices where to fall under this threshold, would we begin to see mining companies scale back in their production. This tells us two things: Firstly, copper prices still have room to fall some 10% before we see a clear threat to the supply. Secondly, if we take this into perspective, we can conclude that a copper price off $2.80/pound is somewhat of a fundamental floor, thus price drops under this level are unlikely.
Figure 5: copper mine cost-curve (Source: Deutsche Bank).
As copper supply will remain plentiful in the coming years, bearing any unexpected crashes, it seems that only demand could possibly push prices higher. In this respect, investors hoping for upside will have little reason for joy. China remains the biggest consumer of copper, with over 40% of World demand coming from the eastern country. Historically, China’s real estate market has been a major and the largest consumer of copper. The slowdown in Chinese construction will only exacerbate the fundamental problems facing copper. Chinese housing starts have taken a large nosedive this year, while investments in residential projects continue to decline (Figure 6).
Figure 6: Chinese construction starts and residential investments (Source: JP Morgan).
This large decline in new housing projects by China’s largest developers can be expected to remain in place for some time as there are more than enough existing housing inventories at the moment (Figure 7). Furthermore, it is unlikely that large developers will ramp up construction in foreseeable future, as balance sheet concerns and recent declines in nationwide house prices will dissuade the addition of large new construction projects going forward.
Figure 7: Chinese housing inventory (Source: JP Morgan).
All in all, the fundamentals for copper remain challenging at best. Adding oil to the fire is the fact that short-term sentiment and technical indicators point to further downside for the red metal.
Short-term sentiment and technical indicators point to further downside.
Even with copper’s weak fundamental backdrop, investors have relatively high amounts of net-long positions in the copper futures market (Figure 8). Looking at the latest CFTC Commitment of Traders data we can see that money managers have the largest net-long exposure to copper in over 5 years of data. This is quite worrisome as future price declines would force these speculators to cut their losses, further exacerbating price drops as they liquidate their positions. This astoundingly high net-long position also reduces possible upside in copper prices as speculative positions are already at extreme levels and are therefore unlikely to be increased further.
Figure 8: COMEX copper net-speculative positioning (Source: Commerzbank).
Lastly, copper technical condition is bearish (Figure 9). Copper is in clear long-term downtrend as the descending light-blue trendlines show. Copper failed to rise above resistance at $3.20/pound and has been declining since and is now trading under all the major moving averages. The RSI and MACD indicators are also bearish. The RSI indicator is now trading under the 50-tickerline, indicating that copper is in a downtrend. While the MACD indicator has broken its up-trending green support line, and is currently declining strongly. Looking at the chart we can expect some support at the psychological $3/pound level, yet when looking at the weak technical posture, I would not expect this support level to hold. In my view, copper might find more stable support near the March 2014 low of around $2.90/pound.
Figure 9: copper technical analysis 13/08/2014.
Copper will remain under considerable fundamental pressure for the coming quarters as new mine supply hits the market. As a result, copper is expected to remain in surplus in 2015 and 2016. Copper mines are still profitable at current prices and only if the copper price where to decrease under $2.80/pound would supply come under threat. Therefore, prices have more room to decline before reaching this fundamental price floor. The slowdown in Chinese construction adds further pressure in an oversupplied market. CFTC data shows that sentiment towards copper is quite bullish as money managers have large net-long positions in the copper futures market. This paradoxical bullish sentiment adds further downside pressure in the near-term. Lastly, copper’s technical condition is bearish and as a result we can expect copper prices to decline further in the near term.
Considering all these factors, I expect copper prices to continue their decline. I expect copper to decline towards my price target of $2.90/pound in the coming months.
(Editorial note: In writing this research report I compiled data from JP Morgan, Credit Suisse, Deutsche Bank, Citigroup, and Commerzbank Reports. Institutional Investors or interested parties can visit the respective research portals for more information: JP Morgan, Credit Suisse, Deutsche Bank, Citigroup, Commerzbank).
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Simon is the CEO and Editor-in-Chief of Foresight Investor. He has been following the markets passionately for over 7 years.