This following is an edited transcript of part one of a presentation on the outlook for copper, delivered at the annual convention of the Prospectors & Developers Association of Canada in Toronto. The second part will appear in our April 15-21 issue.
The distinct message from this conference has been that metals supply is likely to remain constrained for some time to come despite a large increase in mining exploration and development spending over the past year. The latest data from the Halifax, N.S.-based Metals Economics Group show that non-ferrous exploration budgets surged by almost 60% in 2004 (driven by gold, to a large extent), after a 26% rise in 2003. This follows five years of declines in mining exploration budgets, owing to low prices — a key reason for today’s (and tomorrow’s) supply shortfalls and high metals prices.
Many producers say developing new mines now takes longer than ever, owing to rising production costs (driven partly by higher steel prices), tighter environmental and labour regulations, a weaker dollar, and so on. In addition, current output levels should not be taken for granted as plants are already operating flat out, increasing the risk of output disruptions.
Also, over the nearer term, output growth is being restricted by the sheer lack of mining equipment, from drilling parts to tires. This is in line with recent high demand for mining equipment. The situation is creating upside pressure on long-term real prices and supports our bullish outlook on base metal prices over the nearer term. In particular, we expect physical demand to pick up during the normally stronger second quarter.
This time last year, copper prices had just risen above US$3,000 per tonne for the first time since 1995. It was an impressive achievement, and at the time, few market participants believed that these price levels were sustainable. There were great concerns over slowing economic growth rates, rapidly increasing output, while speculation concerning large unreported stockpiles of copper also increased. A year on, copper prices are still above US$3,000 per tonne, and are moving toward all-time highs. However, the same market concerns remain. How serious are these concerns today and what is the current outlook for copper prices?
The copper market is in deficit, and reported inventories have fallen to dangerously low levels; copper stocks in exchange warehouses are enough for only two days of global consumption. In this environment, prices are extremely sensitive to changes in both supply and demand, and the outlook is also exceptionally vulnerable to economic changes. As a result, the market view on copper prices is markedly split. This year’s annual Reuters analyst survey shows average copper price forecasts ranging from a low of US$2,200 per tonne to a high of US$3,100 for 2005 — a spread of almost US$1,000 per tonne.
Last year, we turned out to be one of the most bullish forecasters. We also forecast a “twin peak” in metals prices. While this view was seriously challenged as prices came under severe downside pressure during the summer, it turned out to be a good call. Today, we remain upbeat on copper price prospects, as we believe the various market concerns are, in most cases, overdone.
However, because of the current extreme market sensitivity, prices are also likely to stay highly volatile. Over the past year, copper prices have seen some of their largest daily price moves on record. On three occasions, they fell by almost 10% within a day. We believe similar price swings are likely over the near term, though it would be premature to conclude that the uptrend is nearly over.
Last year saw extraordinarily strong growth in consumption of refined copper. Global demand was up by nearly 9%. This compares with growth of 7.5% in the previous big upturn in the mid-1990s, and represents one of the strongest annual growth rates on record. Consumer re-stocking added to the sharp upswing, and in the US, fixed capital spending surged after a long period of under-investment in the industrial economy. However, this rate of growth is not sustainable.
Although overall growth rates slowed in the second half of 2004, they remained positive. U.S. growth remains above trend, and the most recent leading indicators of economic activity in the region represented by the Organization for Economic Co-operation & Development even suggest a bottoming-out of the growth slowdown. The divergence in a traditionally well-correlated relationship between demand indicators and metals prices was an interesting feature last year. Several factors contributed to the surge in metal prices, including under-investment in new output capacity, rising trend rates in demand growth, low inventories, weakness of the dollar, and increased interest in commodities as an asset class.
A key reason for this divergence in traditional (Western World) leading indicators and metals prices is China’s ever-growing influence in commodity markets, which is driving higher trend rates in global demand growth. China has been a major contributor to global copper consumption growth in recent years, and is now the world’s largest copper consumer. As a result, there has been an increased focus on developments in China, though indicators are perhaps not as accessible as they are in the West. However, we would summarize the current situation for copper by stressing three key factors:
– Chinese copper requirements are large;
– the Chinese market is tight of metal; and
– Chinese consumers are cautious amid high prices.
Chinese copper requirements are huge, driven by the country’s industrialization, urbanization and consumerism. Global trend growth in copper demand is on the rise, which is the main reason we raised our long-term copper price (above consensus) to US$1 per lb. last year. Total Chinese copper imports, including cathode, concentrates, scrap and semis, have risen to record highs as a result. While we expect cathode imports to be largely stable at around 100,000 tonnes a month over the near term, concentrates and scrap imports will continue to drive this rising trend in total Chinese copper imports.
Investment in the power sector is a major cause of China’s high copper consumption. Given continuous power shortages and large future electricity requirements, sizable investments are taking place in that sector, which is benefiting copper. Chinese power infrastructure accounts for at least 30% of the country’s total copper consumption. Indeed, it is the largest end-use sector for copper in China. Double-digit growth rates in power-generating capacity expansion planned for this year and next indicate continued high demand. In fact, there are plans to spend a massive US$560 billion on power generation and transmission by 2010, which translates into roughly 500,000 tonnes of copper.
The Chinese copper market is tight of metal, and physical premiums in China market remain firm as a result, at around US$125-130 per tonne. More upside pressure on freight rates, which have a strong relationship with physical copper premiums, reflects China’s large raw material requirements (and the inability to satisfy those with internal resources).
However, we have noted there is a clear reluctance among copper consumers in China to buy in the first quarter of 2005. London Metal Exchange prices are undesirably high, there is a steep backwardation along the forward curve, physical premiums are around historical highs, and there is the potential for a Renminbi revaluation (though that is looking increasingly unlikely this year). Critically, Chinese copper manufacturers have been unable to pass on higher prices to consumers.
There have been reductions in domestic copper semis output as a result, and we recently saw the first year-over-year fall in semis output growth in more than two years. While this is worrying, it is in line with the desired slowdown in China’s fixed-asset investment, which is still growing at at double digits.
Chinese consumers have shown gre
at sensitivity to the high copper price environment and consequently have brought down their refined copper holdings to a minimum. However, in the current market place, lower prices would most certainly attract renewed buying, and we believe this will provide solid underlying support to copper prices.
To conclude, although growth is slowing, demand conditions remain positive and are extremely supportive against an environment of insufficent supply growth and critically low reported inventory levels.
— The opinions presented are the author’s and do not necessarily represent those of the Barclays group. For access to all of Barclays’ economic, foreign-exchange and fixed-income research, go to the web site at barclayscapital.com. Queries may be submitted to the author at ingrid.sternby@barcap.com
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