| There’s an old saying on Wall Street : The economy is topped with a copper roof. The saying itself does not make much sense, but it's meaning is legend on Wall Street.
In 1946, manufacturing activity accounted for nearly half of America's gross national product. A key commodity used in the building of durable goods is copper. It’s used for electrical wiring in homes and as a key commodity in auto assembly, in appliance production, and in upgrading of the country's fixed line telephone network.
Like oil, copper is an increasingly ubiquitous commodity. Its price, like any other commodity, is quite sensitive to demand. In the early years of the baby boom era (1946 to the early 1960s), copper prices rallied smartly. And drop in copper prices often signaled an imminent recession. When copper prices peaks, it usually coincided with the peak in economic activity.
Since the ratio of copper has reduced of late, it no longer has such a strong predictive power as it once did, but the relationship between copper prices and economic cycles remains quite strong. Copper prices historically tend to peak just before a recession begins and recovers just before the subsequent recovery gets started. This tendency of copper prices has led to the notion that the economy was ‘topped with a copper roof’.
Copper prices have fallen more than 50 per cent since reaching a record high of $8,940 a tonne in July 2008. After rising 5 per cent on November 14, 2008, its prices grew weak on November 17, after Japan went into recession. London Metal Exchange (LME) copper for delivery in three months fell $120 to $3,700 a tonne, while Shanghai’s most active copper contract dropped 2 per cent to 29,400 yuan. During the week ending October 31, 2008; copper stocks on LME grew 7,275 tonnes to 237,925, the highest since March 2004.
The Eurozone, Japan and Hong Kong are now officially in recession, and the is US about to enter into one. A measure of Chinese manufacturing activity showed factory output shrank sharply in October 2008 in the face of waning orders. A lot of copper mining companies have been forced to cut production, reduce capital expenditure and postpone new projects, as metal prices have fallen below marginal costs. However, a force majeure on some deliveries from Chile's Escondida, the world's biggest copper mine, following a mill closure, has kept copper prices from falling apart as supply seems to be still constrained. Unsurprisingly, Citigroup has slashed its 2009 copper-price forecast by 45 per cent. Copper will average $2 a pound next year. That's a steep downward revision from the previous forecast of $3.65/lb.
Sentiments toward the red metal have been dented by the sharp fall in prices of the commodity-in-chief, oil; the resurgence of the dollar and concerns about world economic outlook. Citigroup says growth in global industrial production will slow from 4.2 per cent in 2007 to 2.8 per cent this year. Despite weakness in demand, the data showed the physical copper market in deficit. This is attributable to lack of growth of copper mine supply.
In the first four months of 2008, the deficit totaled around 108,000 tonnes. After making seasonal adjustments, that deficit shrinks to 34,000 tonnes. Given the current fundamentals, supply and demand are priced for perfection. Which means even a small change in either demand or supply or both will have a large impact on market prices. Although the link between a peak in copper prices and a peak in the economic cycle has become somewhat tenuous in the US, since manufacturing accounts for less than 18 per cent of GDP and the services sector typically representing bulk of modern economic activity in the US does not use much of copper. Yet, the link between copper and the manufacturing sector remains as strong as ever.
The copper market is expected to remain tight as existing supply and new mine expansions will struggle to keep pace with demand growth. According to Leon Westgate of Standard Bank, world's largest copper producer Codelco said output fell 11.1 per cent to 715,000 tonnes in the first half of 2008, reflecting declining ore grades and the impact of labour disputes. Codelco has also signaled that output is not expected to return to 2007 levels until 2010. (The writer is the CEO of Global Capital Advisors. Financial Chronicle does not warrant the quality or accuracy of the article. It shall not be deemed a recommendation by FC for buying or selling or investment of any kind. Investments are subject to market risks. Past
performance does not guarantee future success. It is advisable to seek advice from a qualified independent advisor before investing) |