Is Copper Popping Its Top?
The Daily Reckoning: There is no such thing as knowledge in investing - the best we can hope for is a preponderance of evidence, and as Carl Waynberg shows us, theories are constructed to be destroyed...
by Carl Waynberg
A few months ago at our monthly editorial confab, I had the gall, the stones to disagree with the resident metal heads about the direction of copper. They were long-term bullish every one, so, natch, I was bearish. My argument was pooh-poohed with several dismissive waves, which I interpreted as middle fingers sandwiched between superfluous digits - and why not? After all, what the hell do I know? My “expertise” is small-, micro-, and nano-cap equities, not commodities!
But that’s precisely the point: To paraphrase Socrates, I know one thing, and that is that I know nothing. Even with my so-called area of “expertise,” I always rely on research to guide my opinion, not opinion to guide my research. And when my small-cap research takes me, as it often does, into unfamiliar territory, that scientific approach - the idea that there is no such thing as knowledge in investing, that the best we can hope for is a preponderance of evidence, that theories are constructed to be destroyed, etc. - is imperative.
A couple days after that meeting, I sent my argument - an excerpt from an earlier GRIP missive - to Agora Financial’s metal heads, where it landed with a dull ping. True, as is always the case, my bearish inclination toward copper - indeed most base metals (except for nickel and zinc) - was primarily a function of disdain for the consensus opinion. Momentum strategies work short-term, but over the long-term, investors are much better served by taking the road less traveled, which would not describe the present commodities environment.
My earlier opinion vis à vis copper, based on evidence not emotion and excerpted below, holds true months later:
“Three years ago, metal bulls were an extinct species and rock-bottom base metal prices and threats of a global recession presented little enticement to miners to develop new properties. Three years ago, the characterization ‘metal bull’ was an oxymoron, an anachronism fit only for fuddy-duddies.
“Today, the label is a badge of honor. Today, with global demand percolating and metals prices setting new highs, metals bulls roam the ranges of Wall Street freely, graceful bulls in China’s shop of demand. From the New York Mercantile Exchange to the London Metal Exchange (LME) to the Shanghai Futures Exchange, metal bulls are so prevalent, many investors - common institutional investors like pension funds and other late-to-the-party investors - risk stepping in it in a big way.
“Last year, it was metals bears that were in hibernation. Goosed by global growth, demand for metals, especially on the part of China, was so great and stocks so depressed that metal bears did well to remain scarce. Prices could only go up, it was thought, and go up they did. Copper rose 37% last year, aluminum 21%. Lead, tin, and zinc also managed double-digit price advances. Nickel was the only metal to post a decline for ’04, but its average price during the year was nonetheless 44% above its 2003 levels.
“Because it takes many years to develop a new mining property, the lack of exploration and development that was the norm three years ago is, even today, reflected in inventory levels, which, for most metals, remain near 15-year lows. So long as supplies remain low and demand remains high, today’s bullish metals prices can be sustained.
“There is some evidence, however - slowing global growth and, consequently, demand for base metals and increased production on the part of miners thanks to seductively higher prices - to suggest most base metals have peaked.
“In the case of copper - last year’s base metals market star and the metal that tends to lead the way for the others - there is also the threat from high oil prices. Both China and the United States are net energy importers. With crude oil at record price levels, consumers in both countries will be forced to curb their spending on high-ticket items, like automobiles and washing machines, which use copper wiring, further dampening demand.
“In addition, you have promises from copper producers - Phelps Dodge, Freeport-McMoRan, BHP Billiton, Codelco and others - to increase production. No surprise, then, that the International Copper Study Group raised its projections for copper production by 3.2% to 17 million tonnes over the next three years. The increase in output and concomitant decrease in demand will eventually close the copper deficit. Over the long-term the price of copper is unsustainable, as the copper market moves from what has been a tight supply over the past few years to a surplus in 2006.”
Since I wrote this, the price of copper has added roughly 20 points, but warehouse levels have risen by three-fold as demand has fallen 2.1% year-over-year, while copper production has increased 5.1%. My suggestion at that June meeting that the confluence of higher energy prices, slowing demand, and increased production would result in a copper surplus was met with derision, but just a few months later, copper market analysts are no longer asking if there will be a surplus but how much that surplus will be.
According to an article published in Tuesday’s Platts, Peter Hollands, an analyst at Bloomsbury Minerals Economics, said “China was actively exporting and de-stocking, and the stocks of the Chinese traders who were in difficulty had also been released into the market,” resulting in unexpected additional availability of 10,000-15,000 metric tonnes. Mr. Hollands, a relative copper bull, who does not see an economic slowdown to the extent that others do and who predicts a paltry year-end surplus of roughly 10,000 metric tonnes (though he admits a surplus of any size would impact copper’s price negatively), admitted: “There is a worry that the market could be tipping toward a surplus, and I am aware of downside price risk.”
One UK-based analyst, who was not named in the article, took the middle road between two surplus predictions, pegging the shortfall at 100,000 metric tonnes for the second half of the year and twice that for 2006. “The analyst said the physical market was very dull and some cathode consumers had reported 30% decreases in demand for some of their products, while others reported drops of 10-15% in demand,” the article said.
ABN Amro’s Nick Moore cited a recent International Copper Study Group, which indicated that while demand from China, India, and the Russian Federation remained high, seven of the world’s top copper consumers experienced slowing demand in the first half of the year. In light of China’s active exportation and de-stocking, Mr. Moore’s question as to how much copper China is really consuming, as opposed to simply storing away, seems like an answer disguised as a question. Mr. Moore told Platts that many copper analysts were predicting a surplus as high as 1.5 million tonnes for 2006-2008 - the high end of surplus estimates.
Mr. Moore characterized the “price for the pleasure of buying copper” as “‘dislocated’ from the reality of copper supply and demand’” and the copper market as “lethargic.”
Even Australia’s Macquarie Bank, a copper bull, sees copper moving into a surplus next year, though it won’t admit that the size of the surplus is enough to justify the bearish stance embraced by many market analysts recently.
It’s worth noting that even the smallest surplus prediction would represent a considerable change in copper levels from the first half, which saw a deficit of 219,000 metric tonnes.
Of course, the bigger message in all this is that we as investors always do well to at least question conventional wisdom - if not dismiss it entirely - because conventional wisdom is almost always wrong. That’s something you can bank on - at least until it becomes conventional wisdom.
by Carl Waynberg
A few months ago at our monthly editorial confab, I had the gall, the stones to disagree with the resident metal heads about the direction of copper. They were long-term bullish every one, so, natch, I was bearish. My argument was pooh-poohed with several dismissive waves, which I interpreted as middle fingers sandwiched between superfluous digits - and why not? After all, what the hell do I know? My “expertise” is small-, micro-, and nano-cap equities, not commodities!
But that’s precisely the point: To paraphrase Socrates, I know one thing, and that is that I know nothing. Even with my so-called area of “expertise,” I always rely on research to guide my opinion, not opinion to guide my research. And when my small-cap research takes me, as it often does, into unfamiliar territory, that scientific approach - the idea that there is no such thing as knowledge in investing, that the best we can hope for is a preponderance of evidence, that theories are constructed to be destroyed, etc. - is imperative.
A couple days after that meeting, I sent my argument - an excerpt from an earlier GRIP missive - to Agora Financial’s metal heads, where it landed with a dull ping. True, as is always the case, my bearish inclination toward copper - indeed most base metals (except for nickel and zinc) - was primarily a function of disdain for the consensus opinion. Momentum strategies work short-term, but over the long-term, investors are much better served by taking the road less traveled, which would not describe the present commodities environment.
My earlier opinion vis à vis copper, based on evidence not emotion and excerpted below, holds true months later:
“Three years ago, metal bulls were an extinct species and rock-bottom base metal prices and threats of a global recession presented little enticement to miners to develop new properties. Three years ago, the characterization ‘metal bull’ was an oxymoron, an anachronism fit only for fuddy-duddies.
“Today, the label is a badge of honor. Today, with global demand percolating and metals prices setting new highs, metals bulls roam the ranges of Wall Street freely, graceful bulls in China’s shop of demand. From the New York Mercantile Exchange to the London Metal Exchange (LME) to the Shanghai Futures Exchange, metal bulls are so prevalent, many investors - common institutional investors like pension funds and other late-to-the-party investors - risk stepping in it in a big way.
“Last year, it was metals bears that were in hibernation. Goosed by global growth, demand for metals, especially on the part of China, was so great and stocks so depressed that metal bears did well to remain scarce. Prices could only go up, it was thought, and go up they did. Copper rose 37% last year, aluminum 21%. Lead, tin, and zinc also managed double-digit price advances. Nickel was the only metal to post a decline for ’04, but its average price during the year was nonetheless 44% above its 2003 levels.
“Because it takes many years to develop a new mining property, the lack of exploration and development that was the norm three years ago is, even today, reflected in inventory levels, which, for most metals, remain near 15-year lows. So long as supplies remain low and demand remains high, today’s bullish metals prices can be sustained.
“There is some evidence, however - slowing global growth and, consequently, demand for base metals and increased production on the part of miners thanks to seductively higher prices - to suggest most base metals have peaked.
“In the case of copper - last year’s base metals market star and the metal that tends to lead the way for the others - there is also the threat from high oil prices. Both China and the United States are net energy importers. With crude oil at record price levels, consumers in both countries will be forced to curb their spending on high-ticket items, like automobiles and washing machines, which use copper wiring, further dampening demand.
“In addition, you have promises from copper producers - Phelps Dodge, Freeport-McMoRan, BHP Billiton, Codelco and others - to increase production. No surprise, then, that the International Copper Study Group raised its projections for copper production by 3.2% to 17 million tonnes over the next three years. The increase in output and concomitant decrease in demand will eventually close the copper deficit. Over the long-term the price of copper is unsustainable, as the copper market moves from what has been a tight supply over the past few years to a surplus in 2006.”
Since I wrote this, the price of copper has added roughly 20 points, but warehouse levels have risen by three-fold as demand has fallen 2.1% year-over-year, while copper production has increased 5.1%. My suggestion at that June meeting that the confluence of higher energy prices, slowing demand, and increased production would result in a copper surplus was met with derision, but just a few months later, copper market analysts are no longer asking if there will be a surplus but how much that surplus will be.
According to an article published in Tuesday’s Platts, Peter Hollands, an analyst at Bloomsbury Minerals Economics, said “China was actively exporting and de-stocking, and the stocks of the Chinese traders who were in difficulty had also been released into the market,” resulting in unexpected additional availability of 10,000-15,000 metric tonnes. Mr. Hollands, a relative copper bull, who does not see an economic slowdown to the extent that others do and who predicts a paltry year-end surplus of roughly 10,000 metric tonnes (though he admits a surplus of any size would impact copper’s price negatively), admitted: “There is a worry that the market could be tipping toward a surplus, and I am aware of downside price risk.”
One UK-based analyst, who was not named in the article, took the middle road between two surplus predictions, pegging the shortfall at 100,000 metric tonnes for the second half of the year and twice that for 2006. “The analyst said the physical market was very dull and some cathode consumers had reported 30% decreases in demand for some of their products, while others reported drops of 10-15% in demand,” the article said.
ABN Amro’s Nick Moore cited a recent International Copper Study Group, which indicated that while demand from China, India, and the Russian Federation remained high, seven of the world’s top copper consumers experienced slowing demand in the first half of the year. In light of China’s active exportation and de-stocking, Mr. Moore’s question as to how much copper China is really consuming, as opposed to simply storing away, seems like an answer disguised as a question. Mr. Moore told Platts that many copper analysts were predicting a surplus as high as 1.5 million tonnes for 2006-2008 - the high end of surplus estimates.
Mr. Moore characterized the “price for the pleasure of buying copper” as “‘dislocated’ from the reality of copper supply and demand’” and the copper market as “lethargic.”
Even Australia’s Macquarie Bank, a copper bull, sees copper moving into a surplus next year, though it won’t admit that the size of the surplus is enough to justify the bearish stance embraced by many market analysts recently.
It’s worth noting that even the smallest surplus prediction would represent a considerable change in copper levels from the first half, which saw a deficit of 219,000 metric tonnes.
Of course, the bigger message in all this is that we as investors always do well to at least question conventional wisdom - if not dismiss it entirely - because conventional wisdom is almost always wrong. That’s something you can bank on - at least until it becomes conventional wisdom.
Carl Waynberg
Courtesy The Daily Reckoning
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