A Bullish Scenario for Copper
The Daily Reckoning PRESENTS: Commodities guru Jim Rogers once said that there are three questions that need to be asked – and subsequently answered – when looking to determine if a commodity is headed higher in price. Using these questions as a guide, James Boric looks at the “perfect investment” – copper…
A BULLISH SCENARIO FOR COPPER
“You can’t have a bubble when the media have only begun to pay attention to commodities in recent months after years of disinterest. We’re now only in the early part of a long-term commodity price boom that has years to run and will likely see dozens of raw material prices make new highs. Even crude oil and copper have a long way to go, even though they recently set price records.”
Copper is the perfect investment.
The base metal hasn’t received nearly the press that its precious peers, gold, silver, platinum and palladium have. But it should.
The reddish metal is one of the most useful on Earth. It is a very efficient conductor of electricity. It is flexible and strong and it doesn’t corrode easily. It is used for heating, air conditioning, plumbing, roofing, adapters, computers, cars, mobile phones, wiring, electrical leads, transformers, motors and lighting units.
In short, copper is used in nearly every major industry of the world: transportation, engineering, machinery and equipment, electrical, building, automotive and computer.
Thanks to significant demand worldwide, the base metal has outpaced all of its higher-profile precious peers by a significant margin over the last five years. Spot copper prices are up 393% from their lows in 2001. Meanwhile, gold is up only 151%, silver is up 188%, platinum is up 202% and palladium is up 122%.
Surely, the price of copper has gotten way ahead of itself and are due for a major correction. Right? That’s what the bears are saying these days. But the underlying fundamentals in the copper industry paint a different picture. They show a world in which prices will go higher – much higher.
World-famous commodities expert Jim Rogers said there are three questions you need to ask (and answer) to determine if a commodity is headed higher in price: How much production is there worldwide? Are there new sources of supply? And are there new potential supplies?
The perfect scenario for a commodity on the rise is that worldwide production is limited or declining, there are no new supply sources that could boost production in the near-term and there is no viable replacement when prices get “too high.”
Based on all three of these requirements, copper is the perfect investment right now.
Is Production Limited or Declining? Yes.
Thanks in part to rapid growth in India and China, worldwide copper demand is at an all-time high. From 1998 to 2005, total refined production of copper has gone from 14, 142 k tons to 16, 631 k tons. During that same time period, total refined consumption has gone from 13, 352 k tons to 16, 884 k tons. For the last three years, copper consumption has been greater than the total amount of copper produced. As a result, copper supplies and stockpiles have shrunk to five-year lows and copper prices have skyrocketed from 75 cents a pound to as high as almost $4.
Since 1990, copper consumption has increased from 512,000 to 3,482,000 tonnes a year. In India, copper demand has increased from 132,000 to 271,000 tonnes a year. And in the United States, demand has increased from 2,150,000 to 2.5 million tonnes a year. Yet despite this growth, there is massive upside potential from here.
Japan consumes about 12 kg of copper per capita. North America consumes around 10 kg, and Europe consumes 9 kg per capita. But the massive populations in Chile, India, Eastern Europe and South America are all still consuming less than 2 kg per capita. Imagine what will happen to copper prices as they start to catch up to the rest of the world. Prices will rise – especially when you consider there is no major change to the supply side of the equation.
Are There New Supply Sources? No.
There has not been a significant new copper mine discovery in nearly 100 years. And according to the Metals Economics Group, “Worldwide, significant copper discoveries between 1998-2004 have fallen well short of what is needed to replace the copper produced – a total of just 39.9 million mt of copper in reserves and resources has been discovered, while production totaled just about 93.6 mt – although the resources in these deposits have potential for further increases over time.”
Think about that for a second…
Over a six-year span, only 39.9 million tons of copper was discovered, while 93.6 million tons of copper was produced. This ratio of production to discovery simply cannot sustain itself. If we don’t find a major new copper mine soon, copper production will have to slow down and prices will rise – significantly.
And a lack of new discoveries isn’t the only supply concern that can push prices higher. Labor disputes, political instability, natural disasters and major accidents can all wreak havoc on near-term supply issues.
The Escondida mine in Chile is the world’s largest copper mine. It is responsible for 8.5% of global mine output – according to data from Chile and BHP Billiton (the mine’s owner). Global stockpiles depend on it.
For the last five days, production at Escondida has been slashed by 60%. 2,000 unhappy miners are on strike – seeking higher wages and a larger bonus. According to Bloomberg, “The union is seeking a wage increase of 13 percentage points above the inflation rate, which was 3.8 percent in July, and a bonus of 16 million pesos ($29,400) to reflect the surge in copper prices…The company last week offered a wage increase of 3 points above inflation and a bonus of 8.5 million pesos.”
Because there is no cushion in the copper stockpiles any disruption in the supply chain will cause prices to rise. According to the BBC, “There is not a lot of supply coming on stream generally this year and therefore a prolonged strike would have the potential for a significant impact on prices.”
As I type, Chilean miners are blocking access roads, picketing and insisting on much higher wages. Meanwhile, BHP has already said, it will not budge further. Its last offer is its final.
Given the circumstances, it doesn’t look like this strike will end any time soon. I expect copper prices to make an all-time high in the next week. If that happens, you can bet there will be talks about potential alternatives to copper – like aluminum.
Will Aluminum Replace Copper as Prices Continue to Rise? No.
It seems logical to assume that demand for copper could go way down in coming years. After all, conductors, power cables and other wires are being made with aluminum, which is also a very good conductor of electricity, and is lighter and much cheaper.
But how likely is it that everyone will all of a sudden stop using copper in lieu of aluminum?
The bears argue that copper is far heavier and more expensive than aluminum. True. But I would contend that that has always been the case. And in recent years, you can bet than anywhere it was feasible to replace copper with aluminum it was done. That’s evident by the rise in aluminum prices.
There is no doubt whatsoever that aluminum has replaced copper in wires, conductors and various electrical parts – especially as copper prices have more than tripled recently. But I would remind you that the increase in aluminum has not had any major effect on the demand for copper. In fact, demand for both metals has soared in tandem. One has not risen at the other’s expense. And anyone who would have you believe that you could one day stop using copper altogether in lieu of aluminum should consider this one fact: If you took all the aluminum stockpiles in the world, it would only be enough for nine days of global consumption.
In other words, even if aluminum could be used to replace copper in every function under the sun (which it could not), you would only have enough to last nine days.
I don’t think copper is in danger of being totally replaced just yet. The developing world needs both metals – not just one.
He writes that ethanol is not only a waste of money, if taken up widely, it would actually mean starvation for many of the world’s poor people.
“The grain required to fill a 25-gallon tank (with ethanol) would feed one person for a year,” he writes.
Once again, the cure is worse than the disease. If only the meddlers would take note.
The problem with the American way of life, adds our friend Byron King, is that few people can afford it, not even most Americans. It requires a lot of energy. Now, you can get energy from grain by converting the energy of the sun – which makes plants grow – into liquid fuel and thence into energy to power a car or heat a house. But since the sun only has so much energy in it, you would have to use a lot of grain, and a lot of space to grow it, to produce the kind of energy that the average American consumes.
Of course, the American lifestyle was not built on energy from grain at all, but rather on energy from the Earth. Oil, according to most geologists, represents the condensed energy of many, many years’ worth of sunshine…raising up many, many thousands of acres of grains and leaves, which were subsequently packed down into the ground and stored for millions more years. But in the space of only a couple of lifetimes, Americans have used up these millions of years worth of natural inventory of saved-up solar energy. What’s left is getting more and more expensive, because there are more and more people who want it…with more and more money to buy it.
The new buyers are mostly not American. So, while an American once grew up expecting to live with cheap energy his entire life, he now finds that he must compete with an Indian or Indonesian for it. Where he had gotten used to thinking about gasoline as a kind of public utility, like electricity or postal service, now, with the price rising, he sees his way of life threatened.
The poor guy is doomed…in a way. He will never be able to afford as much energy in the future as he is accustomed to using. And that will certainly mean a fall in his standard of living, but what he does not get is that it might not necessarily mean a fall in his quality of living. Europeans, for example, live on far less energy than Americans – and do so quite nicely. But the typical American has no eyes for that; for now, he only sees the price of fuel rising and demands that his elected officials “do something about it.” Thus, the humbug of ethanol.
But it is the lesser humbug.
The greater humbug is the currency in which the price of gasoline and ethanol is quoted. But, it is one that you, dear reader, are probably sick of hearing about, so we will pass on it today and go directly to our latest bubble news:
“House Sales Decline in 28 States,” was the big story on Tuesday. Yesterday brought two follow-up reports from CNN Money. “Builders hit brakes…” and “Home prices in the deep freeze.”
Here, we pause. And broaden our inquiry. We search for the roots of humbuggery and we have found one: loose, sloppy, metaphors.
Builders do not hit brakes; they hit nails. Truckers hit brakes. A better headline would have been “builders stop hitting nails on the head.” Or, “builders hang up their tool belts.”
As for putting home prices in the deep freeze, we find the idea absurd and unimaginable. The meatpacking industry might go into the deep freeze. Or, maybe the ice-cream makers. But not home prices. Home prices might go “down stairs,” “into the basement,” or, “down hill.” Perhaps, “Winter Chill Comes Early…Home prices find they are not properly insulated” might be a better way to put it. But prices “going into the freezer” merely sounds ridiculous.
In the same vein, the metaphors used for describing the working of the economy are tendentious: “Economic growth speeds up,” “Fed opens the throttle,” “Industry powers up,” “manufacturing picks up steam.” How about “Interest rate cuts needed to fuel growth.” Or, “Fed puts on the brakes.” There are those brakes again!
The images reveal a monumental illusion: people think the economy is some vast machine that you can control as if it were a freight train. You want to go faster? Just open up the throttle! You want to slow down? Put on the brakes! It’s so simple.
Once the metaphor takes hold of the popular mind, it leads to natural extensions and unnatural conclusions. After all, if the economy were a machine, it could be easily controlled. Just pull the right levers and turn the right knobs. And if that were so, then if the economy slows down, it must be the fault of the man at the controls. Got a problem with the way your business is doing? It’s the fault of the government. Losing your job? Inflation bother you? Well, talk to Ben Bernanke; he’s the chief engineer on this track. That’s why his photo is on the cover of magazines and newspapers. He’s the guy who’s supposed to be running this train.
Of course, it is all humbug; the economy is no more a machine that your editor is a hamster. Ben Bernanke does not control it as an engineer would control a train. Instead, like all world improvers, he clumsily meddles with it. He botches and bungles an organic, infinitely complex system…only improving things when he is undoing the damage left behind by previous meddlers.
“Dr. Richebächer sees it the other way around. He believes the United States is acting more like Nazi Germany than any other society since. He likened the alliance between the U.S. and Israel to that of Germany and Italy.”
Addison Wiggin, reporting again from the good doctor’s stronghold on the Cote d’Azur:
*** Dr. Richebächer has a curious relationship with his “femme de ménage,” the finely accoutered woman who takes care of him and his house. While she strove to serve us a fresh poulet roti she’d only just finished making, for example, she dropped a delicate sliver on the table.
“Hey!” the good doctor grunted at her.
“S’il vous plait, Kurt!” she shot back, without a pause.
Later she accused him of always giving the minimum she needs to buy things like butter and toothpaste. All the while, cruise ships, sailboats and the scantily clad played in the surf and sun across La Croisette, five stories below. Such is lunch at Le Miramar, where Dr. Richebächer lives.
Suddenly, Kurt checks his watch. “Ja, the CPI numbers are coming out!” He grabs his cane and moves from the table to a comfy chair nearby and clicks on a widescreen TV. Bloomberg. In German. The numbers have been published: 2.7% core…4.1% overall. Traders love the report; the futures market has already begun to rally. Kurt, on the other hand, is flabbergasted. He starts talking to me and to the television in German.
The market reaction is a symptom of what he calls: Late Degenerate Capitalism, (he later explained in English). That’s when a capitalist economy is taken over by the financial markets. Economists no longer regard economic data as a measure of the health and wealth of the nation, but for what impact they might have on the markets.
In this case, CPI (consumer price index) was higher than expected, meaning the Fed would have more leeway to pause in rate hikes and further ease “restrictions” on lending. That’s good for “the markets,” so they rally.
But let’s have a little fun with the numbers Richebächer-style:
The Federal Reserve “target” for acceptable inflation is 2%. So, even the “core” CPI number – after you disregard the things people actually buy like food and energy – is high.
If you compare that core number to personal incomes you end up with almost no possible genesis for growth in the U.S. economy. Or worse. According to the latest numbers available form the Bureau of Economic Analysis, personal income grew 0.4% in June…0.0% in May…0.1% in April…0.0% in March…and 0.1% for February. As for January, a negative 0.3%.
In aggregate through the first half of 2006 there was only two-tenths of a percent increase in personal incomes. With core CPI at 2.7%, consumers are already vastly under water because of inflation alone.
Now, just for fun, let’s add in their spending. For the first six months of 2006, “personal consumption expenditures” rose…0.3% in January…0.4% in February…0.1% in March…0.2% in April…0.2% again in May…and once again in June…for an aggregate total of a 1.4% increase in consumer spending.