Oil and Copper Trends Part 3: Copper Outlook

This article originally published in October 2021.

 

Copper prices have seen tremendous upside over the past year. While the average price of copper was about $6,500 per metric ton over the previous four years, it suddenly increased to above $10,000 per metric ton in the past year, with the average price closer to $8,000 per metric ton.

 

Looking ahead, the outlook for copper is increasingly predicated on our (and the investor community’s) view on China growth and global electric vehicle demand given the use of copper in electric vehicles themselves, their charging stations and transmission lines.

 

Copper prices reached a multi-year high of more than $10,000 per metric ton in May 2021. Since then, it’s dropped to about $9,200 per metric ton.

 

The first question to ask is, “Have copper prices gotten ahead of themselves?” The answer is somewhat, but not entirely. After all, copper has been in this territory before as copper prices reached $10,000 per metric ton in February 2011. And copper is up around 125% from the lows of last year. It seems like a lot, except when we consider that oil is up over 90%.

 

In addition, we know China’s copper demand tangibly surged mid-2020, with the data from China’s Custom General Administration reporting 762,000 tons of unwrought copper that was imported in July 2020, compared with around 400,000 just a few months prior. In fact, the July 2020 reading was the highest on record. Even when copper hit $10,000 a metric ton in 2011, China’s import demand was much lower at 300,000 tons. And in 2011, the world was not buying Teslas at the scale it is today. So, there are factors at play that support the current level of copper prices.

 

There are two interesting takeaways here. First, the rise in copper prices trailed when China started ramping up its imports. This implies that the spike is driven by speculators and not just because of wholesale purchases. Granted, open interest for futures has not risen significantly on the LME. So, it’s less about new entrants coming in and betting on copper prices rather than the entire investor community simply believing that copper is and will remain an asset.

 

Second, why was China ramping up its copper imports in mid-2020 when demand for most commodities was falling? There are two potential answers and takeaways for this.

 

In an attempt to stop COVID-19-related headwinds, China used its fiscal levers to kick start an infrastructure development plan. In contrast with other countries, China’s infrastructure projects were ready to go on Day 1 and these developments required copper. And it’s because of these investments and capital expenditures that China managed to generate positive growth in 2020, whereas no other major economy did.

 

China also was stockpiling copper and other base metals in 2020 and storing them as inventory. As U.S.-China ties deteriorated following the election of President Donald Trump, China likely started to procure various commodities as a hedge and to support its economic needs. Now, it’s not as if worsening ties with the U.S. would imperil China’s access to copper since most copper comes out of Chile, Peru and the Copperbelt.

 

It’s likely China saw copper and other base metals as a way of keeping its economic engine humming – giving it the edge it would need should worsening ties with the U.S. create economic headwinds.

 

In fact, China announced plans to sell some of its copper held in official reserves. Although geopolitical tensions with the U.S. remain high, the approach in Washington, D.C. is markedly different than the previous administration. This allows for an easing in commodity purchases for inventory purposes.

 

Beyond the demand, supply side considerations likely also helped fuel the surge in prices. Copper production isn’t decided by a cartel, like oil, but instead a free-floating product based on availability.

 

Chile provides 25% of the world’s copper, with one mine alone in Escondida responsible for 10% of the world’s supply. Copper makes up 50% of the nation’s export basket. So, any hurdles in Chile can have dramatic effects on the global copper supply.

 

In 2020, some of Chile’s mines were operating at lower capacity due to labor shortages as COVID-19 provisions went into place. Total copper production dipped by just under 1% from 5.79 million tons to 5.7 million tons. This alone isn’t a massive decline until we consider that Peru’s production fell from 2.5 million tons to 2.15 million tons. And when we layer on the market perception of copper shortages, coupled with China’s actual increase in purchases, we can see why copper prices at $10,000 a metric ton makes a lot of sense.

 

Chile and Peru are forecasting that 2021 output will be similar to 2019, which would be a return to normalcy. Beyond 2022, Chile’s production will likely start to increase and slowly approach 6 million tons. Peru’s figures may remain flat and even slightly decline.

 

We also anticipate China’s purchases to slow down. But the electric vehicle component will remain a dominant theme as purchases of electric vehicles grow, and new entrants come into the market.

 

In fact, more car companies are pledging to go electric or at least have electric vehicles as a key product in their lineup. Also, markets like the European Union are increasingly requiring electric vehicle adoption. So, the global electric vehicle market outlook and demand will no longer be dependent on the availability and ability of consumers to buy Teslas since numerous car companies are starting to offer electric vehicles at various price points.

 

As one investment bank recently noted, copper inventory in the value chain of various products is falling. The floods in China also likely affected the domestic copper output in the region. Based upon supply increasing just marginally, while demand is also expected to grow, we expect copper prices to remain supported.

 

One investment bank is forecasting copper to rise to $11,500 per metric ton in the near term. We’re not trying to forecast prices, but we agree that the current range is not excessive and likely where the natural clearing price for copper could be in the near term.

 

In the medium- to longer-term, as supply starts to increase out of Chile and Peru and the effects of the floods in China subsides, we could see some softening of prices. But that could be a long way out. Until then, prices will likely find support and the current level of copper isn’t excessive.

 

For Chile, this is positive as it implies that the already high dollar inflows the nation is receiving may continue. For Peru, the outlook is slightly more mixed due to the lack of policy clarity.

 

President Pedro Castillo is the nation’s new president and has a history of making provocative statements regarding the nation’s mining sector, namely a desire to nationalize the industry and raise taxes.

 

He’s walked back these statements and his party doesn’t have a majority in congress. So, it’s not evident he could even carry through on nationalization even if he tried to.

 

But uncertainty could result in higher copper prices if markets begin to worry about supply constraints and/or additive taxes.

 

Although Castillo’s policies would be net negative for the sector, for the actual commodity, they could provide an additional floor. At the moment, it’s not evident that his commentary is filtering through into copper prices themselves, whereas they have caused some consternation among companies operating mines in the nation.

 

As a final takeaway, over the longer term, oil and copper could be inversely related products and move in separate ways. Granted, oil is used in multiple products. But if electric vehicles truly take off, then theoretically, the demand for oil could dip while the demand for copper could increase.

 

This inverse relationship, should it materialize, could be interesting from a hedging perspective. But until then, as we watch oil, we don’t expect demand to spike just yet. So, supply-side factors will be key to monitor.

 

For copper, it will truly be a demand-led story given that supply decisions are not done via a consortium, but rather each country in the copper space simply maximizing its potential production.

 

We’re less concerned about the day-to-day and week-to-week move in asset prices, but care more about the structural trends underpinning their movement because for us, those factors could affect the macroeconomic landscape and thereby out assessment of our: