It's time to sell copper miners
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Associate Editor
David Stevenson Sep 10, 2009
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Copper is sometimes known as Dr Copper – the metal with a PhD in economics. That's because the copper price has traditionally been a leading indicator of what's in store for the world economy.
And like most other assets, copper prices have enjoyed a seriously good 2009 to date. What's more, as the FTSE 100 index yesterday rattled through the 5,000 barrier for the first time since last October, shares in copper producers were right at the front of the surge.
But one key indicator suggests that Dr Copper may well be wrong this time. The economy is nowhere near as healthy as he's suggesting...
Copper is usually a good barometer of economic activity
Copper and copper alloys are among the most important materials in our everyday lives. Most electrical equipment is full of copper wiring and circuits, and the metal is widely used in electricity generation and transmission. In addition, copper is an essential base metal in the construction industry, particularly in areas such as plumbing and roofing.
So if the economy is growing, demand for copper rises. That in turn, makes the copper price a good barometer of economic activity. If the price rises sharply, you might expect the global economy to get a lot better.
And that's just what it's been doing. The copper price has risen steadily over the first eight months of 2009, more than doubling since the start of the year. Further, shares in copper producers have been among the stock market's prime movers. Since 9th March, when markets bottomed out, Xstrata (LSE: XTA) has almost doubled, while Kazakhmys (LSE: KAZ) has more than trebled, compared with a 'mere' 40% rise in the FTSE 100 index.
And there has indeed been a slight upturn in industrial production around the world recently, helped by schemes such as the US government's 'cash for clunkers' programme, where owners of old bangers have been bribed to trade them in for new models. UK car sales have had a boost from a copycat programme.
Why Dr Copper is wrong this time
But Dr Copper could be giving the wrong signal this time. Because apart from the artificial pick-up in car production, there doesn't seem to be much improvement in other key copper-consuming industries.
For example, in the US, the world's second biggest copper user, a recovery in new housebuilding - which would require lots more of the metal - just isn't happening. What's more, despite politicians' attempts to 'talk up' economic recovery, American shoppers aren't buying into it. In fact, they are now paying back debt, rather than taking out more. US consumer credit has just fallen for the sixth month in a row - the longest decline since 1991 - by a record $21.6bn. That's five times the drop expected by economists, says Bloomberg.
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In other words, it's not US consumer demand for copper that's driving up the price. In fact, without governments globally spending bucket loads of money they don't actually have – and which will have to be found via extra taxes, more borrowing or indeed the printing press – there wouldn't be much economic activity at all right now.
"We did some digging and found that all the world's economic rebound in 2009 – that is, 100% and then some – is being accounted for by fiscal stimulus", says David Rosenberg of Glusken Sheff. And not only is there no sign of organic private sector activity this year, "for 2010 we calculate that 80% of the growth that the consensus is penning in is derived from the public sector".
The reason for the copper price take-off
So why has the copper price taken off if overall demand is so unhealthy? It's all down to China. The Chinese have been stockpiling the metal after prices plunged by two-thirds from their mid-2008 levels. This has been partly funded by China's own $586bn government stimulus package, as well as some pretty racy levels of bank borrowing.
It's been nice for copper and copper producers while it lasted - but that could be about to change. "China's purchases were pretty much inventory adjustments and the restocking has ended", says Robin Bhar of Credit Agricole's Calyon unit. "We're not seeing a pick up in real economic demand or real activities".
In other words, the Chinese haven't been using the copper they've been buying – they've just been sticking it in storage. And once the stores are full again, they'll stop buying.
Where's the evidence for this? The Baltic Dry index, a measure of the cost of hiring ships, has plummeted by 42% from its June peak, while rental rates for Capesize bulk carriers, specifically used to ferry commodities around, have tumbled by as much as 50%. In other words, there's a lot less need for transport ships because the Chinese have stopped stockpiling. And that trend is set to continue, says Eugen Weinberg at Commerzbank, pointing to a downturn in metals prices.
Take a look at the Bloomberg chart below. This compares copper prices – the copper-coloured line – with the Baltic Dry index in blue….
…while the lower section shows that after a big fall in 2009's first half, stockpiles of copper at London Metal Exchange warehouses have now climbed to their highest levels since May. More potential supply on the market is bad news for the copper price.
It's time to sell copper miners
Now in the long run, copper prices will surely climb much higher than today, because one day the world's supply of copper will run out. This is rather like the Peak Oil theory, on which we've written many times (Are we about to hit Peak Oil?), which says that the amount of crude that can be realistically extracted from the earth must eventually top out.
"A big problem is that the world's 14 largest copper mines, accounting for 40% of global output, are ageing, and at the present pace the largest will be exhausted by 2030", says James Regan of Reuters. "There's mounting evidence to suggest copper may be at greater risk than oil – unless prices extend their rally to record highs and beyond".
So there's every reason to think that copper, and copper producers, are still a good long-run investment. And if you still hold shares in those copper stocks that have soared so much, well done. But shorter term, the prices of these shares look ripe for a setback.
Now looks a sensible time to take your profits.
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