Sprott's Thoughts

Copper - It's Been a Bad Few Years

It’s been a bad few years for copper.

Prices have been falling for five years. By last year the situation had deteriorated enough to prompt a slew mine cutbacks, totaling several hundred thousand tonnes.

For several years now copper miners have been doing their all to make money despite the weak copper price. It’s a process that starts with efficiency, with high-grading, with all the ways mines can be tweaked to lower costs. Now, five years into the slump, efforts are finally turning to actual production cuts.

Chile, the world’s number one copper producer, announced January production numbers showing a 14% decrease year-over-year. January’s 453,638 tonnes of Chilean copper also represented the lowest monthly output in months.

Between cuts in Chile and elsewhere, the market is now expected to fall into deficit in this year.

Don’t get too excited about a deficit. Copper is ever a tight market, an 18-million-tonne giant that always seems to finish the year with only a few hundred thousand tonnes of surplus or deficit.

The shortfall in 2016 is expected despite an expected 4% increase in output (yes – production is increasing despite the cutbacks). And that right there is the foundation of the copper optimist case: despite global economic struggles, including slowing in copper-hungry China, demand is still rising faster than supply.

Now, supply could increase – but only to a point. Supply increases this year will come primarily from expansions at existing operations and ramp-ups at mines that came on stream recently. There are also a few new projects this year, led by the massive Las Bambas mine in Peru that just shipped its first copper, but looking ahead new production dwindles.

Prices have simply been too low for too long to incentivize anything other than very low cost mines with access to financing, and that’s a short list.

The copper price chart of late, however, looks a bit better.

I don’t know that January 15 was the bottom for the red metal and that it’s onwards and upwards from here, but sustained positive price movement is notable. This might be part of the reason.

London Metal Exchange copper stocks have fallen by more than a third in the last six months. Levels are still reasonable, but they are not massive.

Who’s buying? China, for one. Chinese copper imports hit their second highest monthly level ever in December. Volumes declined in January but still represented a 16% increase compared to the year prior. January’s 315,000 tonnes of imports also dwarf January import numbers from 2009, 2010, and 2011 (which averaged 239,000 tonnes), when China was building as fast as the government could spend as it worked to offset the impact of the financial crisis.

If China is stockpiling, that means downside ahead when users turn to their stocks rather than buying. But it also means that they think we’re about at bottom.

And there is direct evidence that China is stockpiling. Copper inventories registered with the Shanghai Futures Exchange just hit an historic high of 276,900 tonnes, after increasing by almost 100,000 tonnes in the last two months.

The absolute numbers don’t mean a lot, as there is far more copper in unofficial stockpiles in China than in official counts. What are significant are the rates of increase and the levels relative to historic norms – the Chinese are piling copper up faster and higher than almost ever before.

The world’s biggest copper consumer sees this as the bottom.

So we have a global market where supply and demand are always pretty close, where official stockpiles are down in London but ramping up in bottom-fishing China, where demand continues to rise regardless of global economic slowdowns, and where prices are at their lowest in a decade (excluding a short-lived downspike in 2009). Producers are curtailing and very few new mines are being built. Most production is still profitable based on cash costs, but lots of output is treading water or costing money on an all-in basis.

To me, it all points to a market that will continue sideways for the year IF everything goes as planned. But that is a big ‘if’.

Here’s one example of why: Codelco, which regularly trades places with Freeport McMoRan Copper & Gold as the world’s number one copper producer, is spending $25 billion over the next few years…just to keep output steady. Another example: the giant Escondida complex in Chile, a joint venture between BHP Billiton and Rio Tinto, just saw a $4.2-billion expansion and is still enjoying another $3.4-billion investment to upgrade water facilities, yet output is falling because ore grades are declining.

Those examples point to a market requiring serious investment and focus to keep supplies up. That means it would not take much of a disruption to tip the balance, which is looking at a gap in not that long anyway.

Source: Wood Mackenzie, Rio Tinto

Copper traders are well aware disruptions mean real risk. When deadly clashes at the then-under construction Las Bambas mine caused the Peruvian government to declare a state of emergency in the area in late September, copper prices jumped almost 7% in two weeks out of fear the mine’s 400,000 tonnes of annual output was threatened.

So what does it all mean for copper in 2016? Day to day, macroeconomics will continue to dominate the scene, such as happened in late February: copper futures jumped after China let the Yuan weaken and hinted at further monetary measures to boost its economy and the US released positive numbers on consumer spending and fourth quarter economic growth.

Since those macro machinations are impossible to predict, forecasting the copper price in detail is a bit of a fool’s game. Big picture projections, however, are possible. And as you might have gathered, I am gently optimistic on copper.

The overall scene to me had been showing over-done bearishness, seeing as demand continues to rise while supply is just sufficient and has required massive investments to keep pace. A small list of big projects – expansions and new mines – is keeping things on track, but disruptions are certainly possible. Water and labour issues in Chile, for example, are very real.

Recent price gains suggest copper players and speculators are starting to agree with this perspective. At the end of the day, demand for copper keeps rising because it is essential to development, not to mention integral to most efforts to increase energy efficiency. Inexorably rising demand against a historically low price and a dearth of new production is a recipe for price gains.

Gold moved up sharply to start 2016. Many speculators missed out: if you remain on the side until it is clear that a bear market has turned bull, you will miss a fantastic part of the ride.

Copper will rise. It may not happen tomorrow, but it will happen. And prices have fallen so far that little downside remains. Positioning in the best copper equities today will pay off down the road.