- Everyone was negative on copper just a year ago. Today, most are positive.
- There are two factors that help determine whether there will be a future turnaround or not for a commodity.
- The nice thing is that all the data is easily accessible with a bit of research and a long term view.
I’ve been writing about the imminent supply gap in copper for about a year and a half now. However, when I first came out with this thesis, the copper environment was extremely negative.
The following headlines are an example of just some of the negativity surrounding copper in the last three years.
Figure 1: Goldman and Credit Suisse headlines on copper in 2015 and 2016.
This negativity was due to low copper prices, apparent oversupply, and fears about Chinese and global economic growth. Nevertheless, copper continued to climb on positive economic developments, improved Chinese economics, and larger than expected emerging market demand.
Looking back, the slump in copper prices lasted for approximately a year, from November 2015 to November 2016. Since then, copper prices are up a respectable 50%.
Figure 2: Copper price movement in the last 3 years. Source: Nasdaq.
Unsurprisingly, the news about copper is now very positive.
Figure 3: Recent headlines on copper.
With a bit of common sense and a fundamental, long term approach, it’s possible to take advantage of the natural cyclicality in commodities.
Things To Learn From Such An Environment
In investing, nothing is permanent.
We as humans love linearity and stability. It’s something primordially wired in us that has allowed us to survive in nature. But the investing environment is completely different and one where you have to accept volatility, and it’s even better if you can take advantage of it.
Going back to copper, when I look at mining costs and potential supply and demand, I find the long term price balance is around $3 to $3.5 per pound. This doesn’t mean it will remain stable at those levels. In times of euphoria, it could easily go above $4 while a bit of negative news coming from China or any developed world country entering a recession could soon send copper prices back to $2. This is something completely normal and has to be taken into consideration when investing.
As is the case for copper, so it is for other commodities. Nevertheless, there is a way to determine the downside and upside risks for a commodity.
It’s possible to determine the upside and downside risks for a commodity.
The case with copper shows how investors could have been pretty confident about investing in the metal when the price was around $2 because the downside was limited and higher prices were a highly likely situation. Two factors have to be watched when analyzing the environment for a commodity, mining costs and the long term trend in demand.
With a bit of research, you can find the cost curve for a certain commodity. In the case of copper, you can see how the bulk of global production has cash costs between $0.8 and $1.5 per pound.
Figure 4: Copper cash costs. Source: Hudbay Minerals.
These costs don’t include administrative costs, profit taxes, financing, exploration, or other costs. By adding those costs, you can easily increase the mining costs by 50% or even 100%. This simply means that at copper prices around $2 per pound, it isn’t profitable to operate for many global producers. They are therefore not incentivized to increase production, explore, or grow. This is unsustainable and a shift is inevitable where supply becomes tight and prices surge.
Long Term Demand Trends
Determining long term trends for a commodity also isn’t that difficult. In the case of copper, which is usually the leading indicator for economic activity, all you have to look at is economic activity.
Higher economic activity leads to more demand for copper. The fact is that global economic growth is stable and positive. The current level is around 3.5%.
Figure 5: Global economic growth is pretty stable and forecastable. Source: OECD.
Now, as soon as there is a slowdown in economic growth, many panic in a commodity market. However, we must not forget that global economic growth of 3%, like was the case in 2015 and 2016, is still growth and it increases demand for base metals.
I can confidently say that the world will continue to develop and grow economically, and consequently, demand for copper will grow as well. Therefore, global demand for copper will definitely be 20% to 30% higher in the next decade, making it a very attractive investment.
However, I must say I preferred the risk reward outlook when copper prices were around $2 to the $3 they are at now. Even with a positive copper outlook, I still think we will see prices below $2 and above $4 in the next decade. Therefore, one must be very careful when investing in commodity related plays and never forget that they are cyclicals.
If you followed our call on copper and zinc from the last year, now is the time to start thinking about rebalancing. Not because copper prices will decline, but rather just as a risk reward portfolio adjustment.
Keep reading Investiv Daily as we will continue to discuss low risk, high reward investment opportunities based on a fundamental, long term analysis. Just like we did for copper and zinc.