Copper: Supply Crunch in 2016 May Send Prices Soaring

• While Copper prices still trading around the lowest since 2009, evidence is mounting for a supply crunch in 2016.
• The supply imbalance may send copper prices soaring in 2016: Not a “dead cat bounce”, but the start of a new bull cycle.
• Traders and hedge funds are still ignoring the signs, it could be a good time to long copper miners.

Copper prices are trading around the lowest in six years (since 2009) on concern on China reduced growth prospects, and on oversupply in production.  The Chinese economy grew an annual 6.9% in the third quarter of 2015. It is the slowest growth since 2009, mainly due to a slowdown in industrial output, sluggish property investment and a contraction in exports. The metal shed around 25% of its value in 2015, and current price is around $2.11 per pound.

China consumes more than 40% of the world’s copper, but copper prices have been lately mainly driven by market sentiment surrounding China rather than supply and demand fundamentals.

Oversupply concerns

It all goes back to the high economic growth years in China peaking around 2011, after a slump in 2007-2008 related to the global financial crisis. The peak in China GDP around 2010-2011 coincided with the peak in copper prices in 2011. At the time, mining companies boosted production to peak levels hoping for a continued Chinese economic boom.

While Chinese demand has been the main driver of copper price, it is not the only major factor to consider in the outlook for copper. The world is also beginning to feel the impact of supply cuts as efforts to ease overproduction have been ongoing for the past few years, with some of the most aggressive taking place in 2015:

• Recent production cuts by Chinese copper producers. China’s copper cartel agreed just this month to make deeper production cuts in 2016 than the ones decided earlier.
• Supply-cut announcements by large mining companies, including Freeport-McMoRan Inc. and Glencore: In an effort  to cut cost, Glencore, the Anglo-Swiss giant, announced last September steep production cuts in Zambia and in Congo, effectively taking 400 000 tonnes out of the market.  With global refined copper production estimated around 20 million tonnes, this represents a huge cut from a single producer resulting in around 2% cut in global output.  Furthermore, Freeport-McMoRan’s latest production cut announcement in October will result in consolidated aggregate reduction of about 112,000 tones/year of copper for the producer in 2015.
• With many copper miners in deep trouble due to massive debt, their survival depends on shutting down mines and cutting back on marginal ones. Once mines are decommissioned, it is not evident that this process can be quickly reversed, due to the high cost involved and the lack of available financing.

Other challenges in the production cycle

• Discoveries of higher grade deposits are becoming less frequent, resulting in depletion rates much greater than the rate of discovery.
• Copper takes a very long time from discovery to production. A combination of geological, environmental, and political challenges result in an average lead time to around 20 years for a new mine to become productive.
• High country and business risk are faced by copper producers.
• The average grade quality of copper produced is degrading. The decline in grades is due to aggressive copper mining used by Companies to increase production to enable them to produce the same amount of copper they did in previous years. Lower quality from older existing mines which are the foundation of commodity oversupply, results higher production costs and declining production rate.

Demand side to keep significantly rising

The “Red Gold” commodity is among the most used metals in the world, and high quantities of the metal must be mined every year to meet global demand.  Demand for the commodity is expected to keep very strong:

• Copper is the best conductor of electricity after silver, and is consumed in approximately 75% of all wiring need, including power grid and motherboards.
• Copper is an essential part of the “Green Energy” effort being done worldwide to combat pollution and global warming. It is used extensively in electric and hybrid cars, in “wind power” and other power storage techniques.  President Obama announced in August 2015 new actions to bring renewable energy and energy efficiency to households across the country.
• Last October, China made its sixth interest-rate cut since November of 2014. Easier monetary policy in China should boost the Chinese economy and increase demand for base metals. Furthermore, China has been easing its housing investment rules to increase demand for housing and construction which will help prices in the medium and long term.

Several Warnings: Copper surplus to end in 2015, largely ignored by traders

Many experts have recently issued warnings about the looming production shortage in the commodity:

• World Bureau of Metal Statistics data released in August 2015 a warning that copper record surplus  will end in 2015.
• International Copper Study Group (ICSG) revised down copper production forecasts in October 2015, and said that there will be 130,000 million tonnes deficit in 2016.
• “We expect the copper market will record a deficit before the end of 2016”, analyst at Intesa Sanpaolo, stated in October.
• According to a study done by Wood Mckenzie (December 2015) 2016 will be the year where production cuts will start be felt, while demand remains strong. In the longer term Wood Mackenzie predicts a 10 million tonnes deficit by 2028.
• “Copper price has likely undershot on bearish sentiment in the futures market” Julius Baer analyst Carsten Menke said.
• EIU (Economist Intelligence Unit) in its Economic and Commodity Forecast, July 2015, sees the price of copper in 2016 at around $3 per pound and steadily climbing thereafter.

As the markets generally prices commodities on the basis of future supply/demand balance, prices of Copper are likely to significantly increase in 2016. Overshooting to the upside will not be surprising, as speculators and institutions heavily shorting the commodity will run for cover. It will not be just a “dead cat bounce”, but the start of a new bull cycle.

Conclusion:

The arguments are strong that we are heading to a supply crunch in copper, and that its impact will be felt sometime in 2016. While this article is meant to be a general opinion about the commodity, it should be taken as a warning for those shorting the commodity, and for trader and long-term investors who might want to go long copper producers such as: Freeport-McMoRan FCX, Glencore GLNCY, Southern Copper SSCO, Rio Tinto RIO, and BHP Billiton BHP.