Lately, prices of Copper have fallen below 50% of their peak price of 2011. Reasons are different, we will try to analyze the price-equilibrium motivations and then, look into some correlations of the red metal.
As always, the variation in price is primarily driven by the relationship between supply and demand. It is paramount to look at imports/exports of countries globally to understand the drivers of price.
Firstly, we will analyze the supply side and then, after having grasped the offer, we will move to the demand side of the main industrial metal: Copper.
Geographically, the biggest mines are almost all found in the country of Chile. In fact, 8 of the top 20 largest mines in the world are all within the country’s borders.
Chart 1. Chile’s production dominates the market.
However, this information might be misleading: large mines discoveries do not necessarily imply higher supply. The reason is that companies might decide not to start/continue with the extraction of the resources simply because the related cost of production may be higher than the actual selling price. At the same time, in terms of management, they might be concerned about the subsequent spike in supply that endangers price equilibrium. Note that this is the case for the Oil industry; for instance, Saudi Arabia has changed strategy several times by focusing first almost solely on price until November 2014, then on market share, and now on prices again.
Regarding the Copper industry, as we will see later, demand for the red metal was immense during the Chinese boom: it drove prices up fourfold in the first decade of the millennium. Due to a never-ending demand, companies were concerned only about maximising production quantity without focusing specifically on innovations to decrease average cost of production. This explains the later supply-glut that started in 2012: Chinese investment declined and companies were left with huge mines and inventories.
It is interesting to look deeper into the profitability that Copper entails. By taking Chile as a proxy for the global Copper production costs, it is seen that companies renounced to low average cost of production to exploit high selling volume: strategy that was profitable only before the fall in prices has started.
Chart 2. In the last decade, Copper profitability has been massive. Now, not anymore.
We assume that, given low current demand, companies will focus on reducing cost of production since they do not have to cover rising demand anymore and in the medium-long term, the lower costs will allow them to remain profitable even with low prices. Thus, from the supply-side we do not expect a rise in Copper prices.
Given the characteristics of Copper (malleable, ductile, and an excellent conductor of heat and electricity), the red metal is mainly used for electrical equipment and building construction.
Generally speaking, any country has a need for Copper. In reality though, one country specifically is the main driver of the global demand: China. In fact, it has been growing at an average rate of almost 10% during the last 30 years after having embraced free-market principles. By noticing that the Chinese economy has been relying mainly on investment and exports, it is clearly seen why it highly needs Copper: construction activities (31% of global demand for Copper). In addition, a mixture of low labour cost and technological innovation resulted in a high use of the metal for electrical products (39% of global demand for Copper). Note that by summing up the Copper production of China, second largest producer in the world, and the imports of Copper, 45% of global Copper transits through China. By looking at this data, it is clear why prices fell in 2012 when a milder Chinese growth started to occur. The reason is mainly that the government decided to move from an investment-led economy to a consumption-led one.
In conclusion, from a demand-side perspective, the outlook for Copper does not look great because China is probably not going to enjoy another boost in construction investment while other countries had not impacted the Copper prices much in any way.
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