October 14, 2018
The investment thesis for base metals appears to be getting stronger, with many analysts calling for increased prices in the not too distant future. This post is designed as a place holder for some basic analysis of that market and collection of various data from first hand research as well as collected data and wisdom from other sources. Over time details may be provided to offer evidence and/or context to some of the assumptions and assertions surrounding the market.
This post represents a simple outline, and while it may be sparse or poorly referenced, an attempt to fill in details over time will be made.
Investing in commodities is at the very core of civilization. The use of basic resources drives the economy and copper was one of the first resources (after food) to be harnessed for the advancement, perhaps even betterment, of society.
There are two basic activities involved in every commodity. The first is the production and the second is the consumption. Making an investment is made easier using intermediaries, and in the case of metals such as copper, the easiest intermediary is copper miners. Investing in copper requires some faith that the consumption of copper will outpace the production, and historically, over the long term, this has been true. If that happens, owning miners is an advantageous way to take advantage of those price increases.
There is evidence that, over the long term, supply will continue to lag demand, if not immediately, then within a few years. If this thesis holds true, making long term investments in copper today may prove enriching. Of course if the opposite is true, then the current investments made in copper may take many years to pay off.
Big Picture Items
Looking at the market from the bottom up, the consumption of copper has been growing slowly, but steadily over many years. In the early part of the new century China began buying copper aggressively to supply their growth in power, communication and housing infrastructure. This demand required massive investment in copper production and raised prices for a while.
The demand growth has now slowed down to a trickle, but is not reversing, leading to that slow and steady growth in demand.
Some key issues related to the demand side include the potential for slowdowns in major economies such as China, the US and emerging economies like India and Africa. As well, electrical transmission (power grids) is one of the largest consumers of copper wire, and there have been attempts to substitute aluminum for copper historically. On the other hand, so many things are being electrified, that demand for wiring in electronics and automobiles is increasing rapidly. The move to electric cars which is in very early stages could quadruple the amount of copper in cars. This is a trend which has just begun and may last for decades.
The demand will be examined a bit further along.
World Refined Copper Production 2017 - 23,497 metric tonnes World Refined Copper Usage 2017 - 23,759 metric tonnes Balance -259 metric tonnes Source: ICSG Copper Market Forecast, Sept 21, 2018
Given that steady, growing demand, the supply side has responded admirably. The supply of copper is not an easy task and yet for the past decade, the supply has increased almost in lockstep to the demand. This is unusual, and is based on a couple of key factors, the most prominent of which is low interest rates. Low interest rates allow investors to make an investment decision with less risk, and building a copper mine is a very expensive task that involves a lot of risk. A typical copper mine can cost $1-3 billion to develop. Similarly it often takes 5-7 years to bring a copper mine into production.
Some key issues related to the supply side include a lack of new, economically viable mining projects. Even the projects which are in place or newly begun, there is a decline in yields (amount of copper in a given amount of rock) that has been getting worse for years. Outside of just the mining, other issues are important, such as water usage. With much of the extraction happening at high altitudes and arid areas, the availability and use of water has become an issue. Electricity also may become a factor if energy prices rise substantially. Finally, there are labor and environmental issues along with issues regarding deposits being far away from transportation hubs.
A bit later, the supply side will be examined in more detail.
None of these items are news on their own and most are reviewed by most mining companies in their investor reports. This review may not add much to the discussion, rather it may help investors consider their investment choices in a different light. Namely that a multitude of these factors may impact the market simultaneously and cause shocks.
Broadly, there are two potential outcomes. The first is that demand slows, and there is a surplus of copper being mined and sent to market. This is possibility, and after 10 years of economic growth based on easy credit and government intervention, it is possible that this outcome may precede any shortages in metal availability. Keep in mind that the deficit in production is just 1% of supply, so even a small slowdown in demand could cause a significant demand shock. The supply side can respond relatively quickly to a drop in demand.
The second outcome is that demand will overwhelm supply. This possibility will be much harder to accommodate as the supply side is widely believed to be unable to respond to a rapid rise in demand. That supply deficit of 1% can be magnified by multiple factors, including labor issues, operational difficulties and regulatory problems. All of these have made significant appearances in the past two years.
Given what is known today, it is expected that somewhere around 2020 the supply of copper will lag demand in a significant way, and without substantial new investment, by 2030, the problem will be massive. That new investment is only reasonable if copper prices are much higher leading to better profits and lower risk for producers/investors.
What Should You Do
This information is not intended as investment advice, however the information should help to inform the reader about factors that may affect the timing of investment decisions. There is currently ample evidence that demand for base metals is exceeding supply. This information is tempered by evidence that the current economic expansions is, after 10 years, starting to moderate or perhaps slow and may lead to a drop in demand. The chart below shows the copper in LME storage over the past five years, and suggests that the current supply/demand is very nearly balanced.