While the world has been focused on the bitcoin price explosion, copper and other commodity prices have been climbing to all time highs. Most recently, mainstream headlines and investors are starting to turn their attention to some industrial metals and their relevance in the new green agenda.
Due to its pivotal role in the clean energy revolution, based on electricity and decarbonization, copper prices will probably far exceed the all time highs of the 2000-2011 commodity supercycle.
On this post I analyze the medium-term outlook for copper prices from three different angles:
Supply and demand of copper metal
As vaccination roll-out programs progress and market participants anticipate a strong bounce in global demand, a renewed wave of green policies is gaining ground among government policies.
Since copper is still the material of choice for electric power, these type of projects, based on electricity and decarbonization, will require increasing amounts of the reddish brown metal.
The substantial reduction of fossil-fuel energies will not happen without a surge in the use of copper. Being an excellent electricity conductor, copper plays a crucial role in the clean energy revolution.
Among the key drivers of medium term copper demand we can outline the following:
- Copper is used in almost everything around us, including water pipes, power lines, wiring cars, electric motors and appliances. It is also used to produce wind turbines and solar panels.
- Electric Vehicles (EVs) use three times more copper than internal combustion engine cars. A hybrid vehicle requires two times more copper than a conventional car. In addition, we will need an extensive network of EV chargers, which also use copper.
- The emergence Energy of Independent Vehicles (EIVs) can increase even more the need for copper because they use copper-powered solar photovoltaic panels to harness renewable energy.
Let's start by focusing on where the metal is produced. The production of copper is narrowly concentrated. Only five countries (Chile, Peru, US, China and Democratic Republic of the Congo) account for about 65% of the global production.
Regarding copper supply, the most significant factors are listed below:
- New greenfield projects. The price collapse in the mid-2010s deterred many companies from expanding existing projects or investing in new ones. On top of this, many plans were canceled or delayed due to the uncertainty created during the the pandemic. It is important to bear in mind that it takes between 4 to 12 years to open an ore deposit for production.
- Inventory.The expected surge in demand along with production constraints could cause a substantial depletion in inventory if copper prices don't go up substantially.
- The scrap market. The scrap market is another source of copper supply. How significant it this market segment? As an example, the European copper institute states that during the 2010s around 41% of the EU's copper use came from recycled sources. Furthermore, the response from the scrap market supply is more elastic, grows more rapidly in a high price environment.
- Is there a substitute for copper? The main competitor of copper is aluminum, which is a lighter material and can replace copper in some cases. Yet a number of technological challenges need to be overcome before becoming a broad-based substitute. Issues related to temperature tolerance of connectors and other technical problems raise some difficulties. Undoubtedly, higher copper prices would act as an incentive to overcome these issues. In the mean time and despite being expensive and heavy, copper is still the material of choice for electric power.
Technical Analysis of Copper
Commodity prices are generally determined by supply and demand but extreme short-term moves are typically driven by sentiment. Both aspects, though, are closely related. Commodities are more volatile because their supply is more price inelastic than other assets.
Historical Chart of Copper
Throughout history, copper prices have seen many sharp spikes followed by sudden crashes. The historical chart below shows how the first stages of most recessions tend to coincide with copper price collapses (recessions are shaded). At the end of those recessions, however, copper prices tend to snap back, bouncing back sharply, and in many cases initiating a meaningful uptrend. This was the case at the end of the 1970, 1973-74, 1981-82, 2000-01 and 2008-09 recessions.
Source: Macrotrends.net — Recessions are shaded.
Copper Prices since the Global Pandemic
The immediate reaction of copper prices after the global pandemic recession of 2020 was similar to the previous ones. After an initial decline, prices recovered rapidly and kept surging. About a year later, they hit an all-time high.
Source: Macrotrends.net — Recessions are shaded.
Inflation on the rise
On a recent post I discussed the forces behind the new inflationary regime and why these forces may be stickier than most people think. A broad range of signs are pointing in this direction, including fiscal stimulus packages, central banks willing to tolerate higher inflation, supply bottlenecks and growing wage pressures.
The most important question now is whether inflation is causing commodity prices to rise or rather the opposite, higher commodity prices are leading to inflation.
For the time being, commodity price increases are probably reflecting a decline on the value of the dollar against commodities and other hard assets, not necessarily in terms of exchange rate versus other currencies.
As Jeffrey Gundlach points out, the rising twin deficits and the value of the dollar are very correlated. As of today the US National debt, including debt held by the public as well as unfunded liabilities, is over $132 trillion. (Source: truthinaccounting.org)
The massive escalation in public debt is swelling in front of us, visible to the naked eye and probably impacting, via prices, the psychology of the real estate, commodity, and other hard asset markets.
The huge role of copper in clean and renewable energy may create serious supply-and-demand imbalances. The supply side of the equation can only be revitalized via new projects or by stimulating the scrap market. In either case, substantial price increases will be needed to restore the equilibrium.
Historical charts show that copper is a extremely volatile asset. Following a recession, copper prices tend to decline sharply, then bounce back from the lows, and typically far exceed its all-time highs.
Copper is not alone in its bull run. Higher prices across the commodity space are signaling a powerful supercycle driven by dollar depreciation where the fiscal and current account deficits are driving its decline. The magnitude of the problem is even raising questions about the future status of the dollar as the globe's reserve currency.
Are we in a commodity supercycle? A commodity supercycle requires three main conditions:
- The uptrend should be broad-based, not be concentrated on a limited number of commodity assets.
- A supercycle is a long term cycle, commonly lasting for more than 8 years.
- The price increase should be massive, at least tripling the price during the whole cycle but sometimes substantially more.
Although we can only confirm a commodity supercycle in hindsight, we can say by now that the present commodity cycle meets these conditions.