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Doctor, Doctor sell me the Spooz

Dr Copper, the industrial metal with an honorary PhD in Economics is down 18% from the January 2023 high and 29% from peak. For the macro tourists that is a bearish signal for global growth and the global risk proxy (the S&P500 or what we affectionately call the Spooz). The annual rate of change in copper has remained correlated with leading indicators of global industrial production growth such as the US manufacturing ISM (chart 1). On the positive side, signs of stabilisation in key global leading indicators suggest cyclical downside might be limited. On the negative side, China remains more than 50% of global consumption. The episode in China’s real estate and construction sector has clearly weighed on final (cyclical) demand.

Of course, from a secular demand perspective, copper is critical for energy transition, electric vehicles, and other related industries. While the secular demand for copper, physical market deficit and constrained supply in the medium term are well appreciated key issues, there is simply not enough deposits (copper mines and output) to meet all the projected consumption demand from the industries noted above in addition to the traditional demand from infrastructure and construction.

Tactically, however, elevated Treasury yields increase the value of the competing asset and the cost of carry for commodities (which have a cost of storage). Higher Treasury yields have also underpinned the US dollar strength. Commodities are priced in US dollars and therefore trade inversely to the dollar. It is not surprising that the renewed phase of dollar strength over the past 12 weeks has coincided with a correction in commodity prices and tighter dollar liquidity (chart 2).

Despite the recent weakness in the spot and the cash-three month spread, copper inventory levels remain extremely low by historical standards (chart 3). If global growth has stabilised and is about to recover as indicated above from the ISM manufacturing, tight physical markets and low inventory could be bullish for the spot price of copper in the medium term. Given the secular demand outlook above it would not surprise us if the copper market reverted to the “pinch point” pricing and commodity super cycle experienced after China joined WTO in 2001. As we noted earlier this week, human beings tend not to be very good at non-linear thinking.

Of course, tactically a downside shock to global growth would not be bullish in the near term. For copper mining equities, you should not value the companies based on the spot price. Rather, the valuation ought to be on the net present value of future cash flows. However, in the short term the equities tend to be correlated to spot (final chart). Nonetheless, the sector is inexpensive on cash flow-based measures of valuation. For those interested, there is a Copper Miners ETF listed in the United States.

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