Dr Copper, the industrial metal with an honorary PhD in Economics, has been taken out to the woodshed over the past few months. The spot price has declined by 34% peak to trough this year as macro tourists shifted their focus from inflation risk to growth fear. The annual rate of change in the spot price of copper has maintained its correlation with the tightening in financial conditions (chart 1) and the slowdown in global manufacturing new orders. Moreover, China, at more than 50% of global consumption, has clearly experienced a growth shock, consistent with the slowdown in credit and the episode in real estate construction.
As we have often noted, the rate of change in credit growth or the credit impulse in China is an excellent leading indicator of the rate of change in commodity prices, especially industrial metals (chart 2). The correction in spot commodities is entirely consistent with the moderation in credit growth in China from late 2020 through 2021. The fundamental reason for the relationship is that bank credit drives real estate and infrastructure which is still the largest contribution to growth in China and global final demand for most commodities. The first bullish point on a forward looking basis is that the credit impulse has turned back up as Chinese banks provide liquidity to support growth.
The second bullish observation is that the physical market for copper remains in a persistent supply deficit. In addition, inventory levels remain extremely low (chart 3). The time series below is based on the Commex data, which is not far above trough levels. Typically, inventory is reported in “weeks of consumption” however currently that is now measured in “days” – that is an extremely bullish set up if there is a reacceleration in Chinese growth and demand next year. On a longer time frame, copper’s use in green energy and electric vehicle production is also a potential source of secular demand beyond traditional sources. Sector specialists note that there is not enough global reserves to meet all of that secular demand.
In the first commodity super-cycle after China joined the World Trade Organisation in 2001 and before 2008, the combination of strong cyclical demand, constrained supply and extremely low inventory often led to “pinch point” pricing in copper where the required price to match demand could increase almost exponentially. While underlying cyclical demand is probably not as vigorous as the pre-2008 phase, the persistent supply deficit, extremely low inventory and new sources of demand noted above could lead to an impulsive rally if Chinese growth recovers next year.
In that context, the 35% drawdown in the copper producers and inexpensive valuation provides an interesting set up for 2023. For US investors, Freeport is the obvious one to consider. However, there is a diversified global copper producer ETF, COPX US equity, listed in the United States. That has a number of producers from Asia Pacific. We are already long the diversified miners in Australia who will also benefit from a cyclical recovery in China next year.