Event
Copper prices have been in freefall since the highs over $8600/tonne reached in early July 2008.
Comment
We believe that the following points should be made about the fall in the copper price:
• As in all cycles, prices will undershoot at the bottom just as they overshoot at the top. We see copper prices bottoming over the next few months before starting to rise in mid 2009.
• Metal prices typically bottom out when they are below the average cash cost of production. At this point, exploration, R&D etc, all get slashed, guaranteeing an overshoot in the next cycle due to the lag resulting from long lead times to bring in new supply.
• The market is worried about China. We are not. 9% growth is still excellent by western standards and there was no way that Chinese growth was going to continue at 11 to 12% indefinitely. Research reckoned that for each 1% drop in the USA GDP, Chinese GDP would drop by 0.8%. These figures appear to be about correct and some are forecasting a bounce in the USA GDP next year.
• 94% of Chinese GDP growth is internal. We believe that the Chinese will make sure that internal growth continues strongly. We note that the Shanghai expo in 2010 has a much bigger footprint than the Olympics.
• We perceive that the Chinese economy is only pausing for breath, with the “Olympics effect” exaggerating Q3 weaknesses.
• The slowdown in China can be attributed to tight credit policies introduced last year to address inflation. These policies are now being relaxed. We anticipate that commodity demand in a fast growing developing economy like China's will have a cyclical pattern around a strong underlying trend
• This time around the banks are not prepared to lend, so any marginal mine will likely get closed quickly and not struggle through the cycle losing money. Mineweb ran an article on Oz Minerals potentially closing the Century mine as its cash costs are below the cost of production. This is the second largest zinc mine in the world so it would have a significant impact. By inference, copper production is in the same situation.
• Although the gap is closing we think that the surplus/deficit for copper for 2008 will be very small, which ever way it goes. We have already seen Escondida announce supply problems for the next 18 months over about 10% of their production or 100kt pa. On a smaller scale, a Namibian producer will cease concentrate production next year, removing 6,000t of metal from the market. We understand that the old Phelps Dodge mines in Arizona have cash costs around US1.95/lb, so if the copper price stays down, expect these to start closing.
• The Chinese are shrewd business people. Sitting at home watching the copper price fall, they are probably holding off buying as long as possible, especially as treatment charges/refining charges are low. If a few high cost copper mines go out backwards, concentrate supplies tighten up, TC/RC’s rise and even if the copper prices bounce, the smelters will make more money.