Everything Was Looking So Good For Copper. What Went Wrong?

Everything Was Looking So Good For Copper. What Went Wrong?
Paul Allison, CFA

over 1 year ago5 mins

  • Supply and demand elasticities can lead to sharp (and often unpredictable) price movements in commodities like copper.

  • Be alert to current sentiment, either positive or negative, and aware that the copper price can reverse quickly.

  • Stay focused on the long-term and consider using short-term weakness to invest in mining companies that stand to benefit from future copper supply and demand conditions.

Supply and demand elasticities can lead to sharp (and often unpredictable) price movements in commodities like copper.

Be alert to current sentiment, either positive or negative, and aware that the copper price can reverse quickly.

Stay focused on the long-term and consider using short-term weakness to invest in mining companies that stand to benefit from future copper supply and demand conditions.

Mentioned in story

Copper lately has lost its footing, collapsing 35%. And with a fall of that magnitude, it’s worth looking at why so much could change so quickly, and where you might find opportunities…

Why has copper’s price tumbled so much?

A year ago, as factories roared back to life after a long pandemic lull, copper’s price was closing in on all-time highs. It surged even higher this year, as Russia’s invasion of Ukraine added fuel to an already brightly burning inflation fire. And then came the plunge.

Sure, demand for copper has fallen alongside the slide in global economic growth and future forecasts. And it’s understandable: copper is a barometer for the health of the global economy – it’s how it got its unusual “doctor copper” nickname – and lately, recession fears have been growing. But a price fall of 35%, on the face of it, appears to be an overreaction.

Copper price chart
LME copper price (offer price). Source: LME

One thing to know about copper is that it is susceptible to these unpredictable market moves. There are plenty of reasons for that, but here are two key ones:

1. Sticky supply

Part of the reason for such a big fall has something to do with “supply elasticity” – basically, how flexibly copper producers react to changes in demand. In the short term, the answer to this is: not very. They tend to struggle to adjust output to match either rising or falling demand, which means that supply is left “sticky” or “inelastic”.

The thing is: copper mining is an expensive process and has high costs associated with starting or stopping production. That’s different from the extraction of a commodity like oil, for example, where in the short term it’s sometimes just a case of increasing or decreasing the flow of a well.

That inflexibility is positive for copper prices when demand is rising faster than expected. But in a softening demand environment like the one we have today, it means there’s more copper around than is needed – and that’s why prices drop.

2. Inelastic demand

And then there’s demand, which for copper is also inelastic. See, it’s not just producers who are unable to adjust what they do on the fly. Buyers also find that their copper needs don’t change based solely on how much the stuff costs.

For consumers, big discounts (e.g. 35% off) for things like cars, clothes, or even gold jewelry would boost demand. But for businesses like house builders or car makers, a drop in the price of copper isn’t likely to shift demand: they only need a certain amount of copper piping, or electrical wiring. In other words, copper demand is influenced by things other than price, with economic activity being the biggest driver.

The result, then, is a double whammy of demand and supply inelasticity. In the short term, relatively small changes in economic activity demand can lead to an oversupplied market, which in turn can have an outsized impact on price, as even heavy discounting can’t stimulate buying.

What’s the opportunity then?

In the short term – armed with the elasticity argument above – you could look to short copper using the WisdomTree Copper 1x Daily Short ETF (ticker: SCOP, expense ratio: 0.98%), especially if you’re expecting a rough time for near-term global economic growth. Beware, though, if your strategy is driven by the recent copper price direction, you face the same risks that caught copper bulls off guard – unpredictability.

Frankly, it’s practically impossible to accurately predict the short-term price of commodities. Just flip our entire discussion on its head and you have a positive price spiral and a money-losing short trade. That’s why with copper, it makes sense to just accept the volatility and focus on the long term where, ironically, all the original reasons to be excited about the metal are as valid today as they were last year, if not more so.

1. Demand will rise with decarbonization.

Copper’s likely to see its long-term demand boosted by megatrends like renewable energy and electric vehicles, both of which will require a lot more copper production. On top of that, with challenges thrown up in the past year by Russia, Western governments are working more urgently to reduce their reliance on fossil fuels.

2. Supply will take time to catch up.

As for supply, our elasticity argument is likely to hold for a while longer. In the very long term, of course, supply can and probably will be, ratcheted up to match increasing demand. But increasing supply takes time, and for now, producers don’t appear to be in any great rush.

In 2012, the last time the copper price was molten hot on the heels of a Chinese-led commodity boom, mining firms were all-in on meeting the gigantic demand of the commodity “supercycle”. Copper-producing giants Freeport-McMoRan, Rio Tinto, and BHP spent a combined $42 billion on supply-increasing capital expenditure, representing 30% of sales. Compare that to what they spent in 2021: $15 billion, a comparatively measly 10% of sales.

Capex / sales chart
Source: Koyfin

If this “spending discipline” continues and long-term demand holds up, copper is less likely to see a major oversupply, and that’s positive for its price. It’s good news for copper miners too: the combination of a high commodity price and company spending discipline should lead to some bumper free-cash-flow years ahead. What’s more, share prices for miners have already fallen in line with the recent copper selloff, which at least partially reduces the risk investors are taking on, especially given the aforementioned short-term unpredictability of commodity prices.

So, be wary of short-term copper price unpredictability and volatility. And stay focused on the long-term opportunity, which remains attractive. What’s more, you might consider using any further price dips as an opportunity to buy shares in miners such as Freeport, Rio Tinto, and BHP.

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Disclaimer: These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment advisor.

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