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Is Copper Signaling an Economic Slowdown?

Jul 31, 2018

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Is the Price Action in Copper Signaling an Economic Slowdown?

Copper hit 52-week lows recently and has given up more than 18% of its value after reaching a 4.5-year high in early June. As a metal deeply interwoven with the economy of China and Chile, the instability of copper markets is worrying economists, politicians, and individuals whose livelihood depend on the metal. In this article, we will discuss some of the most significant variables affecting copper markets right now: demand from China, Chilean copper production, the electric vehicle revolution, Chinese loans, and the US housing market. We will also provide information on how to access copper derivatives through Straits Financial.

Copper Background

Copper has been in use for nearly 5,000 years, since Mesopotamian times, and is considered to be one of the first metals used by humans. In modern day, copper is in industrial wiring in motors, electrical generators, radios, TVs, air-conditioners, and heating systems. In 2017, the United States Geological Survey (USGS) reported that copper and copper alloy products were used primarily in building construction (43%), electronics (19%), transportation equipment (19%), consumer and general products (12%) and industrial machinery and equipment (7%).

Copper is integral in industrial and residential construction use; some consider the recent double-digit drop in copper prices to be a leading indicator of slower economic activity, raising red flags among investors. Additionally, nearly 49% of demand comes from China which makes the metal even more sensitive to the current back and forth in tariffs and trade war tensions amongst US, Chinese, and European leaders.

Copper Production

Regarding copper's importance to US mining production, the estimated value of US metal mine production in 2017 was $26.3 billion with the majority of mining activity contributed by gold (38%), copper (30%), iron ore (12%), and zinc (8%). The states with the highest copper production, and therefore most affected by developments in the copper market, are Arizona, Montana, Nevada, New Mexico, and Utah. On a global scale, Chile is the by far the largest producer of copper worldwide, illustrated in the chart below.
world_copper_production_chart

Watching Closely: Difficulties in Chile

With a union strike on the horizon in Chile at their highest producing copper mine in the world, the market could see different tailwinds come into play. It has been six weeks since more than 2,000 union workers began negotiations with BHP and the union is voting on BHP's proposal until August 1. At the same mine last year, workers went on strike for more than 44 days which affected global supply and copper markets. Prices of copper rose during the strike and then fell in the weeks following its resolution. While we do not know the outcome of this potential strike, it is something we are keeping on our radar as a significant variable that could affect copper markets in the very near-term.

Electric Vehicle Use and Long-Term Demand

Some traders are saying demand for copper will continue to grow due to China's ambitions and plans with electric vehicles (EVs) since copper is a critical ingredient in their production. Tesla recently announced it will be building its first factory in Shanghai allowing Chinese to buy the most talked about EV on their soil. As some believe the unusually hot temperatures this summer are the result of global warming, an EV revolution here and abroad seems more likely than ever. Adding to this EV movement, BMW stated it is pledging more than $4 billion into sourcing electronic car battery technology from China's largest battery company, Contemporary Amperex Technology, which is building a massive battery factory in eastern Germany scheduled to open in 2021. It appears automakers are embarking on an enormous revolution in the way we transport and consume energy, and copper will likely benefit from those innovations.

Forecasts by a consulting agency commissioned by the International Copper Association said that demand for EVs would rise to 1.74 million tonnes in 2027, from 185,000 tonnes in 2017. This rise in demand for copper by EVs could mean they would use nearly 6% of global copper supply. Typically, internal combustion engines use up to 23 kg of copper while the ICA report found that a hybrid EVs use nearly 40kg of copper and a plug-in hybrid electric vehicle uses 60kg. Charging stations and solar panels for EVs would also require additional copper usage.

China Loans on Watch

The Chinese use copper as collateral for loans and according to HSBC it is upwards of 30% of low cost loans. When Chinese companies debt repayment capacity comes into question, margin calls may be triggered and copper prices typically decrease. Many fear that the drop in copper prices is led not only by slower near-term demand but also by weakness in China's industrial financing which would be yet another catalyst for a global economic slowdown.

Weakness in Housing Market

The price of copper is sensitive to the housing market, which is starting to show vulnerability. Sales of existing and new homes in the US fell in June, with new home sales falling to the lowest level since last year. While prices continue to rise, mortgage applications are dropping steadily. To compound worries, US mortgage rates are rising, and single-family home construction fell lower than June 2017. In Denver, one of the hottest housing markets, home sales fell 5.5% for the year as prices hit an all-time high, according to RE/MAX. If the housing market continues to show fragility, it could see some pricing pressure downward in copper as it's such an important part in new home construction.

Copper Prices

The USGS reports that through November 2017, the monthly average price of spot copper on COMEX fluctuated between $2.55 and $3.10 per pound. It was estimated to average $2.80 per pound for the full year, up 27% from 2016. According to USGS, this increase is due to lower mine production, depreciation of the US dollar, and continued copper consumption growth in China. At the time of this writing, spot copper is $2.96 per pound and September settled futures are trading at $2.7985 per pound.

Futures Trading Volume

In June 2018, COMEX copper futures at CME group traded more than 3.6 million contracts, reflecting a 57.5% year over year growth from the 2.2 million contracts traded in June 2017. As we have outlined in the chart below, copper is second only to gold when comparing metal futures volume traded at CME group.

top_metal_futures_volume_chart

Straits Financial

With so many changing variables influencing the price of copper, it's important to stay tuned into the markets and have an experienced professional in metal markets on your side. At Straits, we pride ourselves on providing our clients with pricing information, valuable market commentary, and market updates on a daily and weekly basis. We put you at the heart of our business.

Traders can gain access to copper markets through Straits Financial memberships at CME Group. As a leader in the metals and commodities space, the Straits' team can connect traders to sources of liquidity and trading opportunities at a regulated derivatives exchange. We also offer OTC energy, metal and commodity products and access to equity index futures and options. Please contact one of our trading specialists if you are a professional trader looking for access to futures markets. In the US we can be reached at +1 312 462 4499 and in Singapore we can be reached at +65 6672 9669. To stay up to date on the latest in metals, agriculture, and commodities, please sign up to receive our newsletter here.

DISCLAIMER: This document is issued for information purposes only. This document is not intended, and should not under any circumstances to be construed as an offer or solicitation to buy or sell, nor financial advice or recommendation in relation to any capital market product. All the information contained herein is based on publicly available information and has been obtained from sources that Straits Financial believes to be reliable and correct at the time of publishing this document. Straits Financial will not be liable for any loss or damage of any kind (whether direct, indirect or consequential losses or other economic loss of any kind) suffered due to any omission, error, inaccuracy, incompleteness, or otherwise, any reliance on such information. Past performance or historical record of futures contracts, derivatives contracts, and commodities is not indicative of the future performance. The information in this document is subject to change without notice.  The impact on market prices due to seasonal or market cycles and current news events may already be reflected in market prices.