Editorial: Is that it for copper? (January 17, 2007)

Copper mining executives and investors who thought they might settle gently back into work after the holidays got a nasty jolt in the first half of January, as spot copper prices dropped US45, or 15.5%, since the last day of trading in 2006 to just US$2.44 per lb. (US$5,380 per tonne).

Spot copper prices have fallen US55 in the last 30 days, US65 in the last 60 days, and US$1.28 per lb. in the last six months. However, copper is still up US30 per lb. over the past year and US$1.75 per lb. over the past five years.

For 2006, the average price of copper was US$3.06 per lb., almost doubling 2005’s average of US$1.57 per lb.

It seems so long ago now, but copper hit its recent low of US59 per lb. (US$1,300 per tonne) in November 2001, and inched its way up to about US91 per lb. (US$2,000 per tonne) during 2002-2003.

Copper prices peaked in May 2006 at US$3.99 per lb. (US$8,788 per tonne), representing the largest copper-price spike the industry’s seen since World War I, in inflation-adjusted terms.

After a major correction and partial recovery in June 2006, spot copper prices have been in decline ever since, eventually sliding below the $3-per-lb. mark in mid-December.

The reasons for this spike and decline come from both the demand and supply sides of the copper equation.

On the demand side, a tightening of short-term interest rates in the U.S. in the latter half of the year triggered a sharp slowdown in new home construction in America as well as a steep decline in auto and appliance sales — all three of which are large consumers of copper.

Moreover, U.S. homebuilders and automakers who loaded up on copper inventory early in 2006 now have enough inventory to keep them going through the first half of 2007, meaning copper demand and prices are likely to be subdued for many more months, despite continued, substantial Chinese demand.

On the supply side of the equation, copper mine output was tightly squeezed early last year, mostly due to unexpected problems in Chile, the world’s largest copper producer and exporter. In particular, there was a 25-day strike at Escondida (the world’s largest copper mine, with 8% of global production), and a large rockfall at an open pit at Codelco’s vast Chuquicamata operations. There were also strikes last summer at Southern Copper’s northern Mexican mines, and threats of strike elsewhere later in the year.

All of these problems have since been resolved, erasing this critical but ultimately temporary supply shortage.

In another sign of strengthening supply, London Metal Exchange warehouse levels have been on a general uptrend since bottoming out at less than 50,000 tonnes in early July 2005, and have doubled in the last six months to 199,450 tonnes — including a 7,000-tonne boost in the first few days of January 2007 that triggered another 8% copper-price drop.

Meanwhile, the International Copper Study Group estimates that there was a modest surplus of 240,000 tonnes of copper at the end of 2006, or 1.4% of annual usage. This compares with a deficit of about 100,000 tonnes a year earlier.

Putting even more downward pressure on copper prices going forward, there is slated to be a significant increase in global copper mining and refining capacity as the decade unwinds.

Chile’s national mining association, Sonami, estimates that Chile will produce 5.7 million tonnes of copper in 2007, an increase of 6% from the 5.3 million tonnes produced in 2006. Almost all this rise will take place in the private sector, especially with the expansion of cathode capacity caused by the start-up of the Spence mine and the sulphide-leaching plant at Escondida — both operations being controlled by BHP Billiton.

In China, copper output is expected to rise about 10% in 2007 to 3.3 million tonnes.

Worldwide, the ICSG predicts mine output will rise a whopping 6.8% in 2007 to 16.2 million tonnes. This compares with world copper mine production of 15.2 million tonnes in 2006, 14.9 million tonnes in 2005, 14.6 million tonnes in 2004 and 13.7 million tonnes in 2003.

Also, waiting in the wings are four more massive new copper mines set to come on-stream before the end of the decade: Codelco’s Gaby mine in Chile; Equinox Minerals’ Lumwana mine in Zambia; Oxiana’s Prominent Hill mine in Australia; and Phelps Dodge’s Safford mine in Arizona.

Paralleling the expanded mine capacity, the ICSG estimates that global refinery capacity will reach 23.3 million tonnes by 2009, up 3 million tonnes from 2005, with almost equal increases in electrolytic refineries and electrowinning.

Looking ahead, we see a scenario for copper of flattening demand and soaring supply that can only translate into continued weaker prices for the red metal.

Various analysts are already predicting that copper prices will average around US$2.50 per lb. this year, and may test new lows south of US$2.25 along the way.

While that’s a high enough price for miners to make money, it’s low enough to stall and shrink earnings. And when earnings stop growing, the share prices of copper miners and explorers will inevitably get beaten up as large hedge and mutual fund managers decide that now’s a good time to do a little sector rotation and get out of copper and into the next hot segment of the economy.

While the copper rally looks finished, by no means is the bull market in metals over, with shortages in nickel, uranium and lead still prevalent, and gold — with its own logic — headed higher and on track to crack US$1,000 per oz. before the end of the decade.