Investing In Copper – A Bullish Scenario For Copper
-A Daily Reckoning Whitepaper Report
by James Boric
“You can’t have a bubble when the media have only begun to pay attention to commodities in recent months after years of disinterest. We’re now only in the early part of a long-term commodity price boom that has years to run and will likely see dozens of raw material prices make new highs. Even crude oil and copper have a long way to go, even though they recently set price records.”
– Jim Rogers, Barron’s, June 5, 2006
Investing In Copper: Copper is the perfect investment
The base metal hasn’t received nearly the press that its precious peers, gold, silver, platinum and palladium have. But it should.
The reddish metal is one of the most useful on Earth. It is a very efficient conductor of electricity. It is flexible and strong and it doesn’t corrode easily. It is used for heating, air conditioning, plumbing, roofing, adapters, computers, cars, mobile phones, wiring, electrical leads, transformers, motors and lighting units.
In short, copper is used in nearly every major industry of the world: transportation, engineering, machinery and equipment, electrical, building, automotive and computer.
Thanks to significant demand worldwide, the base metal has outpaced all of its higher-profile precious peers by a significant margin over the last five years. Spot copper prices are up 393% from their lows in 2001. Meanwhile, gold is up only 151%, silver is up 188%, platinum is up 202% and palladium is up 122%.
Surely, the price of copper has gotten way ahead of itself and are due for a major correction. Right? That’s what the bears are saying these days. But the underlying fundamentals in the copper industry paint a different picture. They show a world in which prices will go higher – much higher.
World-famous commodities expert Jim Rogers said there are three questions you need to ask (and answer) to determine if a commodity is headed higher in price: How much production is there worldwide? Are there new sources of supply? And are there new potential supplies?
The perfect scenario for a commodity on the rise is that worldwide production is limited or declining, there are no new supply sources that could boost production in the near-term and there is no viable replacement when prices get “too high.”
Based on all three of these requirements, copper is the perfect investment right now.
Investing In Copper: Is Production Limited or Declining? Yes.
Thanks in part to rapid growth in India and China, worldwide copper demand is at an all-time high. From 1998 to 2005, total refined production of copper has gone from 14, 142 k tons to 16, 631 k tons. During that same time period, total refined consumption has gone from 13, 352 k tons to 16, 884 k tons. For the last three years, copper consumption has been greater than the total amount of copper produced. As a result, copper supplies and stockpiles have shrunk to five-year lows and copper prices have skyrocketed from 75 cents a pound to as high as almost $4.
Since 1990, copper consumption has increased from 512,000 to 3,482,000 tonnes a year. In India, copper demand has increased from 132,000 to 271,000 tonnes a year. And in the United States, demand has increased from 2,150,000 to 2.5 million tonnes a year. Yet despite this growth, there is massive upside potential from here.
Japan consumes about 12 kg of copper per capita. North America consumes around 10 kg, and Europe consumes 9 kg per capita. But the massive populations in Chile, India, Eastern Europe and South America are all still consuming less than 2 kg per capita. Imagine what will happen to copper prices as they start to catch up to the rest of the world. Prices will rise – especially when you consider there is no major change to the supply side of the equation.
Investing In Copper: Are There New Supply Sources? No.
There has not been a significant new copper mine discovery in nearly 100 years. And according to the Metals Economics Group, “Worldwide, significant copper discoveries between 1998-2004 have fallen well short of what is needed to replace the copper produced – a total of just 39.9 million mt of copper in reserves and resources has been discovered, while production totaled just about 93.6 mt – although the resources in these deposits have potential for further increases over time.”
Think about that for a second…
Over a six-year span, only 39.9 million tons of copper was discovered, while 93.6 million tons of copper was produced. This ratio of production to discovery simply cannot sustain itself. If we don’t find a major new copper mine soon, copper production will have to slow down and prices will rise – significantly.
And a lack of new discoveries isn’t the only supply concern that can push prices higher. Labor disputes, political instability, natural disasters and major accidents can all wreak havoc on near-term supply issues.
The Escondida mine in Chile is the world’s largest copper mine. It is responsible for 8.5% of global mine output – according to data from Chile and BHP Billiton (the mine’s owner). Global stockpiles depend on it.
For the last five days, production at Escondida has been slashed by 60%. 2,000 unhappy miners are on strike – seeking higher wages and a larger bonus. According to Bloomberg, “The union is seeking a wage increase of 13 percentage points above the inflation rate, which was 3.8 percent in July, and a bonus of 16 million pesos ($29,400) to reflect the surge in copper prices…The company last week offered a wage increase of 3 points above inflation and a bonus of 8.5 million pesos.”
Because there is no cushion in the copper stockpiles any disruption in the supply chain will cause prices to rise. According to the BBC, “There is not a lot of supply coming on stream generally this year and therefore a prolonged strike would have the potential for a significant impact on prices.”
As I type, Chilean miners are blocking access roads, picketing and insisting on much higher wages. Meanwhile, BHP has already said, it will not budge further. Its last offer is its final.
Given the circumstances, it doesn’t look like this strike will end any time soon. I expect copper prices to make an all-time high in the next week. If that happens, you can bet there will be talks about potential alternatives to copper – like aluminum.
Investing In Copper: Will Aluminum Replace Copper as Prices Continue to Rise? No.
It seems logical to assume that demand for copper could go way down in coming years. After all, conductors, power cables and other wires are being made with aluminum, which is also a very good conductor of electricity, and is lighter and much cheaper.
But how likely is it that everyone will all of a sudden stop using copper in lieu of aluminum?
The bears argue that copper is far heavier and more expensive than aluminum. True. But I would contend that that has always been the case. And in recent years, you can bet than anywhere it was feasible to replace copper with aluminum it was done. That’s evident by the rise in aluminum prices. Take a look:
There is no doubt whatsoever that aluminum has replaced copper in wires, conductors and various electrical parts – especially as copper prices have more than tripled recently. But I would remind you that the increase in aluminum has not had any major effect on the demand for copper. In fact, demand for both metals has soared in tandem. One has not risen at the other’s expense. And anyone who would have you believe that you could one day stop using copper altogether in lieu of aluminum should consider this one fact: If you took all the aluminum stockpiles in the world, it would only be enough for nine days of global consumption.
In other words, even if aluminum could be used to replace copper in every function under the sun (which it could not), you would only have enough to last nine days.
I don’t think copper is in danger of being totally replaced just yet. The developing world needs both metals – not just one.
for The Daily Reckoning
Editor’s Note: James Boric is one of the leading small-cap analysts in the country. He is a frequent cotributor to the Free e-letter the Penny Sleuth.
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