Have you ever wondered why copper earned the prestigious title of "Doctor," amongst all the other base metal commodities? That delineation could not be more accurate, as copper price is the best gauge of the health of the global economy. It has the prestige and the curse, all in one, as its price momentum is dictated not only by the current state of the physical copper demand/supply dynamics, but also pushed around by the macro worries that play an important role in forecasting its projected demand. China is the world's largest consumer of copper, accounting for nearly half of its global demand, and China is the world's largest economy, ergo the name Doctor Copper.
Since the second half of 2018, copper has been range bound, trading between $5800-$6300 a tonne, as U.S./China trade tariffs escalated. It is surprising that copper did not drop more, given its dependence on the state of the economy. Several asset classes had been pricing in recession around December, yet copper maintained its levels. On the Christmas Eve massacre, when markets collapsed 8% in a matter of few days, one would have expected copper to fall substantially more, but it did not. The mystery lies in the distinction between actual tight market fundamentals vs. the perceived global economic collapse if trade talks between the U.S. and China did break down.
Let's look at the macro headwinds. There is a significant correlation between China's Manufacturing PMI and the price of copper. Judging by the recent official PMI below 50 for December and January, and the China Caixin index falling to 48.3 (the lowest reading since February 2016), it does not bode well for the copper price.
We know there is a slowdown in China, for now. But the State Grid, a major component of China's copper usage, is forecast to increase spending by 5% in 2019 after being flat in 2018. In addition, China has announced several stimulus measures, including its pledge to increase infrastructure spending, which have yet to make their way into the system.
Recent reserve requirement ratio (RRR) cuts have also been announced since the beginning of this year, all meant to facilitate investment in the economy. But constant breakdown in the talks, or any progress made between the parties, caps any potential rallies in copper.
Now let's investigate the micro tailwinds. Stocks registered on the London Metals Exchange, Shanghai Futures Exchange, and Comex only showed small build of 20,000 tons in January. Inventories continued to decline in the fourth quarter, with around 67,000 tons withdrawn from the LME. Asian inventories declined in October by 33,000 tons, built by 39,000 tons in November, to then resume their decline to close the year at 12,000 tons -- suggesting a tight physical market.
Speculative funds (CFTC's) are not that long copper either, as traders are currently short copper. It does not come as a surprise, given most analysts are now bearish on global growth, and by extension, on copper.
Tug of War
The tug of war continues. One thing is certain: If there is any resolution on the trade talks, even if just on the surface, Doctor Copper will lead the pack and surge higher, breaking away from its trading range. The propensity to squeeze higher should not be ignored as the fundamentals are that supportive. Once the lid is removed, the contents will release viciously. No one knows what impact China's stimulus will have on the economy, but they have been under pressure to get growth back to trend at 6%. These types of manoeuvres tend to overshoot both on the upside as well as on the downside.
There is a macro vs. micro disconnect across a host of asset classes, between what is priced in and what is expected given the unknown outcome of the trade talks, especially as it rests on the resolve of one man, President Trump, who seems to be the most volatile variable in this equation.
For now, Doctor Copper retains its title and should be monitored to see where the fate of the Chinese economy is headed. Any resolution will see a huge bump in the copper price and the copper exposed miners, Rio Tinto (RIO) , Antofagasta (ANFGF) , and Kaz Minerals (KZMYY) , which are trading on cheap multiples, but only need clarity on direction.
