Copper is one of the only Commodities been given the delineation of Doctor; a privilege and honour out of sheer respect as being one of the best gauges for global economic growth and specifically, temperature of the Chinese economy. In a very simplistic way, purely top down, the fate of Copper's demand growth rests predominately on outlook for China. Of course, one needs to take into consideration physical demand/supply and inventory picture, which supersedes any top down analysis, but the tail winds or macro winds come from the macro picture in China. So according to Dr. Copper, what is it telling us of the state of the world as we see it?
LME Copper price has been stuck in a range of $5800-$6200/tonne since the Trade Wars started in earnest in June 2018, after briefly touching highs of $7200/tonne in June 2018. As Trump waged economic war on China, weaponizing the dollar and causing disruption in global supply chains, he managed to choke China's main engine of growth.
This dramatic slowdown caused a ripple effect in the entire world, judging by Singapore, Korea, Emerging Markets data felt all the way across Europe. China is the world's economic growth engine, whether we like it or not. If it slows down, the effects will be felt everywhere given its vast imports (taking in raw material) and exports (producing finished goods). Germany is almost at the cusp of a recession as seen by latest PMI numbers. For three decades, China's insatiable demand for German cars, machines and engineering tools has been a steady engine (no pun intended) of growth for Germany. China is only a small part of its 3.4 trillion euro economy, but it is one component that kept growing year after year, offsetting the general European slowdown. In Q2'19, it shrunk by -0.2% GDP, and Q3'19 was expected to be down -0.1%, but printed +0.1% GDP (avoiding recession by a sliver), but Q2'19 was revised down by 0.1%.
We know how disastrous the global PMI and Manufacturing data is, we have witnessed some of the worst prints over the past two months. The street is divided on either playing the global slowdown macro trade or the liquidity driven central bank boost trade.
There are only two trades in the market right now. All asset classes and sectors' fates will be determined via that view. People who boast of generating alpha are few and far between, it is entirely impossible over the past few months as market whipsaws from one direction to the other. We can debate at length academically and philosophically about the merits of Fed Chair Powell's actions in September onwards towards the repo market operations ad nauseum. Whether we agree or not, we cannot fight it. The old adage "don't fight the Fed" holds firmly in place.
There is always a time to be bearish, but at times one needs to see the facts at hand and be open-minded about where liquidity is headed. The market has been thrown bad data print one after the other, and it has refused to go down. That should speak in and of itself about something.
On Thursday, Powell testified on the economy in front of the House Budget Committee, stating that he was comfortable with where interest rates are currently and would like to see the impact of these rate cuts feed through to the economy. More importantly, and perhaps a little snippet most did not pick up on was the Fed's Open Market Operation schedule from November 15 -- December 12 2019 detailed Thursday, they will continue to offer at least $35 billion twice per week in two-week term repos, and $120 billion in daily overnight repo operations.
In a nutshell, any bank needing liquidity will get it as the Fed is in just-keep-pumping mode for now. It has decided to also offer 3 additional term repos during this calendar period with maturities extended past 2019. This is to ensure supply reserves remain ample prior to end of the year. Call it technical, call it ice-cream money, whatever, it is QE packaged up in a little tiny black box ahead of Christmas.
The market has some 30+ straight up days without a pullback, so some consolidation and short pullback is possible. But the market will be well supported during year end. The leadership will come from oversold value names like Energy and Mining stocks as they represent the "cyclical" growth pick up story. This is where Dr. Copper comes in.
Global consumption of Copper this year has been estimated to be 0.3%, well below of the 2%+ estimates earlier in the year (according to International Copper Study Group). But supply is expected to fare even worse. It is forecasted to show a deficit of 320,000 tonnes this year vs. estimates of 190,000 tonnes in May.
The two main contributors of Copper growth, China and European Union, are showing real apparent growth at a historical low of 1% average. Copper mine output is expected to fall by 0.5% due to supply disruptions and slowing production in Grasberg and Batu Hijau mines in Indonesia, and African copper belt countries.
Taking all this into account, global Copper output is now expected to rise by a paltry 0.5%, compared with previous 2.5-2.8% growth rates. Copper is one Commodity where the taps cannot be just turned on. It takes years to mine and excavate, with long cycles. If we assume trend global economic growth (this is where the debate comes in), there is a shortage of enough viable Copper projects.
So why have prices remained so low? Global slowdown in a nutshell. The call here on Copper comes from forecasting or predicting rather than the demand side of the equation. This is the hardest part as no one data point can tell you, it has to be tracked and gauged from a host of factors. This is where pure academics miss out and eventually adjust the numbers after the fact. Prices never breached below $5600/tonnes during the worst of times this past year. That comes down to marginal cost of production argument for Copper; we need a minimum level of prices to incentivize some growth. We are there already as Copper bases somewhere in the region of $5600-$5800/tonne level.
As global central banks have been easing rates, now with the Fed easing via its non-QE repo operations expanding its balance sheet, there is an underlying stimulation boost to the market. This will show up in data in the next few months. Copper mining Equities like Antofagasta and Kaz Minerals are looking extremely cheap and attractive here. ANTO trades on an EV/EBITDA of 5x forecast for 2020 and has a free cash flow yield of 3%. For a miner, that is quite impressive. It has a cost of production around $0.90-$1.20/lb, one of the more attractive ones in group as management is very disciplined on capital. KAZ Minerals is more levered to the copper price given its newer acreage acquisitions, it has one of the lowest cost profiles in Top Tier 1 assets around $80c-$90c/lb, respectful current production and upside to a project delivering significant copper production growth in the future.
The caveat is of course if Trump continues to play hardball, waging these nonsensical Trade Wars as China has always offered to buy more goods and services with US, but not at the expense of changing their domestic policy. Trump cannot afford a stock market collapse going into election year so a deal of sorts will be signed sooner than later, allowing the market to feel more comfortable with the global economic picture.
If this changes, then Dr. Copper will remain in the low end of the range. But today, from these levels, given what we know about global backdrop and what central banks are doing, the risk-reward looks very attractive in playing the long side. The fundamentals were always tight, but now the Macro is moving in Copper's favour too. Last and perhaps my favourite point, most traders and investors are still short.
