One month ago, when Glencore announced it latest copper production cut initiatives and mine mothballing efforts, we said that aside from the brief price spike, it would have absolutely no impact on the longer-term price dynamics of the metal which has achieved "doctor" status. The main reason we offered is that while Glencore was reducing supply, others such as Rio Tinto would gladly step in to fill the supply void. To wit:
Rio Tinto, warned that it will not cut copper production, saying it would be illogical to hold back output and leave space in the market for higher-cost rivals.
And just like that Glencore's assumption that others in the space will act rationally, and "cooperate" with the attempt by Glencore to impose a new game theoretical equilibrium by reducing supply, and thus boosting prices, has crashed and burned.
According to the FT, Jean-Sebastien Jacques, head of copper and coal at Rio, said the Anglo-Australian mining group would not reduce output even though current prices of the industrial metal did not reflect “fundamentals”.
Rio's CEO summarized his philosophy quite simply: "Why should I make cuts?” Mr Jacques said, in an interview ahead of LME Week, the biggest annual gathering of the metals and mining industry. "If you have marginal assets and marginal projects and you have a pretty weak balance sheet I think you may be in trouble pretty soon,” he said.
One month later, and just moments ago, we got confirmation of this prediction courtesy of the following two Bloomberg headlines:
- COPPER FALLS 1.8% TO $4,856/TON, REACHING LOWEST SINCE 2009
- NY COPPER DROPS AS MUCH AS 1.8% TO $2.177/LB, LOWEST SINCE 2009
Worse for the company that as we said in early 2014 is the best proxy for both global copper demand and the Chinese industrial economy, after dead cat bouncing back to 125p in recent weeks, moments ago troubled Glencore (which alongside Volkswagen was one of the main corporate catalysts unleashing the September swoon) traded back under the psychological level of 100p.
So besides the obvious lack of actual wholesale production cuts as beggar thy higher-cost neighbor strategies are unleashed among the copper miners, did something else cause the latest overnight breakdown in prices?
The answer is yes, and it comes from a Goldman report titled simply enough "Copper poised to move even lower."
Here is how report author Max Layton explains, in many more words than we used a month ago, what we said in early October when previewing this latest tumble in copper prices.
Supply growth has been weak, but demand has been weaker
2015 has seen slow rates of copper mine supply growth on supply disruptions and price-related closures and refurbishments. Despite the lack of supply growth, copper is now trading near its year-to-date lows and more than 20% lower than at the beginning of the year. This speaks to the ongoing demand weakness and deflationary cost environment which has driven the market into surplus and reduced cost support (the latter via a stronger dollar and weaker energy prices). Ongoing price weakness, in spite of price-related output cuts, is consistent with our view that producers do not move markets into deficit by cutting supply... rather they move markets closer to balance (than they otherwise would be). A demand recovery along with further supply discipline is required to see markets such as copper move into deficit.
Nearer term, LME and Comex net speculative positioning has picked up in recent weeks, in our view, partly on an anticipated improvement in Chinese economic data during 4Q15 (Exhibits 1 and 3). Should the Chinese data disappoint, and positioning unwind to January levels, or even lower, to August levels, copper prices may fall further than our base case forecast, which is for $4,800/t by year end. Indeed, SHFE open interest has risen across the base metals complex over the past two weeks as prices have pulled back (Exhibit 2), potentially suggesting that participants trading on the SHFE exchange are concerned about ongoing weakness in China’s commodity intensive ‘old economy’.
Importantly, we expect mine supply growth to accelerate in 2016-17 in the face of only limited demand growth. Indeed, over the coming months and throughout 2016 and 2017 investment during the prior boom period is set to bear more substantial fruit, with 5 major mines (the “big 5”) starting up or expanding output significantly, adding c.1.4mtpa of supply capacity by end 2017, and underpinning an acceleration in mine supply growth from c.1% in 2015 to at least c.3% pa in 2016/17. The “big 5” to watch are Cerro Verde (commissioning, Peru), Las Bambas (commissioning, Peru), Buenavista expansion (ramp up, Mexico), Sentinel (Commissioning, Zambia), and Grasberg (higher grades, Indonesia). We assume far less than nameplate is achieved in our supply and demand balance, in Exhibit 5, which shows pre-disruption allowance figures that we use in our model (Exhibit 4).
Stronger mine supply growth puts pressure on demand to pick up in order to absorb it. While we assume that a modest demand recovery in China will keep the copper market surplus around c.500ktpa in 2016 in our base case (Exhibit 5), our conviction level here is not high, and as a result we continue to see the risks to our supply and demand balance and price forecasts as skewed to the downside.
Overall, we continue to see the risks towards our $4,800/t year end 2015 and $4,500/t year end 2016 price forecasts as skewed to the downside, and recommend producers hedge and investors run long dated short positions.
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Finally more charts than one can wave an electricity-conducting stick at.