Copper cracked today, falling 5.5% to below US$2.50 per lb., its lowest level in five and a half years. It bounced some to close the day at US$2.56.
The PhD of metals fell after the World Bank downgraded its expectations for global growth, which prompted Goldman to lower its copper price forecast, which cause traders to panic, the price to fall, and stop-loss selling to snowball.
While a copper collapse hampers the seasonal lift we in the metals markets are all so desperate for, it is not the end of the world.
For one, few expected fantastic things from copper in the near term. Most of those looking for metal markets opportunities are focused on gold, zinc, uranium, and platinum group metals – metals where supply gaps, significant underpricing, or general financial anxiety (i.e. gold – read on for more) are creating clear price potential.
Second, most copper comes from large open pit mines – precisely the kind of operations where the falling price of oil has cut costs significantly. With their costs reduced, miners can handle lower copper prices.
Three, if you want an argument ask a group of analysts, miners, and refiners whether we are looking at a copper deficit or surplus. Six months ago consensus was that copper would be oversupplied in 2015. Since then several producers have cut back on 2015 guidance, to the point where we might be looking at a deficit.
But copper loves to live right in that balance between supply and demand. The world consumes some 22 million tonnes of copper each year and the supply-demand gap is regularly less than 300,000 tonnes. That tightness means a disruption or two at some major mines – a common occurrence – can erase a surplus overnight.
The potential for the world to suddenly not have enough copper – the metal most essential to modern society – is why the price sometimes spasms. Add in speculators with shorts to cover or stop-loss orders in place and you have the potential for price free falls like we just saw.
The lack of a clear surplus, the fact that stockpiles are not particularly large, and the assurance of continued demand from incessant infrastructure development in China and India mean copper will regain much of its recent loss in the short term.
Remember, even if Chinese growth slows, it is now growing from a huge base. If China’s GDP grows 7% next year, it will expand by roughly $700 billion (excluding Hong Kong). That is bigger than Switzerland’s entire economy. It is also the size of China’s entire economy in 1994, when Chinese growth peaked at more than 30%.
Annual growth compounds the size of China’s economy. Similarly, annual growth has greatly increased China’s basic metal needs. In 2004, a 9% increase in copper consumption increased demand by 280,000 tonnes. A 9% increase in 2013 boosted demand by almost 800,000 tonnes.
Copper is the irreplaceable foundation of modern society. That means copper prices rise when economies are humming and fall when economic outlooks are weak.
Right now, economic outlooks range from ok to weak. The US looks ok, but time will tell if oil’s rout topples that house of cards. Europe is struggling; Japan is barely afloat; Russia is collapsing. None of those bode well for copper.
Gold, however, is a different beast.
Gold is two things: an alternative to fiat currencies and a barometer of investor anxiety.
Neither make gold easy to value. Investors get anxious for all kinds of reasons, from inflation to deflation, sector bubbles to market crashes, currency routs to economic performance, banking battles to real wars. Currencies also respond to these happenings, but in a more convoluted and relative way.
With such a range of impetuses, it’s understandable that not everyone likes gold. It’s hard to predict. Its value is subjective. And its relationship to currencies alternately supports and depresses the yellow metal.
As of right now, there are good reasons to think the gold-versus-currency comparison will strengthen the yellow metal in both the short and long term.
In the short term, the biggest factor is the US dollar.
Normally, gold and the dollar show perfect negative correlation. Gold is priced in dollars, so dollar strength normally pushes down on gold.
Today is not normal. Since early November, when gold bottomed, gold and the dollar have climbed together. Specifically, gold is up 8.5% while the dollar is up 5.2%.
Importantly, gold and the dollar often sync up at the start of gold bull runs.
The blue dashed lines show gold lows. The red dashed lines show dollar highs (lows on the inverted dollar chart). Gold leads each reversal; until the dollar also changes direction, the two are in sync.
Gold leads because when gold rebounds it does so for its own fundamental reasons, not in response to the dollar.
Those fundamental reasons are currency questions, central bank demand, paper gold obligations, and bond yields that are declining or even going negative.
To start: with so many currencies sloshing around, most connected to highly indebted governments, gold is regaining importance as a way to value money.
For example: How much gold does a central bank hold? How much more could it buy with its currency reserves? Those questions create answers that can be compared around the world.
In short, gold is inching its way back to being the yardstick.
Sure, the inverse is still true: gold is currently priced in fiat currencies. However, that just provides a relative valuation, which is the best we can get out of the current currency system.
But gold shouldn’t be thought of within that system.
In direct contrast to currencies, gold doesn’t need a prudent government to preserve its value. Gold does not conduct monetary policy nor does it default, stimulate, or inflate. Instead, it stands in the middle of a mess of currencies and just is.
When we look at how gold performed in 214 in various currencies, what we really see is how currencies fared in 2014 versus the only yardstick that truly endures.
Gold gained against the Euro during 2014 as weak economic performance and continued uncertainty over Greece led to speculation that quantitative easing is imminent. As a result, gold rose 15% against the Euro to reach a 16-month high.
Japan continued – in fact, increased – its massive quantitative easing program and as a result gold climbed 12% against the yen.
The most dramatic performances of the year aren’t on the chart. For example, Argentina defaulted on its bond obligations – again – in 2014 and the Argentinean peso paid the price. Gold climbed 31% compared to the peso over the year or, more appropriately, the peso declined against gold.
As for the ruble, gold finished 2014 up 79% compared to the Russian currency. And gold gained more than 90% against the Ukrainian hryvnia.
Central banks are very aware of gold’s increasing importance in the global scene, which is precisely why many are repatriating their gold reserves. Belgium is the most recent to request return of its yellow metal. The Dutch already got their back from New York. The Germans tried, failed, and now are succeeding. Venezuela repatriated its gold a few years back.
And they aren’t just repatriating – they are buying. Central banks bought almost 100 tonnes of gold in the third quarter. Last year 19 different central banks bought gold.
Another long-term factor is the disjoint between paper and physical gold markets. Central banks have long loaned gold to bullion banks, which use it as collateral for a variety of paper derivatives and in hedging agreements. When the gold price declined, it suddenly became clear that there are too many paper obligations against not enough actual gold.
If that sounds familiar, it is: the 2008 crisis happened because there were too many mortgage-backed derivative against not enough actual mortgage payments, especially when housing prices started to decline.
Also in gold’s favour: it used to be that other ‘safe haven’ investments offered far better yields. But those times have changed.
Sure, gold still carries holding costs and doesn’t pay a dividend. But today so do many government bonds. The Bank of America Merrill Lynch calculates half of all outstanding government debt yields less than 1%. Short-term yields are negative in Germany, France, and Switzerland. Longer maturity bonds are at record-low yields in those and many other places.
With yields going negative, gold starts to shine against other asset classes. Zero yield is better than negative yield!
Currency uncertainties, incessant central bank buying, a shortage of gold to cover paper obligations, increasing safe haven investment appeal, and insatiable appetites for gold in China and India mean there just isn’t enough gold around in the medium to long term to satisfy demand.
Those upward gold price pressures are being amplified by rising geopolitical risks. The Russia-Ukraine dispute, ISIS, and oil’s crash come to mind.
Gold’s sync-up with the dollar suggests to me that gold’s bull run has begun. Copper’s collapse today supports that idea by confirming that economies are slowing.
What does slowing global growth create? Anxiety and weaker currencies.
And round and round we go.
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