Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
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Copper drops but prospects remain positive
Ole Hansen
Head of Commodity Strategy
Summary: Copper range-bound since mid-January within a $3.75 to $4.20 range has seen a sharp decline this week, along with other industrial metals including iron ore and steel in response to a slower than expected recovery in Chinese demand and growth concerns elsewhere. In this update we take a look at the short-term outlook and why our long-held bullish view has not changed despite the current dark clouds.
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Copper range-bound since mid-January within a $3.75 to $4.20 range saw a sharp decline on Tuesday, along with other industrial metals including iron ore and steel in response to a slower than expected recovery in Chinese demand during a time that’s meant to be the busiest construction period of the year. Risks of a global slowdown was given some additional attention following a plunge in US consumer confidence while banking sector risks seemed to be brought back to life with First Republic earnings.
The metal, however, managed to bounce after finding support ahead of $3.82/lb, last month’s banking crisis low, but in the short-term the focus on macro-economic tailwinds is likely to be a key and potentially negative focus, reducing the otherwise long-term bullish outlook for copper. Dollar weakness led by softer Treasury yields and the market pricing in aggressive rate hikes from June and onwards amid worries about an incoming recession has somewhat helped offset the broad weakness across industrial metals led by concerns about the strength of the Chinese recovery story.
In our view, the green transformation theme remains a strong tailwind for copper, the best electrical-conducting metal towards the green transformation which includes batteries, electrical traction motors, renewable power generation, energy storage and grid upgrades. Not least considering how producers face challenges in the years ahead with lower ore grades, rising production costs and a pre-pandemic lack of investment appetite as the ESG focus reduced the available investment pool provided by banks and funds. A development that will likely see the market turn into and remain in a deficit in the coming years, thereby underpinning prices in order to support mining companies' profitability and their appetite for embarking on new multi-billion multi-year projects in order to add supply.
The challenges the sector faces were a key focus at the recently held World Copper Conference in the Chilean capital of Santiago. The main conclusion from the conference, as expected, was that the world’s rising demand for copper will exceed supply over the next decade unless new mines are built. According to Goldman Sachs, regulatory approval for new copper mines has fallen to the lowest in a decade, a major challenge as it often takes 10 to 20 years to permit and build a new mine.
The bullish outlook for demand in the coming years can be seen through a recent wave of M&A activity:
Glencore Plc offering $22.5 billion to buy smaller rival Teck Resources
Lundin Mining Corp paying nearly $1 billion for control of Chile’s Caserones copper mine
BHP Group Ltd buying Australia’s Oz Minerals in a $6.4 billion deal
Rio Tinto Plc paying $3.3 bn for Turqoise Hill Resources, thereby gaining control over giant Mongolian copper mine
Newmont Corp’s push to merge with Newcrest (gold and copper)
Hudbay Minerals Inc paying $439 million for rival Copper Mountain Mining Corp
Returning to the immediate focus, the copper market has also been challenged by a recent rise in inventories at warehouses monitored by the three major futures exchanges in New York, London and Shanghai. However, while there has been a small 11,600 tons increase this week to 232,500 tons, the total remains near the lowest level for this time of year since 2008. During the past ten years, the mentioned inventories have seen an average decline from now to the end of year of around 194,000 tons, and if repeated we could see visible stock levels literally being depleted to below 40,000 tons by year-end.
In addition, the HG copper contract has also been challenged by speculative fund flows following the recent failed attempt to break higher. According to the weekly Commitment of Traders report, the copper long jumped 230% to 19.8k contracts in the week to April18 in response to the failed, as it turned out, breakout that occurred during the reporting week. It highlights a market where traders are worried about missing the upside once it materializes, but also how failure turns to immediate long liquidation and with that fresh price weakness as seen during the past few trading sessions.
For now, as per the chart below, the metal is currently looking for support, having initially found it ahead of $3.82/lb, the March low. Additional weakness would bring the 200-day simple moving average, currently at $3.76/lb, back into play. A reminder that it was the break above the 200-DMA back in January which helped trigger strong momentum buying all the way up to $4.3550/lb, the current cycle peak from where the price has been drifting lower since. We maintain our long-held and long-term bullish outlook for copper, but with global growth concerns attracting a great deal of attention, the upside may take longer to materialize.
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