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Copper is sometimes referred to as "Dr.
Copper," because the metal is used in so many industrial applications
and is essential for many different sectors of the economy, from infrastructure
to housing to consumer electronics. That usually makes its price action a
good indicator of the state of the global economy.
The chart below illustrates the degree to which copper
follows economic health – as opposed to gold, which is a traditionally
a contra-cyclical commodity. Have a look.
This illustration paints a convincing picture: over the
past five years, copper (and the economy) stagnated, while gold was on a steady
uptrend. No surprises here: gold has always been a reliable hedge against
economic and financial turmoil.
In 2012, copper demand started out quite strong. The
International Copper Study Group (ICSG) published
Q112 numbers that showed a healthy uptrend in demand: year-on-year,
apparent usage grew by 9%, while refined production increased by 4%. (This is
defined by ICSG as refined production + refined imports – refined exports
+ refined beginning stocks – ending stocks.)
China, responsible for about 40% of global copper
demand, almost doubled its net imports, with a 99% annual growth rate in
Q112. This does not mean, however, that the metal was used right away by
industry: ICSG indicates that high import levels were accompanied by growing
inventories in bonded warehouses.
This will lower demand in the near term. And it's not
just China: other major sources of demand were largely stagnant in the first
quarter, with the US growing by only 1%, European demand decreasing by 9%,
and Japanese down by 6%.
Some analysts expect the European market to be "dead" for the rest of this
year, due to the lack of trading volumes. Chinese demand is projected to
soften, and its output of copper products is estimated to grow by 10-15%
year-on-year. That may seem robust, but it was 18% last year, according to
Beijing Antaike, a state-run metals research
company. As with many official numbers coming out of China, we take these
with a grain of salt, and thus expect output to be even lower than projected.
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While
official statistics coming
out of China are often suspect, one figure is all too true: the percentage of US
dollar holdings in China's foreign
exchange reserves is dropping.
According
to data supplied by the US Treasury,
in the fiscal year that
ended June 30, 2011,
the percentage of dollar holdings in China's foreign-exchange reserves fell to a decade low 54%. That's down from 65% for the same period ending in 2010. This is bad
news for the dollar.
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On average, the stocks of these copper companies have
dropped about 35% since the end of June 2011. The stocks are more volatile
than the metal itself, and in a weak economy that means rebounds are
unlikely.
But are they still profitable? Yes, they are. Despite
the global economic uncertainty and the volatility in the copper price,
copper producers have had strong margins since Q310.
In the past three years, the net income margin of our
20 copper producers remained, for the most part, above zero. The chart shows
the post-2008 growth very clearly, as well as the weakness in the second half
of 2011. You can also see that the first quarter this year was a good one for
copper producers, though again the results for Q2 may be disappointing due to
economic uncertainties.
This pattern is exactly in line with our expectations,
and it's the reason why we have not only stayed away from most copper plays
the last few years, but other industrial metals as well. It's not that we
only like gold and silver, but that our bearish near-term economic forecasts
are bearish for Dr. Copper as well. So we've stayed away, even from well-run,
profitable companies, opting instead to put them on our shopping list for
when the economic situation looks so dire that they become good contrarian
picks.
We are not there yet, so we still view the precious
metals as the best bets for the foreseeable future.
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