The slumping price of copper is signalling trouble ahead for the economy. But investors in the base metal or related stocks should keep their eyes on the long-term case here: Copper’s importance to renewable energy should get it through this setback.
Things are grim right now, of course. The price of copper slipped below US$4 a pound this week, to an intraday low of US$3.64 early Friday, for the first time in more than 16 months.
That marks a decline of more than 25 per cent from its recent high in March, and it underscores copper’s reputation for signalling economic trouble.
It’s known as Dr. Copper for a reason: Since the metal has many critical uses in communications, technology and infrastructure, the fluctuating price can serve as a useful indicator of broad economic activity, turning a base-metal commodity into an economist.
Investors have turned to copper in recent years as a far more specific bet on addressing climate change. Copper is essential for electrical conductivity in renewable energy systems, including wind and solar power. And electric vehicles use far more copper than traditional cars.
Electrification and copper work well together, offering a relatively straightforward investing strategy and a compelling fit for investors interested in environmental, social and governance (ESG) principles.
Now, though, the share prices of copper producers are floundering, suggesting that the bullish case is in trouble. Arizona-based Freeport-McMoRan Inc., one of the largest producers, has tumbled 29 per cent this year.
Little wonder: An economic slowdown – perhaps even a recession – will sap demand for copper at a time when producers are increasing global output with new projects that have been in the works, likely turning supply shortages over the past two years into surpluses.
Morgan Stanley expects copper will trade at an average of US$3.90 a pound in 2023, suggesting little relief from the current downturn in the near-term. Others see US$3.50 as the next key threshold, causing investors to look more closely at rising inventories of copper.
But investors with longer time horizons could be rewarded for their patience, according to some analysts.
Part of the bullish case rests on the argument that the price of copper remains attractive for producers even well below its recent highs, which should translate into strong profits and dividends.
“Copper at US$4 a pound is a fantastic price. If you had offered that to producers two years ago, they would have bitten your hand off for it,” said Colin Hamilton, the Britain-based commodities analyst at BMO Capital Markets.
What’s more, current lower prices can deliver some advantages.
Since record-high commodity prices can push consumers toward avoiding purchases or looking for alternatives – why splash out on an electric vehicle if the cost has soared? – a lower copper price should reduce this so-called demand destruction.
As well, lower prices can reduce the incentive among producers to increase their output with costly new projects – beyond those that are now coming online – potentially leading to a more attractive supply-and-demand picture down the road.
“The long-term thesis over the past three months has become even more convincing. But in the short term, demand-cycles always win out in commodity markets,” Mr. Hamilton said.
Shane Nagle, a Toronto-based metals and mining analyst at National Bank Financial, expects that the near-term outlook consists of a bad-case and worst-case scenario.
In a bad case, central banks raise interest rates to tackle inflation without creating a significant economic downturn – in other words, a stagflationary environment of prolonged slow growth and high inflation.
Here, copper prices could find support between US$3 and US$3.50 a pound.
In the worst-case scenario, inflation persists as rates rise, leading to an ugly recession at a time when labour negotiations could raise operating costs at copper mines. This could send copper sliding below US$2.50 a pound, and no doubt adding to the sell-off in stocks.
“None of this really changes the long-term picture,” Mr. Nagle said.
At a time when electrification should increase demand for copper, producers are facing greater obstacles to pursuing new projects because of challenging regulatory and environmental hurdles.
Companies have also become more cautious in allocating capital to new projects, potentially adding another obstacle to increased supply when demand ramps up again – and by most accounts, it will.
“We are heading in the right direction,” Mr. Nagle said.
“But when this type of volatility creeps into the market, investors get pretty short-sighted,” he added. “So they are not going to look at the favourable long-term picture in the midst of what could be a global recession.”
Dr. Copper is worried; investors in for the long haul shouldn’t be.
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David Berman