With rising geopolitical tensions, we have witnessed a rise in raw material prices, mostly both gas and oil. But on the other hand, there are certain raw materials such as copper that have suffered losses (35% YTD) so far this year. In today's post we are going to give you training in investing in raw materials to detect what has led to the losses of this precious metal and how to take advantage of the opportunities that arise.
Why has the price of copper fallen so much?臘♀️
A year ago, when factories resumed activity after a long pause caused by the pandemic, the price of copper reached its all-time highs. This year it has risen even more, as Russia's invasion of Ukraine added fuel to the inflation fire. But suddenly, the fall came... Without a doubt, the demand for copper has fallen along with the decline in global economic growth and future forecasts. This is because copper is a barometer of the health of the global economy (he is known by the nickname "copper doctor"). Lately, fears about recession have grown. But a 35% price drop, at first glance, seems a bit exaggerated.
One thing to know about copper is that it is susceptible to these unpredictable market movements. There are many reasons for this, but here are two key ones:
1. The elasticity of copper supply.
This exaggerated drop is due to the "elasticity of supply", that is, the flexibility with which copper producers react to changes in demand. In the short term, the answer is: not much. They tend to have difficulty adjusting production to increases or decreases in demand, which means that supply becomes “stuck” or “inelastic.” The point is that copper mining is an expensive process and has large costs associated with starting or stopping production. It is different from the extraction of a raw material like oil, for example, where sometimes it is enough to increase or decrease the flow rate of a well in the short term.
Growth in copper demand puts supply elasticity under strain in an accelerated energy transition. Source: Wood Mackenzie.
That inflexibility is positive for copper prices when demand increases faster than expected. But in a softening demand environment like the current one, it means there is more copper than is needed, and that is why prices fall.
2. Inelastic demand.♂️
On the other hand, we have demand, another factor to take into account within our training in investment in raw materials. For copper, demand is also inelastic. It's not just producers who are unable to adjust what they do on the fly. Buyers also find that their copper needs do not change solely based on what the metal costs. For consumers, deep discounts (e.g. 35%) on things like cars, clothes or even gold jewelry could boost demand. But for companies, such as home builders or car manufacturers, a drop in the price of copper will not affect demand. They only need a certain amount of copper pipes or electrical wiring. In other words, copper demand is influenced by factors other than price, with economic activity being the main driver.
Global copper production forecast from 2006 to 2026. Source: Mining Technology.
The result is a double inelasticity between demand and supply. In the short term, relatively small changes in demand arising from economic activity can cause excess supply in the market, which in turn can have a strong impact on the price, since even at discount prices can stimulate the purchase.
What is the future outlook for copper?
It is practically impossible to accurately predict the short-term price of raw materials. It is enough to review the investment training that we have given today to visualize positive prices in the near future for this raw material. This is not currently the case, as the global situation tells us that economic growth will be delayed for a long period of time. That's why, in the case of copper, it makes sense to tolerate the volatility and focus on the long term, where all the reasons to be excited about copper are as valid today as they were last year. There are two factors to highlight about the growth of this precious metal in the long term:
1. Demand will grow with decarbonisation.
Long-term copper demand will most likely be driven by major trends in renewable energy and electric vehicles. This will require much more copper production. Furthermore, with the challenges launched last year by Russia, Western governments are working with more urgency to reduce their dependence on fossil fuels.
Energy dependence of the countries of the European Union. Source: European Parliament.
2. The offer will take time to catch up.⏳
On the supply side, the elasticity argument is likely to hold for some time to come. In the very long term supply can, and probably will, grow to meet growing demand. But increasing supply takes time and, for now, producers don't seem to be in much of a hurry. In 2012, the last time the copper price experienced a China-led commodity boom, mining companies were busy meeting the gigantic demand of the commodities “supercycle.” The giant copper producers Freeport-McMoRan, Rio Tinto y BHP They collectively spent $42.000 billion in capital expenditures to grow supply, representing 30% of sales. Some great figures compared to the figures of 2021, where they invoiced 15.000 million dollars, a mediocre 10% of sales.
Comparison between Freeport-McMoRan, BHP and Rio Tinto. Source: Koyfin
If this “spending discipline” continues and long-term demand holds, copper is less likely to suffer from a large oversupply, and that is positive for its price. It is also good news for copper mining companies. This combination of a high copper price and corporate spending discipline should lead to a few years of strong free cash flow. Furthermore, mining stock prices have already fallen in line with the recent copper debacle. This fact reduces, at least partially, the risk assumed by investors, especially taking into account the aforementioned short-term unpredictability of raw material prices.
Are there any investment opportunities?
In the short term, and with the elasticity argument mentioned above, we can choose to go short with the WisdomTree Copper 1x Daily Short ETF (SCOP), especially if we expect a difficult time for global economic growth in the short term. But we must be careful, since if our strategy is based on the recent direction of the copper price, we face the same risks that caught copper bulls off guard: unpredictability.
Therefore, we must be careful about the unpredictability and volatility of the copper price in the short term. And above all, stay focused on the long-term opportunity, which remains attractive. What's more, we could consider taking advantage of any further drop in prices as an opportunity to buy shares of miners such as Freeport (FCX), Rio Tinto (RIO) and BHP. After this training in investment related to copper, we want to remind you that this market fluctuates differently from others. Therefore, we strongly recommend that you review our commodity investment training article to avoid making mistakes and operate efficiently.